New guidance affects gross receipts test for small businesses

| 12/23/2021
New guidance affects gross receipts test for small businesses

Taxpayers that meet the gross receipts test under IRC Section 448(c) are exempt from numerous unfavorable provisions of the code. A taxpayer meets the gross receipts test for any taxable year if its average annual gross receipts for the three-taxable-year period immediately preceding such taxable year does not exceed $25 million, indexed for inflation. Under aggregation rules, all persons treated as a single employer are treated as one person for purposes of applying this test. The IRS recently issued revenue procedures that potentially could affect whether a taxpayer meets the gross receipts test.

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Benefits of meeting the gross receipts test

A taxpayer that meets the gross receipts test in IRC Section 448(c) and that is not a tax shelter under IRC Section 448(d)(3) benefits from exemptions from certain unfavorable provisions of the code, including:

  • Exception from accrual method of accounting. Generally, under IRC Section 448(a), C corporations and partnerships that have a C corporation as a partner are prohibited from using the overall cash method of accounting. However, if this type of taxpayer meets the gross receipts test and is not a tax shelter, the taxpayer may use the cash method of accounting.
  • Exemption from business interest expense limitation under IRC Section 163(j). IRC Section 163(j) generally limits trade or business interest expense deductions to business interest income plus 30% of adjusted taxable income. However, a taxpayer that meets the gross receipts test and is not a tax shelter is exempt from the business interest expense limitation under Section 163(j).
  • Alternatives to inventory rules under IRC Section 471. IRC Section 471 generally requires taxpayers to maintain inventories that might require the capitalization of direct and indirect production costs. However, a taxpayer that meets the gross receipts test and that is not a tax shelter is exempt from the general inventory requirements under IRC Section 471 and instead may either treat its inventory as nonincidental materials and supplies or use the method of accounting for inventory that is reflected in the taxpayer’s applicable financial statement (AFS). If the taxpayer does not have an AFS, it may use the method used in its books and records. 
  • Exemption from uniform capitalization provisions under IRC Section 263A. IRC Section 263A generally requires taxpayers to capitalize additional direct and indirect costs allocable to the acquisition or production of inventory and the production of other property produced by the taxpayer. However, a taxpayer that meets the gross receipts test and is not a tax shelter is exempt from these requirements.
  • Alternatives to percentage of completion method under IRC Section 460 in certain cases. IRC Section 460 requires taxpayers to recognize taxable income from long-term contracts using the percentage of completion method. A taxpayer that meets the gross receipts test and is not a tax shelter is exempt from these requirements with respect to any construction contracts that the taxpayer estimates to be completed within the two-year period beginning on the contract commencement date. Instead, such a taxpayer may use the percentage of completion method, the exempt-contract percentage of completion method, the completed contract method, or any other permissible method to recognize taxable income from its exempt long-term construction contracts.

Recent guidance affecting gross receipts test

Revenue Procedure 2021-45 sets forth the annual inflation adjustments. Under the revenue procedure, the gross receipts threshold in IRC Section 448(c) increases from $26 million for taxable years beginning in 2021 to $27 million for taxable years beginning in 2022.

Although the gross receipts threshold is higher for 2022, recent guidance regarding the Paycheck Protection Program (PPP) could cause some taxpayers to exceed the threshold. The IRS issued Revenue Procedure 2021-48 to grant taxpayers flexibility in determining when tax-exempt income from the forgiveness of a PPP loan is considered received or accrued.

Under Revenue Procedure 2021-48, taxpayers may treat the tax-exempt income as received or accrued when any of the following occur:

  1. As the eligible expenses that give rise to the loan forgiveness are paid or incurred
  2. When an application for PPP loan forgiveness is filed
  3. When PPP loan forgiveness is granted

Taxpayers applying the guidance under Revenue Procedure 2021-48 may report tax-exempt income from PPP loan forgiveness on a timely filed original or amended federal income tax return, information return, or administrative adjustment request, as appropriate. The tax-exempt income must be included as additional gross receipts, which could cause a taxpayer to fail the gross receipts test for a certain tax year. 

The IRS also recently released Revenue Procedure 2022-09, which updates the automatic accounting method change guidance to provide procedures for taxpayers to comply with the final regulations under IRC Sections 263A, 448, 460, and 471. These regulations were published on Jan. 5, 2021, and generally apply to taxable years beginning on or after such date, although taxpayers may early adopt the regulations for taxable years beginning after Dec. 31, 2017, and before Jan. 5, 2021.

Looking ahead

During year-end planning, taxpayers should consider the timing for recognizing tax-exempt income from PPP loan forgiveness under Revenue Procedure 2021-48 and the impact that could have on whether a taxpayer can, or perhaps is no longer able to, take advantage of the favorable tax provisions afforded to small businesses. Taxpayers also should evaluate whether a method change is necessary to comply with the final regulations under IRC Sections 263A, 448, 460, and 471.

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