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Irs free file fillable forms Publication 538 - Main Content Table of Contents Accounting PeriodsCalendar Year Fiscal Year Short Tax Year Improper Tax Year Change in Tax Year Individuals Partnerships, S Corporations, and Personal Service Corporations (PSCs) Corporations (Other Than S Corporations and PSCs) Accounting MethodsSpecial methods. Irs free file fillable forms Hybrid method. Irs free file fillable forms Cash Method Accrual Method Inventories Change in Accounting Method How To Get Tax HelpLow Income Taxpayer Clinics (LITCs). Irs free file fillable forms Accounting Periods You must use a tax year to figure your taxable income. Irs free file fillable forms A tax year is an annual accounting period for keeping records and reporting income and expenses. Irs free file fillable forms An annual accounting period does not include a short tax year (discussed later). Irs free file fillable forms You can use the following tax years: A calendar year; or A fiscal year (including a 52-53-week tax year). Irs free file fillable forms Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. Irs free file fillable forms A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. Irs free file fillable forms You cannot adopt a tax year by merely: Filing an application for an extension of time to file an income tax return; Filing an application for an employer identification number (Form SS-4); or Paying estimated taxes. Irs free file fillable forms This section discusses: A calendar year. Irs free file fillable forms A fiscal year (including a period of 52 or 53 weeks). Irs free file fillable forms A short tax year. Irs free file fillable forms An improper tax year. Irs free file fillable forms A change in tax year. Irs free file fillable forms Special situations that apply to individuals. Irs free file fillable forms Restrictions that apply to the accounting period of a partnership, S corporation, or personal service corporation. Irs free file fillable forms Special situations that apply to corporations. Irs free file fillable forms Calendar Year A calendar year is 12 consecutive months beginning on January 1st and ending on December 31st. Irs free file fillable forms If you adopt the calendar year, you must maintain your books and records and report your income and expenses from January 1st through December 31st of each year. Irs free file fillable forms If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a partner in a partnership, or become a shareholder in an S corporation, you must continue to use the calendar year unless you obtain approval from the IRS to change it, or are otherwise allowed to change it without IRS approval. Irs free file fillable forms See Change in Tax Year, later. Irs free file fillable forms Generally, anyone can adopt the calendar year. Irs free file fillable forms However, you must adopt the calendar year if: You keep no books or records; You have no annual accounting period; Your present tax year does not qualify as a fiscal year; or You are required to use a calendar year by a provision in the Internal Revenue Code or the Income Tax Regulations. Irs free file fillable forms Fiscal Year A fiscal year is 12 consecutive months ending on the last day of any month except December 31st. Irs free file fillable forms If you are allowed to adopt a fiscal year, you must consistently maintain your books and records and report your income and expenses using the time period adopted. Irs free file fillable forms 52-53-Week Tax Year You can elect to use a 52-53-week tax year if you keep your books and records and report your income and expenses on that basis. Irs free file fillable forms If you make this election, your 52-53-week tax year must always end on the same day of the week. Irs free file fillable forms Your 52-53-week tax year must always end on: Whatever date this same day of the week last occurs in a calendar month, or Whatever date this same day of the week falls that is nearest to the last day of the calendar month. Irs free file fillable forms For example, if you elect a tax year that always ends on the last Monday in March, your 2012 tax year will end on March 25, 2013. Irs free file fillable forms Election. Irs free file fillable forms   To make the election for the 52-53-week tax year, attach a statement with the following information to your tax return. Irs free file fillable forms The month in which the new 52-53-week tax year ends. Irs free file fillable forms The day of the week on which the tax year always ends. Irs free file fillable forms The date the tax year ends. Irs free file fillable forms It can be either of the following dates on which the chosen day: Last occurs in the month in (1), above, or Occurs nearest to the last day of the month in (1), above. Irs free file fillable forms   When you figure depreciation or amortization, a 52-53-week tax year is generally considered a year of 12 calendar months. Irs free file fillable forms   To determine an effective date (or apply provisions of any law) expressed in terms of tax years beginning, including, or ending on the first or last day of a specified calendar month, a 52-53-week tax year is considered to: Begin on the first day of the calendar month beginning nearest to the first day of the 52-53-week tax year, and End on the last day of the calendar month ending nearest to the last day of the 52-53-week tax year. Irs free file fillable forms Example. Irs free file fillable forms Assume a tax provision applies to tax years beginning on or after July 1, 2012, which happens to be a Sunday. Irs free file fillable forms For this purpose, a 52-53-week tax year that begins on the last Tuesday of June, which falls on June 26, 2012, is treated as beginning on July 1, 2012. Irs free file fillable forms Short Tax Year A short tax year is a tax year of less than 12 months. Irs free file fillable forms A short period tax return may be required when you (as a taxable entity): Are not in existence for an entire tax year, or Change your accounting period. Irs free file fillable forms Tax on a short period tax return is figured differently for each situation. Irs free file fillable forms Not in Existence Entire Year Even if a taxable entity was not in existence for the entire year, a tax return is required for the time it was in existence. Irs free file fillable forms Requirements for filing the return and figuring the tax are generally the same as the requirements for a return for a full tax year (12 months) ending on the last day of the short tax year. Irs free file fillable forms Example 1. Irs free file fillable forms XYZ Corporation was organized on July 1, 2012. Irs free file fillable forms It elected the calendar year as its tax year. Irs free file fillable forms Therefore, its first tax return was due March 15, 2013. Irs free file fillable forms This short period return will cover the period from July 1, 2012, through December 31, 2012. Irs free file fillable forms Example 2. Irs free file fillable forms A calendar year corporation dissolved on July 23, 2012. Irs free