Ins and outs of cash accounting explained
February 08, 2019
In August 2018, the Internal Revenue Service issued guidance
on the change in tax law that allows small business taxpayers with average annual gross receipts of $25 million or less in the prior three-year period to use the cash method of accounting.
In 2017 the ADA successfully advocated to ensure the dental profession benefits from the Tax Cuts and Jobs Act — the first major rewrite of the U.S. tax code in more than 30 years. With the 2018 filing deadline approaching, the ADA News is featuring a series of articles focusing on how the new law will affect dentists beyond the revised standard deductions. The first article
in the series ran Dec. 10, 2018, and discussed the Student Loan Interest Deduction. The second article ran Jan. 21 on 179 expensing
ADA News talked with Allen M. Schiff, a certified public accountant and president of the Academy of Dental CPAs, to see what dentists need to know about cash accounting. Mr. Schiff is the president of the academy, which is made up of 24 dental CPA firms representing more than 9,000 dental practices.
What is the difference between the cash method and accrual method of accounting?
This is a great question. Many dentists may not be aware of the distinction of the two. With the accrual basis of accounting, the taxpayer pays taxes on their production, whereas with the cash basis of accounting the taxpayer pays taxes on the monies collected for professional services rendered. Operating expenses are recognized when incurred with the accrual basis whereas with the cash basis of accounting, operating expenses are recognized when paid.
What types of dental practices are likely to use the cash method of accounting?
Most, if not all, dental practices should be filing their income tax returns on the cash basis of accounting. Why? The reason is, for you as a dentist who produces dentistry each and every day along with your hygiene department, do not want to pay income taxes on your production — accounts receivable, not collected. This is because you just may not collect all of your income you produced, so, why pay income taxes on monies not received? This is why a dentist may choose to file their annual income taxes using the cash basis of accounting.
In all of my years of accounting, I have only seen a handful of dentists filing their income taxes using the accrual basis of accounting as opposed to the cash basis of accounting. Please be sure to meet with your dental CPA to gain confirmation of the method of accounting you are using to file your taxes.
How might it benefit a dental practice to use the cash method of accounting?
The largest tax benefit of using the cash basis of accounting, from a tax perspective, is that the taxpayer (dentist) does not pay income taxes on monies until they are received versus when they were produced. The advantage of this is the taxpayer – although obligated to pay income taxes on the monies received — has, in fact, the monies received to pay the income tax liability, since the monies are in hand when the tax liability was incurred. As mentioned above, if the taxpayer filed their income taxes on the accrual basis of accounting, the taxpayer would then pay income taxes on their production and not the collections of the dental practice.
Are there any other considerations?
Mr. Schiff: There are two exceptions to the cash basis of accounting as it relates to the recognition of operating expenses. Here are the two exceptions assuming your tax year end was Dec. 31, 2018:
- Credit card charges. If the practice uses a credit card to obligate itself for various tax-deductible operating expenses such as dental supplies, lab fees, dues, subscriptions, professional fees, auto expenses, etc., then these expenses are tax deductible as long as they incurred before the end of 2018. For example, let's assume you purchased dental supplies on or before Dec. 31, 2018. As long as the credit card charge is posted on the statement on or before Dec. 31, 2018, you are entitled to the tax deduction, even though if you have not paid the charge off. If the credit card charge posts to your credit card statement on Jan. 2, 2019, you are not entitled to the deduction and will have to wait until filing in 2019 for that particular item.
- Retirement plan contributions. If you have a qualified retirement plan (defined contribution or defined benefit such as a simplified employee pension, SIMPLE Individual Retirement Trust Account, 401k, profit sharing, pension plan and or a cash balance plan), you can take the 2018 tax deduction in 2018 even though you may not pay for the contribution until Sept. 15, 2019 — the corporations and partnerships tax filing deadline) or Oct.15, 2019, (sole proprietorship filing deadline). This exception applies both to cash basis and accrual basis of accounting.
With the example mention above as it relates to retirement plan contributions, the tax due date for such payment would be either March 15, 2019, or April 15, 2019. There are exceptions. If you are incorporated or taxed as a partnership, your dental CPA could file an automatic six-month extension and extend the March 15 due date until Sept. 15 each year. The same is true with the April 15 due date which could be extended six months to Oct. 15 each year. This would be for dental practices filing as a sole proprietorship or a single member a limited liability corporation.
The information in this piece is not intended to be, nor should it be construed as, tax, accounting or legal advice. Readers are urged to consult a qualified professional when seeking such advice. The ADA makes no endorsement of the above advice, nor of any website or organization mentioned in the above piece.