[Congressional Record Volume 147, Number 21 (Wednesday, February 14, 2001)]
[Senate]
[Pages S1420-S1422]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. BOND:
  S. 336. A bill to amend the Internal Revenue Code of 1986 to allow 
use of cash accounting method for certain small businesses; to the 
Committee on Finance.
  Mr. BOND. Mr. President, I rise today to introduce a bill that 
addresses an issue of growing concern to small businesses across the 
nation--tax accounting methods. I am pleased to be working with our 
colleague in the other body, Congressman Wally Herger, who is 
introducing the companion to this legislation.
  While this topic may lack the notoriety of some other tax issues 
currently in the spotlight like tax-rate reductions, estate-tax repeal, 
or elimination of the alternative minimum tax, it goes to the heart of 
a business' daily operations--reflecting its income and expenses. And 
because it is such a fundamental issue, one may ask: ``What's the big 
deal? Hasn't this been settled long ago?'' Regrettably, efforts by the 
Treasury Department and Internal Revenue Service (IRS) over the past 
couple of years have muddied what many small business owners have long 
seen as a settled issue.
  To many small business owners, tax accounting simply means that they 
record gross receipts when they receive cash and expenses when they 
write a check for the various costs associated with operating a 
business. The difference is income, which is subject to taxes. In its 
simplest form, this is known as the ``cash receipts and disbursements'' 
method of accounting--or the ``cash method'' for short. It is easy to 
understand, it is simple to undertake in daily business operations, and 
for the vast majority of small enterprises, it matches their income 
with the related expenses in a given year. Coincidentally, it's also 
the method of accounting used by the Federal government to keep track 
of the nearly $2 trillion in tax revenues it collects each year as well 
as all of its expenditures for salaries and expenses, procurement, and 
the cost of various government programs.
  Unfortunately, what's good for the Federal government apparently is 
not good enough for small businesses. In recent years, the IRS has 
taken a different view with respect to small businesses on the cash 
method. In too many cases, the IRS has asserted that a small business 
should report its income when all events have occurred to establish the 
business' right to receipt and the amount can reasonably be determined. 
Similar principles are applied to determine when a business may 
recognize an expense. This method of accounting is known as ``accrual 
accounting.'' The reality of accrual accounting for a small business is 
that it may be deemed to have income well before the cash is actually 
received and an expense long after the cash is actually paid. As a 
result, accrual accounting can create taxable income for a small 
business that has yet to receive the cash necessary to pay the taxes.
  While the IRS argues that the accrual method of accounting produces a 
more accurate reflection of ``economic income,'' it also produces a 
major headache for small enterprise. Few entrepreneurs have the time or 
experience to undertake accrual accounting, which forces them to hire 
costly accountants and tax preparers. By some estimates, accounting 
fees can increase as much as 50 percent when accrual accounting is 
required, excluding the cost of high-tech computerized accounting 
systems that some businesses must install. For the brave few that try 
to handle the accounting on their own, the accrual method often leads 
to major mistakes, resulting in tax audits and additional costs for 
professional help to sort the whole mess out--not to mention the 
interest and penalties that the IRS may impose as a result of the 
mistake.
  To make matters even worse, the IRS focused on small service 
providers who use some merchandise in the performance of their service. 
In an e-mail sent to practitioners in my State of Missouri and in 
Kansas on March 22, 1999, the IRS'' local district office took special 
aim at the construction industry asserting that ``[t]axpayers in the 
construction industry who are on the cash method of accounting may be 
using an improper method. The cash method is permissible only if 
materials are not an income producing factor.'' For those lucky service 
providers, the IRS has asserted that the use of merchandise requires 
the business to undertake an additional and even more onerous form of 
bookkeeping--inventory accounting.
  Let's be clear about the kind of taxpayer at issue here. It's the 
home builder who by necessity must purchase wood, nails, dry wall, and 
host of other items to provide the service of constructing a house. 
Similarly, it's a painting contractor who will often purchase the paint 
when he renders the