file fillable forms Its final return is due by October 15, 2012. Irs free file fillable forms It will cover the short period from January 1, 2012, through July 23, 2012. Irs free file fillable forms Death of individual. Irs free file fillable forms   When an individual dies, a tax return must be filed for the decedent by the 15th day of the 4th month after the close of the individual's regular tax year. Irs free file fillable forms The decedent's final return will be a short period tax return that begins on January 1st, and ends on the date of death. Irs free file fillable forms In the case of a decedent who dies on December 31st, the last day of the regular tax year, a full calendar-year tax return is required. Irs free file fillable forms Example. Irs free file fillable forms   Agnes Green was a single, calendar year taxpayer. Irs free file fillable forms She died on March 6, 2012. Irs free file fillable forms Her final income tax return must be filed by April 15, 2013. Irs free file fillable forms It will cover the short period from January 1, 2012, to March 6, 2012. Irs free file fillable forms Figuring Tax for Short Year If the IRS approves a change in your tax year or you are required to change your tax year, you must figure the tax and file your return for the short tax period. Irs free file fillable forms The short tax period begins on the first day after the close of your old tax year and ends on the day before the first day of your new tax year. Irs free file fillable forms Figure tax for a short year under the general rule, explained below. Irs free file fillable forms You may then be able to use a relief procedure, explained later, and claim a refund of part of the tax you paid. Irs free file fillable forms General rule. Irs free file fillable forms   Income tax for a short tax year must be annualized. Irs free file fillable forms However, self-employment tax is figured on the actual self-employment income for the short period. Irs free file fillable forms Individuals. Irs free file fillable forms   An individual must figure income tax for the short tax year as follows. Irs free file fillable forms Determine your adjusted gross income (AGI) for the short tax year and then subtract your actual itemized deductions for the short tax year. Irs free file fillable forms You must itemize deductions when you file a short period tax return. Irs free file fillable forms Multiply the dollar amount of your exemptions by the number of months in the short tax year and divide the result by 12. Irs free file fillable forms Subtract the amount in (2) from the amount in (1). Irs free file fillable forms The result is your modified taxable income. Irs free file fillable forms Multiply the modified taxable income in (3) by 12, then divide the result by the number of months in the short tax year. Irs free file fillable forms The result is your annualized income. Irs free file fillable forms Figure the total tax on your annualized income using the appropriate tax rate schedule. Irs free file fillable forms Multiply the total tax by the number of months in the short tax year and divide the result by 12. Irs free file fillable forms The result is your tax for the short tax year. Irs free file fillable forms Relief procedure. Irs free file fillable forms   Individuals and corporations can use a relief procedure to figure the tax for the short tax year. Irs free file fillable forms It may result in less tax. Irs free file fillable forms Under this procedure, the tax is figured by two separate methods. Irs free file fillable forms If the tax figured under both methods is less than the tax figured under the general rule, you can file a claim for a refund of part of the tax you paid. Irs free file fillable forms For more information, see section 443(b)(2) of the Internal Revenue Code. Irs free file fillable forms Alternative minimum tax. Irs free file fillable forms   To figure the alternative minimum tax (AMT) due for a short tax year: Figure the annualized alternative minimum taxable income (AMTI) for the short tax period by completing the following steps. Irs free file fillable forms Multiply the AMTI by 12. Irs free file fillable forms Divide the result by the number of months in the short tax year. Irs free file fillable forms Multiply the annualized AMTI by the appropriate rate of tax under section 55(b)(1) of the Internal Revenue Code. Irs free file fillable forms The result is the annualized AMT. Irs free file fillable forms Multiply the annualized AMT by the number of months in the short tax year and divide the result by 12. Irs free file fillable forms   For information on the AMT for individuals, see the Instructions for Form 6251, Alternative Minimum Tax–Individuals. Irs free file fillable forms For information on the AMT for corporations, see the Instructions to Form 4626, Alternative Minimum Tax–Corporations. Irs free file fillable forms Tax withheld from wages. Irs free file fillable forms   You can claim a credit against your income tax liability for federal income tax withheld from your wages. Irs free file fillable forms Federal income tax is withheld on a calendar year basis. Irs free file fillable forms The amount withheld in any calendar year is allowed as a credit for the tax year beginning in the calendar year. Irs free file fillable forms Improper Tax Year Taxpayers that have adopted an improper tax year must change to a proper tax year. Irs free file fillable forms For example, if a taxpayer began business on March 15 and adopted a tax year ending on March 14 (a period of exactly 12 months), this would be an improper tax year. Irs free file fillable forms See Accounting Periods, earlier, for a description of permissible tax years. Irs free file fillable forms To change to a proper tax year, you must do one of the following. Irs free file fillable forms If you are requesting a change to a calendar tax year, file an amended income tax return based on a calendar tax year that corrects the most recently filed tax return that was filed on the basis of an improper tax year. Irs free file fillable forms Attach a completed Form 1128 to the amended tax return. Irs free file fillable forms Write “FILED UNDER REV. Irs free file fillable forms PROC. Irs free file fillable forms 85-15” at the top of Form 1128 and file the forms with the Internal Revenue Service Center where you filed your original return. Irs free file fillable forms If you are requesting a change to a fiscal tax year, file Form 1128 in accordance with the form instructions to request IRS approval for the change. Irs free file fillable forms Change in Tax Year Generally, you must file Form 1128 to request IRS approval to change your tax year. Irs free file fillable forms See the Instructions for Form 1128 for exceptions. Irs free file fillable forms If you qualify for an automatic approval request, a user fee is not required. Irs free file fillable forms Individuals Generally, individuals must adopt the calendar year as their tax year. Irs free file fillable forms An individual can adopt a fiscal year provided that the individual