Cash or Accrual?

By: Brady Pipkin, CPA

Businesses with gross receipts under $1 million are eligible to elect to file tax returns on the cash basis of accounting. Most businesses with gross receipts between $1 and $10 million are eligible to file returns on a cash basis. Taxpayers who derive the largest part of their gross receipts from the following activities are not eligible to file cash basis tax returns.

• Mining activities

• Manufacturing

• Wholesale trades

• Retail trade

• Information industries such as newspapers, periodical books, database
publishers and sound recording industries

Why does this matter? By filing returns on the accrual basis of accounting (the other way to do it), taxpayers are taxed on receivables. Taxpayers are not able to deduct your prepaid expenses until they are actually expensed. The accrual method also allows taxpayers to deduct unpaid expenses (accounts payable and accrued liabilities) in the year the expenses are incurred. By switching to the cash basis of accounting for tax purposes, taxpayers can postpone the tax on receivables until collected and can deduct prepaid expenses when paid. The cash method also disallows deductions for unpaid expenses until those expenses are paid (i.e. you cannot deduct your expenses in accounts payable until you pay them).

Ultimately, the amount difference between the accrual and cash method comes down to the timing of when you will be taxed on income and allowed deductions for expenses. For many trucking companies, receivables are large, especially in today’s economy when customers are paying slower. By switching to the cash method for tax reporting, the tax on these receivables can be deferred until they are collected. In the year that taxpayers elect cash basis, it is typical to have a large adjustment that has a large decreasing effect on taxable income.

For a trucking company that has $350,000 in receivables and $100,000 in payables (and yes, we can still elect cash basis for 2008), the adjustment would result in a $250,000 decrease to taxable income in the first year. This adjustment usually results in substantial tax savings for the stockholders. If you assume a 25% tax rate (which is not unrealistic with both federal and state taxes) and that the company would still have income after the adjustment with no carryover losses from prior years, the tax savings would be $62,500.

As with any major tax election or change, you should consult with us or your tax advisor. If your tax advisor has not informed you that this election is available, you should consider switching (or at a minimum, get a second look at your tax returns). Failing to take advantage of the cash method can cost businesses a lot of money in taxes that are paid too early. In today’s economy, trucking companies need to defer the tax and use the savings to pay other bills.

If you would like to discuss the benefits of converting your company to the cash basis for income tax reporting, please contact Brady Pipkin, CPA at 501.753.9700.