Proposed regulations for small business taxpayer exceptions clarify gross receipts test rules, definitions
The Tax Cuts and Jobs Act (TCJA) amended Internal Revenue Code (IRC) sections 263A, 448, 460, and 471, giving small businesses – with average annual gross receipts of $25 million or less (“small businesses” or “small taxpayers”) – the option to simplify their tax accounting methods. The $25 million gross receipts test is contained in Section 448(c) and is incorporated – by reference – into sections 263A, 460, and 471. The $25 million threshold is indexed for inflation and is currently $26 million. A tax shelter (as defined in Section 448) may not take advantage of the small taxpayer rules.
On July 29, 2020, the IRS published proposed regulations that provide rules interpreting Sections 263A, 448, 460, and 471 as amended by the TCJA. The rules relate to the application of the $25 million gross receipts test (including the aggregation rules) and to the definition of a “tax shelter” for purposes of Section 448.
The proposed regulations are over 100 pages and contain many detailed rules. The following is a summary of some of the provisions.
Section 448 – Limitations on use of cash method of accounting: The TCJA amended the Section 448(c) gross receipts test to permit a taxpayer to use the cash method of accounting if the taxpayer’s average annual gross receipts are $25 million or less (indexed for inflation). Section 448 and the regulations thereunder contain the rules relating to the $25 million gross receipts test (including the aggregation rules) as well as the definition of a “tax shelter” for purposes of Section 448. A tax shelter may not use the cash method of accounting regardless of whether it meets the $25 million gross receipts test.
The proposed regulations generally follow the existing rules contained in Temp Treas. Reg. Section 1.448-1T, but provide certain clarifications. The proposed Section 448 regulations contain rules relating to the aggregation of partnership gross receipts with the gross receipts of C corporation owners, and clarify the definition of “syndicate” for purposes of Section 448. The regulations clarify that for taxpayers other than partnerships and corporations, gross receipts from all trades or businesses are aggregated, but certain “inherently personal amounts” are not included in the calculation of gross receipts for purposes of the $25 million gross receipts test. This clarification applies to sections 263A, 448, 460, and 471.
Section 263A – Uniform Capitalization: The proposed regulations modify existing regulations to reflect the amendments made by TCJA. Specifically, they remove references to other pre-TCJA gross receipts tests and replace them with references to the $25 million gross receipts test contained in Section 448(c). For example, the regulations eliminate the references to the “small reseller” exception and change the certain dollar thresholds contained in the interest capitalization regulations (See Prop. Treas. Reg. 1.263A-7 through 9).
Section 460 – Requirement to use percentage of completion: The TCJA amended Section 460(e)(1)(B), to replace the $10 million gross receipts test in Section 460(e) with the $25 million gross receipts test contained in Section 448(c). The proposed regulations under Section 460 provide rules that relate to the application of the look-back rule when a company is subject to alternative minimum tax (AMT), as well as revisions to Treas. Reg. Section 1.460-6 to reflect the enactment of the base erosion anti-abuse tax (BEAT).
Section 471 – Requirement to account for inventories: The TCJA added new Section 471(c) to exempt small taxpayers from the requirement to account for inventories. How 471(c) applies varies based on whether the taxpayer decides to treat inventories as non-incidental materials and supplies, and whether the taxpayer has an applicable financial statement.
Under Section 471(c)(1)(B)(i), a taxpayer (other than a tax shelter) that meets the Section 448(c) gross receipts test can treat its inventory as non-incidental materials and supplies (“section 471(c) materials and supplies”).
Proposed Treas. Reg. Section 1.471-1(b)(4)(i) provides that the cost of inventory treated as Section 471(c) materials and supplies may not be deducted under the de minimis safe harbor election under Treas. Reg. Section 1.263(a)-1(f).
Proposed Treas. Reg. Section 1.471-1(b)(4)(ii) “permits taxpayers to determine the amount of their Section 471(c) materials and supplies by using either a specific identification method, a first-in, first-out (FIFO) method, or an average cost method, provided that the method is used consistently,” the proposed regulations say. “Taxpayers may not identify their inventory using a last-in, first-out (LIFO) method or value Section 471(c) materials and supplies using a lower-of-cost-or-market (LCM) method.”
The proposed regulations also provide guidance on the definition of “applicable financial statement” (AFS), the types and amounts of costs reflected in one that can be recovered under Section 471(c), and when such costs may be taken into account.
Effective date: While proposed regulations are not binding, taxpayers may rely on these proposed regulations for taxable years beginning after Dec. 31, 2017. Taxpayers may request accounting method changes to adopt the new small taxpayer rules contained in sections 263A, 448, 460, and 471 by filing a Form 3115 in accordance with Revenue Procedure 2019-43.
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