maintains his or her books and records on the basis of the adopted fiscal year. Irs free file fillable forms Partnerships, S Corporations, and Personal Service Corporations (PSCs) Generally, partnerships, S corporations (including electing S corporations), and PSCs must use a required tax year. Irs free file fillable forms A required tax year is a tax year that is required under the Internal Revenue Code and Income Tax Regulations. Irs free file fillable forms The entity does not have to use the required tax year if it receives IRS approval to use another permitted tax year or makes an election under section 444 of the Internal Revenue Code (discussed later). Irs free file fillable forms The following discussions provide the rules for partnerships, S corporations, and PSCs. Irs free file fillable forms Partnership A partnership must conform its tax year to its partners' tax years unless any of the following apply. Irs free file fillable forms The partnership makes an election under section 444 of the Internal Revenue Code to have a tax year other than a required tax year by filing Form 8716. Irs free file fillable forms The partnership elects to use a 52-53-week tax year that ends with reference to either its required tax year or a tax year elected under section 444. Irs free file fillable forms The partnership can establish a business purpose for a different tax year. Irs free file fillable forms The rules for the required tax year for partnerships are as follows. Irs free file fillable forms If one or more partners having the same tax year own a majority interest (more than 50%) in partnership profits and capital, the partnership must use the tax year of those partners. Irs free file fillable forms If there is no majority interest tax year, the partnership must use the tax year of all its principal partners. Irs free file fillable forms A principal partner is one who has a 5% or more interest in the profits or capital of the partnership. Irs free file fillable forms If there is no majority interest tax year and the principal partners do not have the same tax year, the partnership generally must use a tax year that results in the least aggregate deferral of income to the partners. Irs free file fillable forms If a partnership changes to a required tax year because of these rules, it can get automatic approval by filing Form 1128. Irs free file fillable forms Least aggregate deferral of income. Irs free file fillable forms   The tax year that results in the least aggregate deferral of income is determined as follows. Irs free file fillable forms Figure the number of months of deferral for each partner using one partner's tax year. Irs free file fillable forms Find the months of deferral by counting the months from the end of that tax year forward to the end of each other partner's tax year. Irs free file fillable forms Multiply each partner's months of deferral figured in step (1) by that partner's share of interest in the partnership profits for the year used in step (1). Irs free file fillable forms Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1). Irs free file fillable forms Repeat steps (1) through (3) for each partner's tax year that is different from the other partners' years. Irs free file fillable forms   The partner's tax year that results in the lowest aggregate (total) number is the tax year that must be used by the partnership. Irs free file fillable forms If the calculation results in more than one tax year qualifying as the tax year with the least aggregate deferral, the partnership can choose any one of those tax years as its tax year. Irs free file fillable forms However, if one of the tax years that qualifies is the partnership's existing tax year, the partnership must retain that tax year. Irs free file fillable forms Example. Irs free file fillable forms A and B each have a 50% interest in partnership P, which uses a fiscal year ending June 30. Irs free file fillable forms A uses the calendar year and B uses a fiscal year ending November 30. Irs free file fillable forms P must change its tax year to a fiscal year ending November 30 because this results in the least aggregate deferral of income to the partners, as shown in the following table. Irs free file fillable forms Year End 12/31: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Irs free file fillable forms 5 -0- -0- B 11/30 0. Irs free file fillable forms 5 11 5. Irs free file fillable forms 5 Total Deferral 5. Irs free file fillable forms 5 Year End 11/30: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Irs free file fillable forms 5 1 0. Irs free file fillable forms 5 B 11/30 0. Irs free file fillable forms 5 -0- -0- Total Deferral 0. Irs free file fillable forms 5 When determination is made. Irs free file fillable forms   The determination of the tax year under the least aggregate deferral rules must generally be made at the beginning of the partnership's current tax year. Irs free file fillable forms However, the IRS can require the partnership to use another day or period that will more accurately reflect the ownership of the partnership. Irs free file fillable forms This could occur, for example, if a partnership interest was transferred for the purpose of qualifying for a particular tax year. Irs free file fillable forms Short period return. Irs free file fillable forms   When a partnership changes its tax year, a short period return must be filed. Irs free file fillable forms The short period return covers the months between the end of the partnership's prior tax year and the beginning of its new tax year. Irs free file fillable forms   If a partnership changes to the tax year resulting in the least aggregate deferral, it must file a Form 1128 with the short period return showing the computations used to determine that tax year. Irs free file fillable forms The short period return must indicate at the top of page 1, “FILED UNDER SECTION 1. Irs free file fillable forms 706-1. Irs free file fillable forms ” More information. Irs free file fillable forms   For more information about changing a partnership's tax year, and information about ruling requests, see the Instructions for Form 1128. Irs free file fillable forms S Corporation All S corporations, regardless of when they became an S corporation, must use a permitted tax year. Irs free file fillable forms A permitted tax year is any of the following. Irs free file fillable forms The calendar year. Irs free file fillable forms A tax year elected under section 444 of the Internal Revenue Code. Irs free file fillable forms See Section 444 Election, below for details. Irs free file fillable forms A 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Irs free file fillable forms Any other tax year for which the corporation establishes a business purpose. Irs free file fillable forms If an electing S corporation wishes to adopt a tax year other than a calendar year, it must request IRS approval using Form 2553, instead of filing Form 1128. Irs free file fillable forms For information about changing an S corporation's tax year and information