NEW YORK (CNNfn) - The Internal Revenue Service, in a move that is likely to stun small business owners, will release a new set of guidelines next week that will force many small businesses to change their methods of accounting.|
Under the new rules, businesses with revenue of between $1 million and $5 million may have to use an accrual method of accounting. Previously, under IRS rules, only businesses with more than $5 million in revenue had to use the complicated accrual method of reporting income to the IRS.
Small business advocates object to the change because accrual methods are much more complex than cash accounting, which, like personal tax reporting, is a straightforward report of money earned and spent in the course of a year.
"We feel it's an undue burden on small business," said Jim Hirni, legislative affairs manager for National Federation of Independent Business. "They are absolutely going to have to hire someone to do their taxes if they use the accrual method because it is too complicated. What small business owner is going to go through and read the 7 million words and 703 tax forms in the income tax laws and regulations to do this themselves?"
To cash or to accrue
Accrual accounting is a complex formula of projected earnings. For example, a business may complete a $100,000 project or sale in one year, but only receive $10,000 of the total amount it is owed. The rest may be paid in increments over several years. Using cash accounting, the business owner has to report only the amount received -- $10,000. Under accrual accounting, the business owner will have to report, and pay tax on, $100,000.
So, although the change in accounting will not force business owners to pay any additional taxes, they will have to pay them sooner. Hirni said small business owners who convert to accrual accounting will have to hire accountants. Small business owners who take in between $1 million and $5 million a year, don't convert, and are later audited could face severe penalties.
Change can be costly
Shane Mieras, owner of Mid-Michigan Ceilings and Drywall in Rockford, Mich., knows what is in store for those small businesses the IRS says must change their accounting methods.
Mieras' company was recently forced, after an IRS audit, to switch to the accrual method of accounting. He said he will definitely have to hire an accountant to handle the books, a task he used to take care of himself.
Also, to cover at least $80,000 in penalties, he is going to have to take out a bank loan. The change has put several goals he had for his business, including buying a new truck, scaffolding and tools, in jeopardy.
Although Mieras' case is not the result of the proposed changes, he said his experience is one many small business owners will go through once the new guidelines are put into effect.
Capitol Hill takes sides
On Capitol Hill, too, lawmakers have denounced the new IRS proposal. The chairmen of the Senate and House Small Business Committees - Sen. Christopher S. "Kit" Bond, R-Mo., and Rep. James M. Talent, R-Mo., recently sent a joint a letter to Treasury Secretary Lawrence H. Summers criticizing the new rule.
Bond and Talent said in their letter there is no authorization in the Internal Revenue Code for such a change. They also claim the Treasury Department should have solicited comments from small business owners and advocates before instituting such a change.
The lawmakers requested that Treasury create an opportunity for public comment before it issues the new guidelines next week. Additionally, they have asked Treasury to continue to observe the $5 million threshold for accrual accounting rules that has been in place since 1986.
Bond and Talent have also introduced companion bills in the Senate and House that would force the IRS to adhere to the accounting regulations set by the Treasury in 1986. No action has been taken on either bill.