The accounting method used by your business governs the timing of reporting income and expenses. The two main methods are the cash method and the accrual method. An installment method is also allowed for certain sales. Due to recent developments, you may want to use a different method from the one you currently use.
Installment method barred to accrual basis businesses. If you report on the accrual method and sell property on the installment basis, you can no longer use the installment method to spread your gain over the years in which proceeds are received. This change applies to sales on or after December 17, 1999, so eligible sales made prior to this date can continue to be reported on the installment basis.
Note: There are bills now pending in Congress to repeal this ban on the use of installment reporting or to create a "small business" exception to the ban.
Cash method allowed for small inventory-based businesses. As a general rule, if a business maintains inventory for sale to customers in the ordinary course of business, it must use the accrual method. However, the IRS now allows "small" businesses to use the cash method even if they maintain inventory. Use of the cash method simplifies accounting and tax reporting. "Small" businesses for this purpose are those with average annual gross receipts in the three prior years of $1 million or less (or for the period the company was in business if less than three years).
Effect of the change. If you opt to use the cash method, then you treat your inventory as material and supplies. This means you'll deduct inventory on hand as you use the items. You must also be consistent in your use of the cash method, using it not only for tax reporting but also for financial reporting purposes. Switching to the cash method means that the business can use the installment method to report gains from installment sales.
Making the change. If you qualify for the cash method under this special rule but have been using the accrual method, you must file for an automatic change of accounting method. Use Form 3115, Application for Change in Accounting Method, which you may download from www.irs.gov. You don't need IRS approval to make the switch.
Note: Accounting methods are explained in IRS Publications 537, Installment Sales, and 538, Accounting Periods and Methods, also available at www.irs.gov.
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BARBARA WELTMAN is an attorney and a trusted professional advocate for small businesses and entrepreneurs. She is the author with such titles as J.K. Lasser’s Small Business Taxes and Smooth Failing, and she contributes regularly to American Express OPEN and SBA.gov. Her articles have appeared in the Wall Street Journal and U.S. News and World Report. Weltman is also the publisher of Idea of the Day and monthly e-newsletter Big Ideas for Small Business at www.barbaraweltman.com and hosts radio shows and podcasts, including Build Your Business radio. She has been named one of the 100 Small Business Influencers in the U.S. for the third year in a row. @barbaraweltman