about ruling requests, see the Instructions for Form 1128. Irs free file fillable forms Personal Service Corporation (PSC) A PSC must use a calendar tax year unless any of the following apply. Irs free file fillable forms The corporation makes an election under section 444 of the Internal Revenue Code. Irs free file fillable forms See Section 444 Election, below for details. Irs free file fillable forms The corporation elects to use a 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Irs free file fillable forms The corporation establishes a business purpose for a fiscal year. Irs free file fillable forms See the Instructions for Form 1120 for general information about PSCs. Irs free file fillable forms For information on adopting or changing tax years for PSCs and information about ruling requests, see the Instructions for Form 1128. Irs free file fillable forms Section 444 Election A partnership, S corporation, electing S corporation, or PSC can elect under section 444 of the Internal Revenue Code to use a tax year other than its required tax year. Irs free file fillable forms Certain restrictions apply to the election. Irs free file fillable forms A partnership or an S corporation that makes a section 444 election must make certain required payments and a PSC must make certain distributions (discussed later). Irs free file fillable forms The section 444 election does not apply to any partnership, S corporation, or PSC that establishes a business purpose for a different period, explained later. Irs free file fillable forms A partnership, S corporation, or PSC can make a section 444 election if it meets all the following requirements. Irs free file fillable forms It is not a member of a tiered structure (defined in section 1. Irs free file fillable forms 444-2T of the regulations). Irs free file fillable forms It has not previously had a section 444 election in effect. Irs free file fillable forms It elects a year that meets the deferral period requirement. Irs free file fillable forms Deferral period. Irs free file fillable forms   The determination of the deferral period depends on whether the partnership, S corporation, or PSC is retaining its tax year or adopting or changing its tax year with a section 444 election. Irs free file fillable forms Retaining tax year. Irs free file fillable forms   Generally, a partnership, S corporation, or PSC can make a section 444 election to retain its tax year only if the deferral period of the new tax year is 3 months or less. Irs free file fillable forms This deferral period is the number of months between the beginning of the retained year and the close of the first required tax year. Irs free file fillable forms Adopting or changing tax year. Irs free file fillable forms   If the partnership, S corporation, or PSC is adopting or changing to a tax year other than its required year, the deferral period is the number of months from the end of the new tax year to the end of the required tax year. Irs free file fillable forms The IRS will allow a section 444 election only if the deferral period of the new tax year is less than the shorter of: Three months, or The deferral period of the tax year being changed. Irs free file fillable forms This is the tax year immediately preceding the year for which the partnership, S corporation, or PSC wishes to make the section 444 election. Irs free file fillable forms If the partnership, S corporation, or PSC's tax year is the same as its required tax year, the deferral period is zero. Irs free file fillable forms Example 1. Irs free file fillable forms BD Partnership uses a calendar year, which is also its required tax year. Irs free file fillable forms BD cannot make a section 444 election because the deferral period is zero. Irs free file fillable forms Example 2. Irs free file fillable forms E, a newly formed partnership, began operations on December 1. Irs free file fillable forms E is owned by calendar year partners. Irs free file fillable forms E wants to make a section 444 election to adopt a September 30 tax year. Irs free file fillable forms E's deferral period for the tax year beginning December 1 is 3 months, the number of months between September 30 and December 31. Irs free file fillable forms Making the election. Irs free file fillable forms   Make a section 444 election by filing Form 8716 with the Internal Revenue Service Center where the entity will file its tax return. Irs free file fillable forms Form 8716 must be filed by the earlier of: The due date (not including extensions) of the income tax return for the tax year resulting from the section 444 election, or The 15th day of the 6th month of the tax year for which the election will be effective. Irs free file fillable forms For this purpose, count the month in which the tax year begins, even if it begins after the first day of that month. Irs free file fillable forms Note. Irs free file fillable forms If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day. Irs free file fillable forms   Attach a copy of Form 8716 to Form 1065, Form 1120S, or Form 1120 for the first tax year for which the election is made. Irs free file fillable forms Example 1. Irs free file fillable forms AB, a partnership, begins operations on September 13, 2012, and is qualified to make a section 444 election to use a September 30 tax year for its tax year beginning September 13, 2012. Irs free file fillable forms AB must file Form 8716 by January 15, 2013, which is the due date of the partnership's tax return for the period from September 13, 2012, to September 30, 2012. Irs free file fillable forms Example 2. Irs free file fillable forms The facts are the same as in Example 1 except that AB begins operations on October 21, 2012. Irs free file fillable forms AB must file Form 8716 by March 17, 2013. Irs free file fillable forms Example 3. Irs free file fillable forms B is a corporation that first becomes a PSC for its tax year beginning September 1, 2012. Irs free file fillable forms B qualifies to make a section 444 election to use a September 30 tax year for its tax year beginning September 1, 2012. Irs free file fillable forms B must file Form 8716 by December 17, 2012, the due date of the income tax return for the short period from September 1, 2012, to September 30, 2012. Irs free file fillable forms Note. Irs free file fillable forms The due dates in Examples 2 and 3 are adjusted because the dates fall on a Saturday, Sunday or legal holiday. Irs free file fillable forms Extension of time for filing. Irs free file fillable forms   There is an automatic extension of 12 months to make this election. Irs free file fillable forms See the Form 8716 instructions for more information. Irs free file fillable forms Terminating the election. Irs free file fillable forms   The section 444 election remains in effect until it is terminated. Irs free file fillable forms If the election is terminated, another section 444 election cannot be made for any tax year. Irs free file fillable forms   The election ends when any of the following applies to the partnership, S