How the Cash Accounting Method Can Optimize Tax Savings
Numerous funding programs issued in 2020 have provided independent pharmacies with the opportunity to optimize cash flow and tax savings. After many pharmacies received Paycheck Protection Program (PPP) relief loans, Small Business Administration (SBA) debt relief and Economic Injury Disaster Loan (EIDL) support, pharmacies ended the year with many opportunities for tax savings. For pharmacies facing a tax liability when filing this year, there may still be time to file using the cash accounting method. It is one more tool to manage tax impacts through 2025.
Cash Accounting Method
The Tax Cuts and Jobs Act of 2017 allows pharmacies to report, for tax purposes, on the cash method of accounting instead of the accrual method beginning in years after December 31, 2017. Many pharmacies already take advantage of this accounting method to optimize tax savings, but at Sykes & Company we continue to see pharmacies that have not yet taken advantage of this tax strategy.
This method of accounting differs from the accrual method in a few key ways.
Reporting Income and Expenses. Income accounts, such as accounts receivable from third parties, are not included in income until constructively received. Additionally, expenses are deducted when paid instead of accrued. The switch to the cash accounting method will often result in a write-off or expense which lowers taxable income and tax liability.
Inventory. Inventory is excluded and should not be a component when following the cash accounting method. Inventory must remain on the books, however, for book and tax purposes. The IRS has recently provided clarification as to how inventory should be reported in this method of accounting. Talk with an advisor at Sykes & Company if you have written off inventory in prior years to correct and return to compliance with the law. Income, in compliance with the law, that is added back from reporting inventory can be spread out over four years, lowering your tax burden.
Qualifications to Use the Cash Accounting Method
Pharmacies that qualify for the cash accounting method have average annual gross receipts that exceed $26 million for the prior three-year reporting periods. Gross receipts of related entities and those pharmacies under common ownership must aggregate their gross receipts to determine the gross receipts test. This would include controlled groups with more than 50% common control and affiliated service groups.
Connect with a pharmacy CPA if you own multiple pharmacies to ensure you take advantage of this accounting method.
Planning for the Accounting Change
Plan ahead with your advisor before making this accounting change. This is not a strategy that can be implemented automatically, as numerous other factors need to be considered. It’s important to remember that it is still best practice to keep your books and financial statements on the accrual method of accounting for the most accurate financial data when managing cash flow.
How We Can Help
Paying taxes is one of the largest expenses you’ll pay as an independent pharmacy owner. Optimize your taxes by taking advantage of the opportunities the law provides. If you haven’t already, consider the cash method of accounting. These rules are set to expire in 2025. Connect with our team of pharmacy advisors to plan and determine what accounting method best meets your needs and benefits your pharmacy in the long run.
Source: This article originally appeared in the March 2021 issue of Drug Topics and in Total Pharmacy on March 11, 2021.