Automatic Change to Cash Method

Notice 2001-76 generally provides an automatic change in accounting method from the accrual to the cash method for eligible taxpayers. Eligible taxpayers must have average annual gross receipts of $10 million or less (calculated using a three-year moving average) and their principal activity cannot involve:

• Farming (which is subject to its own set of eligibility rules);
• Mining;
• Manufacturing (other than job-shop manufacturing, which generally is eligible);
• Wholesale trade;
• Retail trade; or
• Information industries (within the meaning of North American Industry Classification System codes 5111 and 5122).

Taxpayers with average annual gross receipts of $1 million or less may be eligible for the cash method under Rev. Proc 2001-10.

Important Exceptions

Even ineligible activities can qualify for the cash method if the principal business activity is service. For instance, a plumbing business that derives 60% of its gross revenue from the installation of plumbing products and 40% from the retail sale of plumbing products qualifies for the automatic change.

A company that has two or more business activities and keeps separate books and records for them may be eligible for an automatic change for the separate activities that do qualify under Notice 2001-76.

Computing the Eligibility Threshold

Taxpayers treated as a single employer under Sec. 52(a) or (b) can aggregate their income. Taxpayers in existence for fewer than three years compute their average gross income over the lesser period. Short tax years count as full years; taxpayers must count them in making the computation. Taxpayers include gross receipts of predecessors (as defined in Sec. 448(c)(3)(D)) in the gross-receipts test.

Taxpayers with inventory wanting to take advantage of Notice 2001-76 treat inventoriable items, incidental to providing services, as not incidental materials and supplies under Regs. Sec. 1.162-3. This regulation defers the deduction until the year in which the taxpayer consumes the materials in the business. Similarly, if the inventoriable items are more than incidental (such as the plumber mentioned), the cost is deductible only in the later of the year in which the taxpayer sells the item to a customer or the year in which he pays for the item. A qualified business can use any reasonable and consistent method (such as average costs, FIFO, etc.) to determine the amount of the deduction.

Effective Date

The effective date of Notice 2001-76 for calendar-year taxpayers is retroactive to the beginning of the current year. The notice is a proposed amendment to Rev. Proc. 99-49. It specifically provides, however, that taxpayers wanting to take advantage of its provisions may do so for the first tax year ending after Dec. 30, 2001. Rev. Proc. 99-49 would permit taxpayers to make this change any time before the extended due date of their return, in the first year in which the change becomes effective.

From Thomas P. Ochsenschlager, Washington, DC