corporation, or PSC. Irs free file fillable forms The entity changes to its required tax year. Irs free file fillable forms The entity liquidates. Irs free file fillable forms The entity becomes a member of a tiered structure. Irs free file fillable forms The IRS determines that the entity willfully failed to comply with the required payments or distributions. Irs free file fillable forms   The election will also end if either of the following events occur. Irs free file fillable forms An S corporation's S election is terminated. Irs free file fillable forms However, if the S corporation immediately becomes a PSC, the PSC can continue the section 444 election of the S corporation. Irs free file fillable forms A PSC ceases to be a PSC. Irs free file fillable forms If the PSC elects to be an S corporation, the S corporation can continue the election of the PSC. Irs free file fillable forms Required payment for partnership or S corporation. Irs free file fillable forms   A partnership or an S corporation must make a required payment for any tax year: The section 444 election is in effect. Irs free file fillable forms The required payment for that year (or any preceding tax year) is more than $500. Irs free file fillable forms    This payment represents the value of the tax deferral the owners receive by using a tax year different from the required tax year. Irs free file fillable forms   Form 8752, Required Payment or Refund Under Section 7519, must be filed each year the section 444 election is in effect, even if no payment is due. Irs free file fillable forms If the required payment is more than $500 (or the required payment for any prior year was more than $500), the payment must be made when Form 8752 is filed. Irs free file fillable forms If the required payment is $500 or less and no payment was required in a prior year, Form 8752 must be filed showing a zero amount. Irs free file fillable forms Applicable election year. Irs free file fillable forms   Any tax year a section 444 election is in effect, including the first year, is called an applicable election year. Irs free file fillable forms Form 8752 must be filed and the required payment made (or zero amount reported) by May 15th of the calendar year following the calendar year in which the applicable election year begins. Irs free file fillable forms Required distribution for PSC. Irs free file fillable forms   A PSC with a section 444 election in effect must distribute certain amounts to employee-owners by December 31 of each applicable year. Irs free file fillable forms If it fails to make these distributions, it may be required to defer certain deductions for amounts paid to owner-employees. Irs free file fillable forms The amount deferred is treated as paid or incurred in the following tax year. Irs free file fillable forms   For information on the minimum distribution, see the instructions for Part I of Schedule H (Form 1120), Section 280H Limitations for a Personal Service Corporation (PSC). Irs free file fillable forms Back-up election. Irs free file fillable forms   A partnership, S corporation, or PSC can file a back-up section 444 election if it requests (or plans to request) permission to use a business purpose tax year, discussed later. Irs free file fillable forms If the request is denied, the back-up section 444 election must be activated (if the partnership, S corporation, or PSC otherwise qualifies). Irs free file fillable forms Making back-up election. Irs free file fillable forms   The general rules for making a section 444 election, as discussed earlier, apply. Irs free file fillable forms When filing Form 8716, type or print “BACK-UP ELECTION” at the top of the form. Irs free file fillable forms However, if Form 8716 is filed on or after the date Form 1128 (or Form 2553) is filed, type or print “FORM 1128 (or FORM 2553) BACK-UP ELECTION” at the top of Form 8716. Irs free file fillable forms Activating election. Irs free file fillable forms   A partnership or S corporation activates its back-up election by filing the return required and making the required payment with Form 8752. Irs free file fillable forms The due date for filing Form 8752 and making the payment is the later of the following dates. Irs free file fillable forms May 15 of the calendar year following the calendar year in which the applicable election year begins. Irs free file fillable forms 60 days after the partnership or S corporation has been notified by the IRS that the business year request has been denied. Irs free file fillable forms   A PSC activates its back-up election by filing Form 8716 with its original or amended income tax return for the tax year in which the election is first effective and printing on the top of the income tax return, “ACTIVATING BACK-UP ELECTION. Irs free file fillable forms ” 52-53-Week Tax Year A partnership, S corporation, or PSC can use a tax year other than its required tax year if it elects a 52-53-week tax year (discussed earlier) that ends with reference to either its required tax year or a tax year elected under section 444 (discussed earlier). Irs free file fillable forms A newly formed partnership, S corporation, or PSC can adopt a 52-53-week tax year ending with reference to either its required tax year or a tax year elected under section 444 without IRS approval. Irs free file fillable forms However, if the entity wishes to change to a 52-53-week tax year or change from a 52-53-week tax year that references a particular month to a non-52-53-week tax year that ends on the last day of that month, it must request IRS approval by filing Form 1128. Irs free file fillable forms Business Purpose Tax Year A partnership, S corporation, or PSC establishes the business purpose for a tax year by filing Form 1128. Irs free file fillable forms See the Instructions for Form 1128 for details. Irs free file fillable forms Corporations (Other Than S Corporations and PSCs) A new corporation establishes its tax year when it files its first tax return. Irs free file fillable forms A newly reactivated corporation that has been inactive for a number of years is treated as a new taxpayer for the purpose of adopting a tax year. Irs free file fillable forms An S corporation or a PSC must use the required tax year rules, discussed earlier, to establish a tax year. Irs free file fillable forms Generally, a corporation that wants to change its tax year must obtain approval from the IRS under either the: (a) automatic approval procedures; or (b) ruling request procedures. Irs free file fillable forms See the Instructions for Form 1128 for details. Irs free file fillable forms Accounting Methods An accounting method is a set of rules used to determine when income and expenses are reported on your tax return. Irs free file fillable forms Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item. Irs free file fillable forms You choose an accounting method when you file your first tax return. Irs free file fillable forms If you later want to change your accounting method, you must get IRS approval. Irs free file fillable forms See Change in