Accounting Methods, Permissable

This article discusses information on permissible accounting methods. An accounting method is a set of rules used to determine when and how income and expenses are reported. The term “accounting method” includes not only the overall method of accounting you use, but also the accounting treatment you use for any item.

When you file your first tax return, you must choose a method of accounting. The same method must then be used from year to year, unless you first get the consent of the IRS to change methods.

Your accounting method must clearly show your income. An accounting method clearly shows income only if all items of gross income are treated the same from year to year. Generally, any method of accounting that shows the consistent use of generally accepted accounting principles for your trade or business is considered to clearly show income. If you do not regularly use an accounting method that clearly reflects your income, your income will be figured under a method that, in the opinion of the IRS, clearly reflects income.

Generally, you may use any of the following accounting methods:

• the cash method,

• the accrual method,

• a special method for certain items of income and expense, or

• a method that combines elements of any of the above.

Under the cash method, gross income includes all items of income you actually, or constructively, receive during the year. An amount is constructively received when it is credited to your account or made available to you. Property and services are included at their fair market value. The cash method is used by most individuals and many small businesses with no inventories. Any business that must maintain inventories, must use the accrual method. An exception to this rule applies for qualifying small business taxpayers with gross receipts of $10,000,000 or less and another exception applies to small businesses with gross receipts of $1,000,000 or less. Corporations (other than S corporations and corporations with gross receipts of $5,000,000 or less), partnerships with a corporation (other than an S corporation) as a partner, and tax shelters are also generally precluded from using the cash method.