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A taxpayer, Form 1040 Schedule C, is on the cash basis. The…

A taxpayer, Form 1040 Schedule...
A taxpayer, Form 1040 Schedule C, is on the cash basis. The average revenue for the last 5 years is $5,100,000. There is no inventory. The NAICS is 423600Can he remain on the cash basis?
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Answered in 10 minutes by:
8/15/2017
Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 13,473
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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For sole proprietors, S corporations, limited liability companies and partnerships:

  • The cash method is always allowed if the entity meets the $1 million average revenue test.
  • The entity test does not apply.
  • The cash method is allowed if the company has more than $1 million in sales and meets the service business test.
  • The accrual method is required if the entity fails both the $1 million average revenue and the material income-producing factor tests.

...

The $5MM revenue issue regard C-Corps. C corporations (other than farms) must use the accrual method if they have average annual gross receipts for the previous three tax years of more than $5 million [IRC section 448(b)(3)]. The accrual method is also required for tax shelters [IRC section 448(a)(3)], and for general partnerships failing the $5 million test that have a C corporation as a partner (section 448(a)(2)).

...

Your statement about inventory goes to the "material income-producing factor tests." (generally, companies that sell merchandise)

...

From the information you've provided, he can remain on the cash basis.

...

(You might find the attached flow chart helpful)

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Please let me know if you have ANY questions at all, before rating me.

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Lane

I hold a law degree (J.D.), with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice on three continents since 1986

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Customer reply replied 6 months ago
At what point would he have to change to accrual?
Customer reply replied 6 months ago
Hello?

What does this business do, and is this a sole proprietor or a single member LLC?

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Customer reply replied 6 months ago
Sole proprietor
Customer reply replied 6 months ago
Installs light fixtures as a contractor

As a service business, I don't think he'll ever have to... There WAS some proposed legislation back in 2015 that would require service businesses to change to accrual at $10MM. Not sure if it passed. let me check

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Customer reply replied 6 months ago
ok, there is also a separate LLC for Horse Racing, cash basis as well

As long as a single member, an no S- or C-Corp taxation election, still a disregarded entity (taxed as a sole proprietor)

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Qualifying small business taxpayer exception under Revenue Procedure 2002-28.

A qualifying small business taxpayer is any taxpayer with average annual gross receipts of $10,000,000 or less that is not prohibited from using the cash method under section 448 (see below - Prohibited Principal Activities Under Revenue Procedure 2002-28).

...

This cash method safe harbor applies to service businesses, custom manufacturrers, and any other taxpayer whose pricipal activity is not specifically ineligible under Revenue Procedure 2002-28 (see prohibited activities below).

...

Prohibited Principal Activities Under Revenue Procedure 2002-28

Ineligible Activities:

  • Retail sales
  • Wholesale sales
  • Manufacturing (other than eligible custom manufacturing)
  • Publishing
  • Sound recording
  • Mining
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Customer reply replied 6 months ago
if $10,000,000 or over reveue no safe harbor and has to use a accrual? Is that right?

As of right now there has been no enforcement for purely service businesses.

...

In the spring of 2013, then Chairman Camp released his original draft tax reform bill known as the “Tax Reform Act of 2013,” which included many provisions such as the accrual accounting requirements contained in Section 212 of the legislation... which would require the switch to accrual at $10 million of receipts for service businesses.

...

In February 2016, Speaker Ryan created a new House Tax Reform Task Force chaired by House Ways & Means Committee Chairman Brady to develop a new tax reform plan based on several key principles including tax simplification, closing loopholes, lowering rates, and encouraging the growth of small businesses. The House tax reform plan, known informally as the “Blueprint,” was released in June 2016 and included several major proposals such as lower corporate and individual tax rates, a new 25% tax rate for small pass-through businesses, and full expensing. To pay for these tax reductions, committee members and staff continue to examine other possible changes to the tax code, including the previous mandatory accrual accounting proposals.

...

To address this continuing threat, the ABA sent a new letter to the House Ways and Means Subcommittee on Tax Policy on April 13, 2016 in connection with its hearing on "Fundamental Tax Reform Proposals." The ABA also sent similar letters to the full House Ways and Means Committee and the Senate Finance Committee in April 2017.

...

Although the Trump Administration has not taken a formal position on the mandatory accrual accounting proposals, there is still a significant risk that the proposals could be included in the new comprehensive tax reform legislation that is now being developed in the new 115th Congress

...

but as of today, the switch to accrual for a purely services based business is still only a threat.

Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 13,473
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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