Accounting Method, later. Irs free file fillable forms No single accounting method is required of all taxpayers. Irs free file fillable forms You must use a system that clearly reflects your income and expenses and you must maintain records that will enable you to file a correct return. Irs free file fillable forms In addition to your permanent accounting books, you must keep any other records necessary to support the entries on your books and tax returns. Irs free file fillable forms You must use the same accounting method from year to year. Irs free file fillable forms An accounting method clearly reflects income only if all items of gross income and expenses are treated the same from year to year. Irs free file fillable forms If you do not regularly use an accounting method that clearly reflects your income, your income will be refigured under the method that, in the opinion of the IRS, does clearly reflect income. Irs free file fillable forms Methods you can use. Irs free file fillable forms   In general, you can compute your taxable income under any of the following accounting methods. Irs free file fillable forms Cash method. Irs free file fillable forms Accrual method. Irs free file fillable forms Special methods of accounting for certain items of income and expenses. Irs free file fillable forms A hybrid method which combines elements of two or more of the above accounting methods. Irs free file fillable forms The cash and accrual methods of accounting are explained later. Irs free file fillable forms Special methods. Irs free file fillable forms   This publication does not discuss special methods of accounting for certain items of income or expenses. Irs free file fillable forms For information on reporting income using one of the long-term contract methods, see section 460 of the Internal Revenue Code and the related regulations. Irs free file fillable forms The following publications also discuss special methods of reporting income or expenses. Irs free file fillable forms Publication 225, Farmer's Tax Guide. Irs free file fillable forms Publication 535, Business Expenses. Irs free file fillable forms Publication 537, Installment Sales. Irs free file fillable forms Publication 946, How To Depreciate Property. Irs free file fillable forms Hybrid method. Irs free file fillable forms   Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently. Irs free file fillable forms However, the following restrictions apply. Irs free file fillable forms If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. Irs free file fillable forms See Exceptions under Inventories, later. Irs free file fillable forms Generally, you can use the cash method for all other items of income and expenses. Irs free file fillable forms See Inventories, later. Irs free file fillable forms If you use the cash method for reporting your income, you must use the cash method for reporting your expenses. Irs free file fillable forms If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Irs free file fillable forms Any combination that includes the cash method is treated as the cash method for purposes of section 448 of the Internal Revenue Code. Irs free file fillable forms Business and personal items. Irs free file fillable forms   You can account for business and personal items using different accounting methods. Irs free file fillable forms For example, you can determine your business income and expenses under an accrual method, even if you use the cash method to figure personal items. Irs free file fillable forms Two or more businesses. Irs free file fillable forms   If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. Irs free file fillable forms No business is separate and distinct, unless a complete and separate set of books and records is maintained for each business. Irs free file fillable forms Note. Irs free file fillable forms If you use different accounting methods to create or shift profits or losses between businesses (for example, through inventory adjustments, sales, purchases, or expenses) so that income is not clearly reflected, the businesses will not be considered separate and distinct. Irs free file fillable forms Cash Method Most individuals and many small businesses use the cash method of accounting. Irs free file fillable forms Generally, if you produce, purchase, or sell merchandise, you must keep an inventory and use an accrual method for sales and purchases of merchandise. Irs free file fillable forms See Inventories, later, for exceptions to this rule. Irs free file fillable forms Income Under the cash method, you include in your gross income all items of income you actually or constructively receive during the tax year. Irs free file fillable forms If you receive property and services, you must include their fair market value (FMV) in income. Irs free file fillable forms Constructive receipt. Irs free file fillable forms   Income is constructively received when an amount is credited to your account or made available to you without restriction. Irs free file fillable forms You need not have possession of it. Irs free file fillable forms If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. Irs free file fillable forms Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. Irs free file fillable forms Example. Irs free file fillable forms You are a calendar year taxpayer. Irs free file fillable forms Your bank credited, and made available, interest to your bank account in December 2012. Irs free file fillable forms You did not withdraw it or enter it into your books until 2013. Irs free file fillable forms You must include the amount in gross income for 2012, the year you constructively received it. Irs free file fillable forms You cannot hold checks or postpone taking possession of similar property from one tax year to another to postpone paying tax on the income. Irs free file fillable forms You must report the income in the year the property is received or made available to you without restriction. Irs free file fillable forms Expenses Under the cash method, generally, you deduct expenses in the tax year in which you actually pay them. Irs free file fillable forms This includes business expenses for which you contest liability. Irs free file fillable forms However, you may not be able to deduct an expense paid in advance. Irs free file fillable forms Instead, you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules. Irs free file fillable forms Expense paid in advance. Irs free file fillable forms   An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Irs free file fillable forms   Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Irs free file fillable forms 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Irs free file fillable forms   If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must obtain approval from the IRS before using the general rule and/or the 12-month rule. Irs free file fillable forms See Change in Accounting Method, later. Irs free file fillable forms Example 1. Irs free file fillable forms You are a calendar year taxpayer and pay $3,000 in 2012 