Accounting Method Choice for Small Businesses

• In Event: Debits, Credits, and Taxes

Abstract

Section 448 allows small businesses the option of preparing their tax returns on an accrual or cash basis. Although accounting accruals may be more informative for decision-making, they also introduce complexity and higher compliance costs. In this paper we explore the reasons and consequences of accounting method choices following the expansion of Section 448 by the Tax Cuts and Jobs Act to larger businesses with average gross receipts below 25M. We find evidence that many firms in the pre-reform period that were ineligible for cash-basis returns continued to file on a cash basis and that many firms which were on an accrual basis switched to a cash basis, consistent with accrual accounting being costly for certain types of small businesses. We also find that these choices are often associated with capital structure factors like issuance of debt or raising equity.

Authors

• Nathan Born, US Department of the Treasury

• James Omartian, University of Michigan

• Lindsey Gallo, University of Michigan