Filing & Paying Business Taxes (Part 12)

Filing & Paying Business Taxes

Continued from last week

Keeping inventories. When the production, purchase, or sale of merchandise is an income-producing factor in your business, you must generally take inventories into account the beginning and the end of your tax year. If you must account for an inventory, you must generally use an accrual method of accounting for your purchases and sales.

Special rule for related persons. You cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until you make the payment and the corresponding amount is includible in the related person’s gross income. Determine the relationship, for this rule, as of the end of the tax year for which the expense or interest would otherwise be deductible. If a deduction is not allowed under this rule, the rule will continue to apply even if your relationship with the person ends before the expense or interest is includible in the gross income of that person. Related persons include members of your immediate family, including only brothers and sisters (either whole or half), your spouse, ancestors, and lineal descendants.

Combination Method

You can generally use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. However, the following restrictions apply. If an inventory is necessary to account for your income, you must generally use an accrual method for purchases and sales. You can use the cash method for all other items of income and expenses. If you use the cash method for figuring your income, you must use the cash method for reporting your expenses. If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. If you use a combination method that includes the cash method, treat that combination method as the cash method.

Change in Accounting Method. Once you have set up your accounting method, you must generally get IRS approval before you can change to another method. A change in your accounting method includes a change in: 1. Your overall method, such as from cash to an accrual method, and 2. Your treatment of any material item. To get approval, you must file Form 3115, Application for Change in Accounting Method. You can get IRS approval to change an accounting method under either the automatic change procedures or the advance consent request procedures.

Automatic change procedures. Certain taxpayers can presume to have IRS approval to change their method of accounting. The approval is granted for the tax year for which the taxpayer requests a change (year of change), if the taxpayer complies with the provisions of the automatic change procedures. No user fee is required for an application filed under an automatic change procedure generally covered in Revenue Procedure 2002-9.

Generally, you must use Form 3115 to request an automatic change.

This column is offered as a public service with the understanding that each person's tax situation is different; and that you should consult your CPA before taking any action based upon comments made in this article. Call me and I will be happy to explain my “CPA Quality Tax Preparation at H&R Block Rates”.  I can be reached at 825-2771.

Continued next week