Smaller can be better - tax advantages for small businesses - For Your Tax File - column

Nation's Business, Jan, 1990 by Gerald W. Padwe

Smaller Can Be Better

In the daily struggle to keep a small business operating, it is often easy to lose track of how the tax code favors smaller enterprises. In this and next month's column, we will look at some of the "smaller is better" tax advantages.

For instance, consider something as important as your method of tax accounting. There are two basic systems: the accrual method and the cash method.

Under the accrual method, income and expenses are recorded in a year when "all events" have occurred to determine income or liability. Generally it does not matter when you are paid for what you sell; what matters is when the sale takes place.

Under the cash method, income is recorded when the cash is received, and deductions are recorded when expenses are paid. For most businesses, the cash basis can be invaluable. Not only is it simple and logical, but usually deductions come sooner than the income from the product or project that the expenses support. Deferring income and accelerating deductions is a basic tenet of tax-wise planning.

The 1986 Tax Reform Act wiped out the cash basis for all but three categories of taxpayer: small business (corporations, proprietorships, or partnerships with gross receipts of $5 million or less), farmers, and some personal-service organizations. However, a small business with inventories is required to continue using accrual accounting.

Another consideration for smaller firms is the last-in, first-out (LIFO) method of valuing inventory. The last-purchased, high-cost inventory is what is deducted from purchases in determining the cost of goods sold. Unfortunately, using LIFO can be complicated. Therefore, there are special rules under which small businesses with gross receipts of $5 million or less can elect a simplified method that makes LIFO much easier to use. For details, consult your tax accountant.