Business / Tax

Cash Basis Method of Accounting

Issue
Section 448 of the Internal Revenue Code requires most C corporations with more than $5 million in annual revenues to use the accrual method of accounting. An exception applies to “qualified personal service corporations” (QPSCs), which can continue to use the cash basis accounting method regardless of revenues.

A QPSC is defined as any corporation that meets a function test and an ownership test. The function test is met if substantially all of the corporation’s services in a taxable year involve any of the following fields: health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting (professional services). The ownership test is met if at all times during the taxable year, substantially all of the value of the corporation’s stock is held directly or indirectly by employees or retirees who performed professional services of the QPSC. Indirect ownership of stock is only taken into account when the stock is owned by partnerships, S corporations or QPSCs.

Changes in the practice of engineering — including the need to hire larger numbers of non-engineers due to the needs of current project delivery — have caused many engineering companies to fear losing eligibility to use the cash method of accounting. Clarification needs to be made so that such expanded services will meet the definition of engineering and therefore not restrict the service provider’s ability to continue to qualify as a QPSC. The current stock ownership requirements of section 448, together with the evolving services provided by engineering QPSCs, foster uncertainty with respect to corporate taxpayers filing consolidated tax returns and to teaming arrangements (such as joint ventures) that are often needed to carry out the vital services that engineering QPSCs provide. As QPSCs expand globally, stock ownership by U.S. expatriates and foreign nationals working as employees of foreign subsidiaries should not materially impact the QPSC’s qualification for use of the cash method of accounting.

ACEC Position
ACEC supports the Qualified Personal Service Corporation Clarification Act, authored by Representative Allyson Schwartz (D-PA), which would amend section 448 of the Internal Revenue Code to better enable those QPSC s that are currently eligible to use the cash method of accounting for tax purposes to continue doing so.