Congress, Tax Court crimp use of case method for tax accounting
Cash accounting is nice and simple: Count the money as it comes in and as it goes out. If the first number is higher than the second at the end of the year, pay income tax on the difference.
The alternative, accrual accounting, requires sometimes confusing judgments as to when revenue must be counted and expenses deducted. For many small businesses, the rules seem to mean income must be declared for tax purposes before all the cash has come in, and expenses cannot be deducted even though the firm has paid at least part of the bill.
For more and more small businesses, including trucking companies, life is getting more complicated. As part of the 1986 tax reform, Congress restricted the cash method to companies with revenues under $5 million and no inventories. Last year, Congress took another whack at this method by forcing companies to declare the full value of an installment sale as having been realized in the year of sale, instead of spreading out the taxes to match the timing of the payments.
Recently the U.S. Tax Court sided with the IRS in a case that further limits eligibility for the cash method. Although the carrier was in a specialized niche, the result could well apply to other types of fleets as well.
Von Euw and L.J. Nunes Trucking carried sand and gravel from suppliers to construction sites. Some customers bought the materials themselves and hired Von Euw to haul it. Others relied on Von Euw to buy the sand and gravel and deliver it to job sites the same day.
In either case, the carrier held no inventory on its premises overnight; it either delivered the customer's materials from the supplier or bought the materials and delivered them immediately to the customer. The company took the position that it never held inventories and therefore could use the cash method.
But the IRS argued that because Von Euw bought and sold materials, it had inventories of materials for sale, even if they were sold the same day. The dispute reached the Tax Court, which decided in favor of the IRS.
The judge reasoned that Von Euw was primarily in the business of selling a product for which it also provided delivery. Although he was not asked to rule on the proper tax treatment if Von Euw had primarily hauled sand and gravel that it did not take title to, the outcome may well have been different.
Neither the change in law nor the Tax Court ruling are necessarily the last word. Recently, the Treasury Dept. allowed sales of businesses with gross receipts below $1 million to continue being reported under the installment sales method. At the same time, Treasury said it was up to Congress to go further if it wanted to repeal the unpopular new law. Whether Congress will pass any tax changes this year that become law under President Clinton's signature remains to be seen. Changing the law over his veto is even less likely, given the close split between the parties in both houses of Congress.
The Tax Court decision was one judge's ruling, which has not been reviewed by either the full Tax Court or an appellate court. Nevertheless, his conclusion that construction and paving materials are merchandise is consistent with other IRS rulings, some of which even favor the taxpayer.
The bottom line: Small carriers that think they are secure in using the cash method of accounting should double check. If they purchase the goods they deliver, they may find they're acquiring inventory that can cause them tax trouble even if they dispose of it the same day. They may also find they face an unexpectedly large tax bill if they sell the company.