for a business insurance policy that is effective for three years (36 months), beginning on July 1, 2012. Irs free file fillable forms The general rule that an expense paid in advance is deductible only in the year to which it applies is applicable to this payment because the payment does not qualify for the 12-month rule. Irs free file fillable forms Therefore, only $500 (6/36 x $3,000) is deductible in 2012, $1,000 (12/36 x $3,000) is deductible in 2013, $1,000 (12/36 x $3,000) is deductible in 2014, and the remaining $500 is deductible in 2015. Irs free file fillable forms Example 2. Irs free file fillable forms You are a calendar year taxpayer and pay $10,000 on July 1, 2012, for a business insurance policy that is effective for only one year beginning on July 1, 2012. Irs free file fillable forms The 12-month rule applies. Irs free file fillable forms Therefore, the full $10,000 is deductible in 2012. Irs free file fillable forms Excluded Entities The following entities cannot use the cash method, including any combination of methods that includes the cash method. Irs free file fillable forms (See Special rules for farming businesses, later. Irs free file fillable forms ) A corporation (other than an S corporation) with average annual gross receipts exceeding $5 million. Irs free file fillable forms See Gross receipts test, below. Irs free file fillable forms A partnership with a corporation (other than an S corporation) as a partner, and with the partnership having average annual gross receipts exceeding $5 million. Irs free file fillable forms See Gross receipts test, below. Irs free file fillable forms A tax shelter. Irs free file fillable forms Exceptions The following entities are not prohibited from using the cash method of accounting. Irs free file fillable forms Any corporation or partnership, other than a tax shelter, that meets the gross receipts test for all tax years after 1985. Irs free file fillable forms A qualified personal service corporation (PSC). Irs free file fillable forms Gross receipts test. Irs free file fillable forms   A corporation or partnership, other than a tax shelter, that meets the gross receipts test can generally use the cash method. Irs free file fillable forms A corporation or a partnership meets the test if, for each prior tax year beginning after 1985, its average annual gross receipts are $5 million or less. Irs free file fillable forms    An entity's average annual gross receipts for a prior tax year is determined by: Adding the gross receipts for that tax year and the 2 preceding tax years; and Dividing the total by 3. Irs free file fillable forms See Gross receipts test for qualifying taxpayers, for more information. Irs free file fillable forms Generally, a partnership applies the test at the partnership level. Irs free file fillable forms Gross receipts for a short tax year are annualized. Irs free file fillable forms Aggregation rules. Irs free file fillable forms   Organizations that are members of an affiliated service group or a controlled group of corporations treated as a single employer for tax purposes are required to aggregate their gross receipts to determine whether the gross receipts test is met. Irs free file fillable forms Change to accrual method. Irs free file fillable forms   A corporation or partnership that fails to meet the gross receipts test for any tax year is prohibited from using the cash method and must change to an accrual method of accounting, effective for the tax year in which the entity fails to meet this test. Irs free file fillable forms Special rules for farming businesses. Irs free file fillable forms   Generally, a taxpayer engaged in the trade or business of farming is allowed to use the cash method for its farming business. Irs free file fillable forms However, certain corporations (other than S corporations) and partnerships that have a partner that is a corporation must use an accrual method for their farming business. Irs free file fillable forms For this purpose, farming does not include the operation of a nursery or sod farm or the raising or harvesting of trees (other than fruit and nut trees). Irs free file fillable forms   There is an exception to the requirement to use an accrual method for corporations with gross receipts of $1 million or less for each prior tax year after 1975. Irs free file fillable forms For family corporations engaged in farming, the exception applies if gross receipts were $25 million or less for each prior tax year after 1985. Irs free file fillable forms See chapter 2 of Publication 225, Farmer's Tax Guide, for more information. Irs free file fillable forms Qualified PSC. Irs free file fillable forms   A PSC that meets the following function and ownership tests can use the cash method. Irs free file fillable forms Function test. Irs free file fillable forms   A corporation meets the function test if at least 95% of its activities are in the performance of services in the fields of health, veterinary services, law, engineering (including surveying and mapping), architecture, accounting, actuarial science, performing arts, or consulting. Irs free file fillable forms Ownership test. Irs free file fillable forms   A corporation meets the ownership test if at least 95% of its stock is owned, directly or indirectly, at all times during the year by one or more of the following. Irs free file fillable forms Employees performing services for the corporation in a field qualifying under the function test. Irs free file fillable forms Retired employees who had performed services in those fields. Irs free file fillable forms The estate of an employee described in (1) or (2). Irs free file fillable forms Any other person who acquired the stock by reason of the death of an employee referred to in (1) or (2), but only for the 2-year period beginning on the date of death. Irs free file fillable forms   Indirect ownership is generally taken into account if the stock is owned indirectly through one or more partnerships, S corporations, or qualified PSCs. Irs free file fillable forms Stock owned by one of these entities is considered owned by the entity's owners in proportion to their ownership interest in that entity. Irs free file fillable forms Other forms of indirect stock ownership, such as stock owned by family members, are generally not considered when determining if the ownership test is met. Irs free file fillable forms   For purposes of the ownership test, a person is not considered an employee of a corporation unless that person performs more than minimal services for the corporation. Irs free file fillable forms Change to accrual method. Irs free file fillable forms   A corporation that fails to meet the function test for any tax year; or fails to meet the ownership test at any time during any tax year must change to an accrual method of accounting, effective for the year in which the corporation fails to meet either test. Irs free file fillable forms A corporation that fails to meet the function test or the ownership test is not treated as a qualified PSC for any part of that