By Milton Zall
April 2001 - Right before the 106th Congress adjourned, the House and Senate unanimously passed a bill to provide tax relief for small-business owners. The bill reverses sections of the 1999 Ticket to Work and Work Improvements Act, which prevented accrual-method taxpayers from using the installment method of accounting.
The new regulation permits businesses to use the installment plan when selling their assets, such as equipment, a part of the company, or the entire business. A small company that meets the $1 million-or-less revenue threshold can adopt the cash accounting method and sell its assets on the installment plan.
This strategy benefits entrepreneurs who sell a business and negotiate for the buyer to pay over time. If the buyer of the machinery or equipment agrees to pay the seller over, say, five years, then the seller can report the payments as they're received, gaining tax advantages during the five-year period.
The rule applies to the sale of any assets except those considered inventory. Thus, you can't use the installment method to report the sale of items for which you're a dealer.
Ways and Means Committee Chairman Bill Archer, a Republican from Texas, cited the measure as necessary in overturning a harmful tax provision that adversely affected 260,000 small-business owners.
"During the negotiations on the 1999 tax package, we were told this provision was a 'loophole closer,' that it was noncontroversial, that no one would be hurt," Mr. Archer says. "Months after the bill became law, however, we learned from the small-business community that this 'harmless loophole closer' would in fact hurt, and hurt significantly."
Small-business groups have complained that the 1999 repeal decreased the value of many closely held small businesses by up to 20 percent. U.S. Chamber of Commerce Executive Vice-President Bruce Josten heralded the reinstatement of the installment method as being a perfect congressional Christmas present to business owners. "Today's congressional action has saved small-business owners from the loss of billions of dollars in depressed sale prices for their businesses," he reported.
Ways and Means Committee member Wally Herger, a Republican from California, noted that passage of the bill before the end of the congressional session could save many small businesses from getting stuck with monstrous tax bills.
"This legislation, which is retroactive to the time of the tax change last December, will ensure that small business owners who find themselves facing a large tax burden as a result of an installment sale will receive tax relief before having to file their tax returns next year," according to Mr. Herger.
Related developments will make it easier for some small-business owners to use the cash accounting method. Under the cash method, income and expenses appear on the books when they are received, as opposed to the accrual method, in which they appear when earned or incurred, even if no cash changes hand.
Last year, the Internal Revenue Service (IRS) announced that firms grossing an average of $1 million or less in the past three years that were on the accrual method could switch to the cash method. But the switch was permitted only for businesses that kept their books on the cash method.
Usually, keeping your books on the accrual accounting method gives you more reliable information on how your business is performing, so it makes a lot of sense to set up your accounting that way.
Recently, the IRS changed its position by dropping the cash method conformity requirement. The agency now says it will permit use of the cash method even if a company's books and records are on accrual method, as long as the company grossed $1 million or less in average revenue over the past three years.
You should consult your accountant or tax adviser to determine whether you would have a lower tax bill using the cash method of accounting. If cash accounting provides better results, you can switch to the cash method of accounting for the 2000 tax year. If you have already filed your 2000 return using the accrual method, you can still file an amended return using the cash accounting method.
Milton Zall is a free-lance writer specializing in taxes and investment. He is a Certified Internal Auditor and a Registered Investment Advisor.
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