[[Page S1421]]

service of painting the interior of a house. These service providers 
generally purchase materials to undertake a specific project and at its 
end, little or no merchandise remains. They may even arrange for the 
products to be delivered directly to their client.
  Mr. President, if we thought that accrual accounting is complicated 
and burdensome, imaging having to keep track of all the boards, nails, 
and paint used in the home builder's and painter's jobs each year. And 
it doesn't always stop at inventory accounting for these service 
providers. Instead, the IRS has used it as the first step to imposing 
overall accrual accounting--a one-two punch for the small service 
provider when it comes to compliance burdens.
  Even more troubling is the cost of an audit for these unsuspecting 
service providers who have never known they were required to use 
inventories or accrual accounting. According to a survey of 
practitioners by the Padgett Business Services Foundation, audits of 
businesses on the issue of merchandise used in the performance of 
services resulted in tax deficiencies from $2,000 to $14,000, with an 
average of $7,200. That's a steep price to pay for an accounting method 
error that the IRS for years has never enforced.
  The bill I'm introducing today--the Cash Accounting for Small 
Business Act of 2001--addresses both of these issues and builds on the 
legislation that I introduced in the 106th Congress. First, the bill 
establishes a clear threshold for when small businesses may use the 
cash method of accounting. Simply put, if a business has an average of 
$5 million in annual gross receipts or less during the preceding three 
years, it may use the cash method. Plain and simple--no complicated 
formula; no guessing if you made the right assumptions and arrived at 
the right answer. If the business exceeds the threshold, it may still 
seek to establish, as under current law, that the cash method clearly 
reflects its income.
  Some may argue that this provision is unnecessary because section 
448(b) and (c) of the Internal Revenue Code already provide a $5 
million gross receipts test with respect to accrual accounting. That's 
a reasonable position since many in Congress back in 1986 intended 
section 448 to provide relief for small business taxpayers using the 
cash method. Unfortunately, the IRS has twisted this section to support 
its quest to force as many small businesses as possible into costly 
accrual accounting. The IRS has construed section 448 to be merely a $5 
million ceiling above which a business can never use the cash method. 
My bill corrects this misinterpretation once and for all--if a business 
has average gross receipts of $5 million or less, it is free to use 
cash accounting.
  Additionally, the bill indexes the $5 million threshold for inflation 
so it will keep pace with price increases. As a result, small 
businesses will not be forced into the accrual method merely because 
their gross receipts increased due to inflation.
  Second, for small service providers, the Cash Accounting for Small 
Business Act exempts these taxpayers from inventory accounting if they 
meet the general $5 million threshold. These businesses will be able to 
deduct the expenses for such inventory that are actually consumed and 
used in the operation of the business during that particular taxable 
year. While the small service provider will still have to keep some 
minimal records as to the merchandise used during the year, it will be 
vastly more simple than having to comply with the onerous inventory 
accounting rules currently in place in the tax code.
  The $5 million threshold set forth in my bill is a common-sense 
solution to an increasing burden for small businesses in this country, 
which was recently highlighted by the IRS National Taxpayer Advocate. 
In his 2001 Report to Congress, the Advocate noted that ``Small 
business taxpayers may be burdened by having to maintain an accrual 
method of accounting for no other purpose than tax reporting. Because 
these taxpayers can be relatively unsophisticated about tax and 
inventory accounting issues, they are likely to hire advisors to help 
them comply with their tax obligations.'' Unfortunately, these higher 
costs of recordkeeping and tax preparation take valuable capital away 
from the business and hinder its ability to grow and produce jobs. The 
Cash Accounting for Small Business Act takes a big step toward easing 
those burdens and allowing small business owners to dedicate their time 
and money to running successful enterprises--instead of filling out 
government paperwork.
  In addition, it sends a clear signal to the IRS: stop wasting scarce 
resources forcing small businesses to adopt complex and costly 
accounting methods when the benefit to the Treasury is simply a matter 
of timing. Whether a small business uses the cash or accrual method or 
inventory accounting or not, in the end, the government will still 
collect the same amount of taxes--maybe not all this year, but very 
likely early in the next year. What small business can go very long 
without collecting what it is owed or paying its bills?
  Last year, the Treasury Department's answer was to propose a $1 
million threshold under which a small business could escape accrual 
accounting and presumably inventories. While it is a step in the right 
direction, it simply doesn't go far enough. Even ignoring inflation, if 
a million dollar threshold were sufficient, why would Congress have 
tried to enact a $5 million threshold 14 years ago? My bill completes 
the job that the Clinton Treasury Department was unable or unwilling to 
do.
  More recently, the IRS issued a notice announcing that the agency has 
temporarily changed its litigation position concerning the requirement 
that certain taxpayers must use inventory and accrual accounting. Based 
on losses in several court cases, the IRS has decided to back off on 
taxpayers in construction businesses similar to those addressed by the 
courts. For those taxpayers, the agency has turned down the fire, and I 
applaud the IRS for its decision. The new litigation position, however, 
does not solve the underlying statutory issues that led the IRS to 
pursue these taxpayers in the first place, nor is it any assurance that 
the litigation position will not be changed again once the IRS'' Chief 
Counsel has completed its study of these issues. The Cash Accounting 
for Small Businesses resolves this matter once and for all small 
businesses giving them clear rules and certainty as they struggle to 
keep their businesses running.
  The legislation I introduce today is the companion to the bill that 
Congressman Herger is introducing in the other body. Together with 
Congressman Herger and the small business community, I expect to 
continue the momentum that we started last year and achieve some much 
needed relief from unnecessary compliance burdens and costs for 
America's small businesses.
  The call for tax simplification has been growing increasingly loud in 
recent years, and this bill provides an excellent opportunity for us to 
advance the ball well down the field. This is not a partisan issue; 
it's a small business issue. And I urge my colleagues on both sides of 
the aisle to join me in this common-sense legislation for the benefit 
of America's small enterprises, which contribute so greatly to this 
country's economic engine.
  Mr. President, I ask unanimous consent to have printed in the Record, 
the text of the bill and a description of its provisions.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

