When it comes to accounting for Architecture & Engineering firms (A&E), choosing the right tax reporting method can have a significant impact on your bottom line.
We’ve found that many firms are missing out on one major tax-saving opportunity… transitioning from the accrual method to the cash basis method for tax reporting and accounting.
In this article, we’ll explain what the cash basis method is and how it can result in a substantial one-time tax deduction, improved long-term cash flow, and tax planning flexibility for firms like yours.
What Is the Cash Basis Method vs. Accrual Basis?
The cash basis method of accounting recognizes income when it is received and expenses when they are paid. This contrasts with the accrual basis, which recognizes income when it is earned and expenses when they are incurred, regardless of when the money actually changes hands.
For many A&E firms, especially those qualifying as personal service corporations, the cash method offers several distinct tax advantages without requiring changes to their financial statement reporting.
Tax Advantages of the Cash Basis Method of Accounting for A&E Firms
Switching to the cash method vs. the accrual basis for tax reporting can offer a range of benefits, including:
Deferred Income Recognition
Most income does not need to be reported until it is received or constructively received (i.e., when it is within your control).
Immediate Deduction of Expenses
Most expenses can be deducted when paid, which allows firms to better align taxable income with actual cash flow. Exceptions include:
- Payroll-related withholdings: Deductible on the date of the payroll.
- Accrued pension expenses: Deductible in the year accrued, provided payment is made by the tax return’s due date and within IRS contribution limits.
- Capital expenditures: Items that don’t qualify for Section 179 expensing must be depreciated over time.
Tax Bracket Flexibility
The cash method gives firms more control over taxable income, especially useful when anticipating changes in tax laws or brackets.
Who Qualifies for the Cash Basis Method?
The IRS permits certain types of businesses to use the cash method. If your A&E firm fits into one of the following categories, you may be eligible:
- Qualified Personal Service Corporations (PSCs): These are businesses where the services are performed by employee-owners (individuals who own at least 10% of the company).
- Farming or tree-raising businesses that are not incorporated.
- Eligible small businesses without inventories.
- Eligible small businesses with average annual gross receipts under $10 million.
Most A&E firms qualify as PSCs under IRS rules, making them strong candidates for this tax strategy.
What Happens When You Switch from Accrual to Cash Basis?
If your firm currently uses the accrual method and meets the eligibility criteria, you can file for a change in accounting method with the IRS (Form 3115). Here’s what to expect:
- If the switch results in a tax deduction (which it often does), the entire deduction is typically taken in the year of the change.
- If the switch results in additional income (rare), it’s usually spread evenly over a four-year period.
This transition can create significant tax savings, particularly in the first year, and is a valuable tool for optimizing taxable income in future years.
Why Architects & Engineers Need Specialized Accountants
Tax planning for engineering firms is not one-size-fits-all. Working with a CPA firm that understands the unique financial structures of the A&E industry, including how to navigate government contracts, overhead rates, and indirect cost recovery, is critical to maximizing tax efficiency.
At Kreischer Miller, we don’t just provide compliance for our A&E clients; we provide strategic tax planning that aligns with your operational and business goals. Explore our services for the A&E industry and contact us to schedule a consultation and learn how much your firm could save by switching to the cash basis.