Rev Proc 2019-40: Small Business Accounting Method Changes

Eligibility for Simplified Procedures

Qualification for these simplified accounting methods depends on the gross receipts test, as defined in Internal Revenue Code Section 448. A business meets this test if its average annual gross receipts for the three preceding tax years do not exceed an inflation-adjusted threshold. For tax years beginning in 2025, this threshold is $31 million.

The calculation is not always confined to a single company, as aggregation rules prevent businesses from splitting into multiple entities to meet the test. These rules, found in IRC Sections 52 and 414, treat certain related businesses as a single employer for this calculation. The gross receipts of all entities within a controlled group, such as parent-subsidiary or brother-sister corporations, must be combined before applying the threshold.

For example, consider two corporations, each with $18 million in average annual gross receipts. Individually, each is below the $31 million threshold. If one individual owns a controlling interest in both corporations, they are a controlled group and their gross receipts must be aggregated, resulting in a total of $36 million and making the entire group ineligible.

This test is applied annually, so a business’s eligibility can change from year to year. A business that exceeds the threshold may fall below it in a subsequent year and become eligible. The three-year averaging calculation must be performed for each tax year a simplified method is desired.

Covered Accounting Method Changes

The procedural guidance provides access to several accounting method changes that can simplify bookkeeping and potentially defer tax liability. These automatic changes allow eligible small businesses to move away from complex accounting rules required for larger companies. Each change addresses a specific area of accounting simplified by the TCJA.

Change to the Overall Cash Method

A significant change is the ability to switch from the accrual method to the overall cash method of accounting. Under the accrual method, revenue is recognized when earned and expenses when incurred. The simpler cash method allows a business to recognize income when payment is received and expenses when paid, which can defer taxes for businesses with high accounts receivable.

Inventory Methods

This guidance allows qualifying small businesses to opt out of traditional inventory requirements. A business can choose to treat its inventory as non-incidental materials and supplies, deducting the cost in the later of the year they are used or paid for. Alternatively, a business can adopt an inventory method that conforms to its financial statements, often called its “book” method, which aligns tax reporting with internal accounting.

Exemption from UNICAP Rules

The Uniform Capitalization (UNICAP) rules, in IRC Section 263A, require producers and resellers to capitalize direct costs and a portion of indirect costs. Complying with UNICAP can be burdensome, requiring complex allocations of overhead. Eligible small businesses are exempt from these rules, allowing them to deduct these indirect costs as they are incurred rather than capitalizing them.

Long-Term Contracts

Companies with projects spanning more than one tax year are often required to use the percentage-of-completion method (PCM) under IRC Section 460. PCM requires recognizing revenue based on the percentage of the project completed during the year. The simplified procedures allow eligible businesses to use the completed-contract method, which defers all income and profit until the year the contract is fully completed.

Required Documentation and Form Completion

To implement these changes, a taxpayer must file IRS Form 3115, Application for Change in Accounting Method. While the form is lengthy, these procedures allow for a simplified filing, meaning not all parts must be completed. Taxpayers must refer to the current list of automatic accounting method changes, such as Rev. Proc. 2025-23, to identify the exact filing requirements.

The form requires a Designated Automatic Accounting Method Change Number (DCN). This three-digit number tells the IRS which automatic change is being made. Because these numbers can be updated, taxpayers must consult the latest Form 3115 instructions or the governing revenue procedure for the year of change to ensure they use the correct DCN.

The form involves calculating the net Section 481(a) adjustment. This represents the cumulative financial difference between the old and new methods, calculated as of the beginning of the year of change. It is necessary to prevent the duplication or omission of income or deductions, such as adjusting for accounts receivable when switching from accrual to cash.

The treatment of the Section 481(a) adjustment depends on whether it is positive or negative. A negative adjustment, which decreases taxable income, is taken entirely in the year of the change. A positive adjustment, which increases taxable income, must be spread over a four-year period, beginning with the year of change.

The Filing Process

The process for an automatic change operates on the principle of “automatic consent,” meaning the IRS’s permission is granted if the taxpayer follows all procedures correctly. Unlike non-automatic changes, there is no need to mail the form in advance, wait for permission, or pay a user fee. The responsibility rests with the taxpayer to ensure they are eligible and have completed Form 3115 accurately, as an incorrect filing can invalidate the consent.

To file, a signed copy of the completed Form 3115 must be attached to the taxpayer’s timely filed federal income tax return for the year of the change, including any valid extensions. For example, a change for the 2025 tax year requires attaching the form to the 2025 tax return filed in 2026.

After filing, the business begins using the new accounting method for the year of change. This includes reporting income and expenses on the tax return according to the new method and properly reporting the Section 481(a) adjustment.