                                 S. 336

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Cash Accounting for Small 
     Business Act of 2001''.

     SEC. 2. CLARIFICATION OF CASH ACCOUNTING RULES FOR SMALL 
                   BUSINESS.

       (a) Cash Accounting Permitted.--Section 446 of the Internal 
     Revenue Code of 1986 (relating to general rule for methods of 
     accounting) is amended by adding at the end the following new 
     subsection:
       ``(g) Small Business Taxpayers Permitted to Use Cash 
     Accounting Method Without Limitation.--
       ``(1) In general.--Notwithstanding any other provision of 
     this title, an eligible taxpayer shall not be required to use 
     an accrual method of accounting for any taxable year.
       ``(2) Eligible taxpayer.--For purposes of this subsection--
       ``(A) In general.--A taxpayer is an eligible taxpayer with 
     respect to any taxable year if--

[[Page S1422]]

       ``(i) for all prior taxable years beginning after December 
     31, 1999, the taxpayer (or any predecessor) met the gross 
     receipts test of subparagraph (B), and
       ``(ii) the taxpayer is not a tax shelter (as defined in 
     section 448(d)(3)).
       ``(B) Gross receipts test.--A taxpayer meets the gross 
     receipts test of this subparagraph for any prior taxable year 
     if the average annual gross receipts of the taxpayer (or any 
     predecessor) for the 3-taxable-year period ending with such 
     prior taxable year does not exceed $5,000,000. The rules of 
     paragraphs (2) and (3) of section 448(c) shall apply for 
     purposes of the preceding sentence.
       ``(C) Inflation adjustment.--In the case of any taxable 
     year beginning in a calendar year after 2001, the dollar 
     amount contained in subparagraph (B) shall be increased by an 
     amount equal to--
       ``(i) such dollar amount, multiplied by
       ``(ii) the cost-of-living adjustment determined under 
     section 1(f)(3) for the calendar year in which the taxable 
     year begins, by substituting ``calendar year 2000'' for 
     ``calendar year 1992'' in subparagraph (B) thereof.

