Special Report: New IRS rules concerning the cash method of accounting, March 2001
The Internal Revenue Service has advised us that it has taken several significant
actions regarding the issue of when a business can use the cash method of accounting.
Previously, the IRS has argued that employers such as roofing contractors were in
the business of providing merchandise, and, therefore, had to use inventory accounts
and an accrual method of accounting.
In a letter addressed to NRCA, Joseph G. Kehoe, Commissioner of the IRS's Small
Business/Self-Employed Division, says, "We recognize that it is a burden for small
businesses to use inventory accounts and an accrual method and we have taken several
significant actions to reduce that burden."
Those actions include two that are important to roofing contractors:
First, the IRS published a revenue procedure that permits taxpayers that have average
annual gross receipts of $1 million or less to use the cash method of accounting.
This includes taxpayers "that provide goods in connection with their services."
Second, pending the issuance of future guidance, the IRS Chief Counsel issued a
notice that says the IRS "will not assert that taxpayers that provide goods in connection
with services are providing merchandise and, therefore, must use inventory accounts
and an accrual method of accounting. For example, this would apply to taxpayers
such as paving, painting, roofing, drywall or landscaping contractors."
Please note, however, that the Chief Counsel's notice goes on to say that this new
policy "does not apply to taxpayers that are resellers, manufacturers, or otherwise
required by section 448 to use an accrual method of accounting—e.g., a C corporation
with gross receipts of $5 million or more." We are seeking a clarification from
the IRS as to whether this policy would apply, for example, to a subchapter S corporation
with gross receipts in excess of $5 million, as it would appear.
The IRS also has recommended that a project intended to resolve this issue be placed
on the Service's Priority Guidance Plan for publication this year.
We urge our members to consult with their accountants and tax advisors concerning
these changes. Following is a copy of the letter we received from the IRS for your
information; copies of the relevant documentation are available to any member on
request.
March 16, 2001
Mr. William Good
National Roofing Contractors Association
10255 W. Higgins Road, Suite 600
Rosemont, IL 60018
Dear Mr. Good;
Knowing of your interest in being able to use the cash method of accounting, I want
to give you an update on several significant actions the Internal Revenue Service
(IRS) has taken regarding this issue,
As you know, there has been significant controversy over whether small businesses
that provide goods in connection with their services should be required to use inventory
accounts and an accrual method of accounting. In cases that involved emulsified
asphalt, concrete, and flooring contractors, and health-care providers that administered
chemotherapy drugs, the IRS argued that the taxpayers were in the business of providing
merchandise and, therefore, had to use inventory accounts and an accrual method,
The courts, however, disagreed and the IRS has listened. We recognize that it is
a burden for small businesses to use inventory accounts and an accrual method and
we have taken several significant actions to reduce that burden.
First, the IRS published a revenue procedure that permits taxpayers that have average
annual gross receipts of $1 million or less to use the cash method of accounting,
This includes taxpayers that provide goods in connection with their services. We
hope this change will make a difference to many small firms.
Second, the IRS has issued an action on decision (AOD) in response to the case that
involved health care providers who administered chemotherapy drugs. The AOD says
that the IRS now agrees that prescription drugs or similar items administered by
a health-care provider are not merchandise that could prevent the provider from
using the cash method of accounting. This AOD would also apply to veterinarians
who do not market pet care or other products to their customers. We know that this
decision is a relief for those in the health-care community.
Third, pending the issuance of future guidance, the IRS has changed its policies
in litigation and examination regarding use of the cash method of accounting. The
IRS Chief Counsel issued a notice that says the IRS will not assert that taxpayers
that provide goods in connection with services are providing merchandise and, therefore,
must use inventory accounts and an accrual method of accounting. For example, this
would apply to taxpayers such as paving, painting, roofing, drywall or landscaping
contractors. This does not apply, however, to taxpayers that are resellers or manufacturers.
Further, the Deputy Commissioner has directed that our examiners in the Small Business/Self-Employed,
Wage and Investment, and Large and Mid-Size Business Operating Divisions not propose
that taxpayers in similar types of businesses use inventory accounts and an accrual
method.
Finally, we have recommended that a project aimed at finally resolving this issue
be placed on the 2001 Priority Guidance Plan for publication this year.
I am personally pleased that we have taken these significant steps for our small
business partners and have enclosed copies of all the relevant guidance. I hope
that these are the first of many actions that the IRS can take to reduce the burden
on small businesses in meeting their tax obligations. This letter is hopefully,
the start of an improved relationship between you and the IRS. A relationship that
is marked by open, honest and frequent communication about issues affecting the
small business community.
Sincerely,
Joseph G. Kehoe
Commissioner
Small Business/Self-Employed Division