Tax Accounting Methods
San Diego corporations must be agile and flexible to achieve success in today’s ever-changing business landscape. As revenue streams, distribution channels and sourcing become more fluid, a company’s internal accounting system must also evolve to keep pace with internal and external reporting requirements. Organizations which go through such changes often benefit from a detailed review of their tax accounting methods.
What is a method accounting? Whatever type of business you hold, whether it is a partnership, C-corp, S-corp or a sole proprietorship, you are required to declare a method of accounting used for your business when reporting corporate taxable income. As a general rule, taxable income should be computed under the same method that was regularly used to keep its respective books. On your schedule C, under the Line F section, you are asked if your method is accrual, cash or other.
Cash basis accounting recognizes revenue and expenses when cash changes hands. If a customer bought a product or service from you in July, your July reports would show the transaction. It’s an easy-to-understand method, but it’s limited.
The accrual method of accounting recognizes revenue and expenses when incurred. If you sent an invoice in July and your customer paid you in August, you’d recognize the income in July. Accrual accounting is more complex to understand, but it provides a better long-term view of your business. The only real downside of accrual accounting is that it makes tracking your cash more challenging.
In other words, a method of accounting is a consistent treatment, from year to year, of when you report an item of income, expense, deduction or any other miscellaneous charge. In general, you must complete a Form 3115 in order to request permission from the IRS to change your accounting method.
With the new revenue recognition standard comes new book/tax differences. As you start to adopt the changes, how will you determine your federal and state income tax returns remain compliant?
So, regulation by regulation, ruling by ruling, case by case- each passing year brings complexity to the task of determining the timing of recognizing income and deductions. This also involves identifying the optimal treatment for a company’s specific size and particular industry. Companies must understand that each item of income and deduction could have multiple methods of accounting which would be acceptable for filing income tax purposes. The aim of a competent CPA review, on a business’ tax accounting methods, is to find and identify the most advantageous accounting method, while also locating and correcting impermissible methods that must be altered. Accounting method reviews can lead to more tax-efficient methods for improving cash flow, managing effective tax rates, mitigating past noncompliance or even managing expiring net operating losses.
Appropriate accounting methods can allow you to defer or accelerate income and deductions to minimize tax exposure and increase cash flow.
We have seen cases where changing the tax method of accounting (for even just one item) yielded significant tax benefits. It’s imperative to understand that the choice of accounting method, for many items throughout the tax return, can often have a remarkable impact on a corporation’s risk exposure, profitability and cash flow. Some areas of benefit can include:
- Cash Flow – By implementing more favorable, allowable elections and accounting method changes can generate semi-permanent cash tax benefits by deferring of income taxes.
- Interest Rates – When rates rise this can make accounting method changes more valuable.
- IRS Consent – Receive IRS approval and eliminate uncertainty
- Reportability – Generally does not require additional disclosure
- Mitigate Uncertain Tax Positions. Companies can correct erroneous methods and secure back-year audit protection.
Thomas Huckabee, CPA can help your San Diego business navigate the choices and impact of a changing business environment so that you can feel confident that your accounting methods are aligned with your business goals.
Consider the following questions:
- Are you a manufacturer or reseller business?
- Are you considering buying or selling a business?
- Does your business hold inventory?
- Do you have deferred revenue on your financial statements but not on your corporate tax returns?
If you have answered yes to any of these questions or have not reviewed your accounting methods in the last 5 years, then an accounting methods review could be very beneficial.
Some of the areas in which our tax professionals can assist include:
- Inventories – LIFO, FIFO and RIM
- Fixed Asset Analysis – Capitalization, Depreciation and Cost Segregation
- Revenue Recognition
- Accounting for Bad Debts
- Deductions such as compensation, inventory and A/R reserves
- 263(a) – ‘Repair’ Regulation Compliance
- Long-Term Contract Accounting
- Leasing Transactions
- Converting Accounting Methods – Cash to Accrual or Vice Versa
Let Thomas Huckabee, CPA allow you the peace of mind that comes from knowing that you have the right tax accounting methods for your business.