     If any amount as adjusted under this subparagraph is not a 
     multiple of $100,000, such amount shall be rounded to the 
     nearest multiple of $100,000.''.
       (b) Clarification of Inventory Rules for Small Business.--
     Section 471 of the Internal Revenue Code of 1986 (relating to 
     general rule for inventories) is amended by redesignating 
     subsection (c) as subsection (d) and by inserting after 
     subsection (b) the following new subsection:
       ``(c) Small Business Taxpayers Not Required to Use 
     Inventories.--
       ``(1) In general.--An eligible taxpayer shall not be 
     required to use inventories under this section for a taxable 
     year.
       ``(2) Treatment of taxpayers not using inventories.--If an 
     eligible taxpayer does not use inventories with respect to 
     any property for any taxable year beginning after December 
     31, 2000, such property shall be treated as a material or 
     supply which is not incidental.
       ``(3) Eligible taxpayer.--For purposes of this subsection, 
     the term `eligible taxpayer' has the meaning given such term 
     by section 446(g)(2).''.
       (c) Indexing of Gross Receipts Test.--Section 448(c) of the 
     Internal Revenue Code of 1986 (relating to $5,000,000 gross 
     receipts test) is amended by adding at the end the following 
     new paragraph:
       ``(4) Inflation adjustment.--In the case of any taxable 
     year beginning in a calendar year after 2001, the dollar 
     amount contained in paragraph (1) shall be increased by an 
     amount equal to--
       ``(A) such dollar amount, multiplied by
       ``(B) the cost-of-living adjustment determined under 
     section 1(f)(3) for the calendar year in which the taxable 
     year begins, by substituting ``calendar year 2000'' for 
     ``calendar year 1992'' in subparagraph (B) thereof.

     If any amount as adjusted under this paragraph is not a 
     multiple of $100,000, such amount shall be rounded to the 
     nearest multiple of $100,000.''.
       (d) Effective Date and Special Rules.--
       (1) In general.--The amendments made by this section shall 
     apply to taxable years beginning after December 31, 2000.
       (2) Change in method of accounting.--In the case of any 
     taxpayer changing the taxpayer's method of accounting for any 
     taxable year under the amendments made by this section--
       (A) such change shall be treated as initiated by the 
     taxpayer;
       (B) such change shall be treated as made with the consent 
     of the Secretary of the Treasury; and
       (C) the net amount of the adjustments required to be taken 
     into account by the taxpayer under section 481 of the 
     Internal Revenue Code of 1986 shall be taken into account 
     over a period (not greater than 4 taxable years) beginning 
     with such taxable year.
                                  ____


    Cash Accounting for Small Business Act of 2001--Description of 
                               Provisions

       The bill amends section 446 of the Internal revenue Code to 
     provide a clear threshold for small businesses to use the 
     cash receipts and disbursements method of accounting, instead 
     of accrual accounting. To qualify, the business must have $5 
     million or less in average annual gross receipts based on the 
     preceding three years. Thus, even if the production, 
     purchase, or sale of merchandise is an income-producing 
     factor in the taxpayer's business, the taxpayer will not be 
     required to use an accrual method of accounting if the 
     taxpayer meets the average annual gross receipts test.
       In addition, the bill provides that a taxpayer meeting the 
     average annual gross receipts test is not required to account 
     for inventories under section 471. The taxpayer will be 
     required to treat such inventory in the same manner as 
     materials or supplies that are not incidental. Accordingly, 
     the taxpayer may deduct the expenses for such inventory that 
     are actually consumed and used in the operation of the 
     business during that particular taxable year.
       The bill indexes the $5 million average annual gross 
     receipts threshold for inflation. The cash-accounting safe 
     harbor will be effective for taxable years beginning after 
     December 31, 2000.
                                 ______