tax year. Irs free file fillable forms Accrual Method Under the accrual method of accounting, generally you report income in the year it is earned and deduct or capitalize expenses in the year incurred. Irs free file fillable forms The purpose of an accrual method of accounting is to match income and expenses in the correct year. Irs free file fillable forms Income Generally, you include an amount in gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. Irs free file fillable forms Under this rule, you report an amount in your gross income on the earliest of the following dates. Irs free file fillable forms When you receive payment. Irs free file fillable forms When the income amount is due to you. Irs free file fillable forms When you earn the income. Irs free file fillable forms When title has passed. Irs free file fillable forms Estimated income. Irs free file fillable forms   If you include a reasonably estimated amount in gross income and later determine the exact amount is different, take the difference into account in the tax year you make that determination. Irs free file fillable forms Change in payment schedule. Irs free file fillable forms   If you perform services for a basic rate specified in a contract, you must accrue the income at the basic rate, even if you agree to receive payments at a reduced rate. Irs free file fillable forms Continue this procedure until you complete the services, then account for the difference. Irs free file fillable forms Advance Payment for Services Generally, you report an advance payment for services to be performed in a later tax year as income in the year you receive the payment. Irs free file fillable forms However, if you receive an advance payment for services you agree to perform by the end of the next tax year, you can elect to postpone including the advance payment in income until the next tax year. Irs free file fillable forms However, you cannot postpone including any payment beyond that tax year. Irs free file fillable forms Service agreement. Irs free file fillable forms   You can postpone reporting income from an advance payment you receive for a service agreement on property you sell, lease, build, install, or construct. Irs free file fillable forms This includes an agreement providing for incidental replacement of parts or materials. Irs free file fillable forms However, this applies only if you offer the property without a service agreement in the normal course of business. Irs free file fillable forms Postponement not allowed. Irs free file fillable forms   Generally, one cannot postpone including an advance payment in income for services if either of the following applies. Irs free file fillable forms You are to perform any part of the service after the end of the tax year immediately following the year you receive the advance payment. Irs free file fillable forms You are to perform any part of the service at any unspecified future date that may be after the end of the tax year immediately following the year you receive the advance payment. Irs free file fillable forms Examples. Irs free file fillable forms   In each of the following examples, assume the tax year is a calendar year and that the accrual method of accounting is used. Irs free file fillable forms Example 1. Irs free file fillable forms You manufacture, sell, and service computers. Irs free file fillable forms You received payment in 2012 for a one-year contingent service contract on a computer you sold. Irs free file fillable forms You can postpone including in income the part of the payment you did not earn in 2012 if, in the normal course of your business, you offer computers for sale without a contingent service contract. Irs free file fillable forms Example 2. Irs free file fillable forms You are in the television repair business. Irs free file fillable forms You received payments in 2012 for one-year contracts under which you agree to repair or replace certain parts that fail to function properly in television sets manufactured and sold by unrelated parties. Irs free file fillable forms You include the payments in gross income as you earn them. Irs free file fillable forms Example 3. Irs free file fillable forms You own a dance studio. Irs free file fillable forms On October 1, 2012, you receive payment for a one-year contract for 48 one-hour lessons beginning on that date. Irs free file fillable forms You give eight lessons in 2012. Irs free file fillable forms Under this method of including advance payments, you must include one-sixth (8/48) of the payment in income for 2012, and five-sixths (40/48) of the payment in 2013, even if you do not give all the lessons by the end of 2013. Irs free file fillable forms Example 4. Irs free file fillable forms Assume the same facts as in Example 3, except the payment is for a two-year contract for 96 lessons. Irs free file fillable forms You must include the entire payment in income in 2012 since part of the services may be performed after the following year. Irs free file fillable forms Guarantee or warranty. Irs free file fillable forms   Generally, you cannot postpone reporting income you receive under a guarantee or warranty contract. Irs free file fillable forms Prepaid rent. Irs free file fillable forms   You cannot postpone reporting income from prepaid rent. Irs free file fillable forms Prepaid rent does not include payment for the use of a room or other space when significant service is also provided for the occupant. Irs free file fillable forms You provide significant service when you supply space in a hotel, boarding house, tourist home, motor court, motel, or apartment house that furnishes hotel services. Irs free file fillable forms Books and records. Irs free file fillable forms   Any advance payment you include in gross receipts on your tax return for the year you receive payment must not be less than the payment you include in income for financial reports under the method of accounting used for those reports. Irs free file fillable forms Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Irs free file fillable forms IRS approval. Irs free file fillable forms   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payment for services. Irs free file fillable forms Advance Payment for Sales Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods held primarily for sale to customers in the ordinary course of your trade or business. Irs free file fillable forms However, the rules do not apply to a payment (or part of a payment) for services that are not an integral part of the main activities covered under the agreement. Irs free file fillable forms An agreement includes a gift certificate that can be redeemed for goods. Irs free file fillable forms Amounts due and payable are considered received. Irs free file fillable forms How to report payments. Irs free file fillable forms   Generally, include an advance payment in income in the year in which you receive it. Irs free file fillable forms However, you can use the alternative method, discussed next. Irs free file fillable forms Alternative method of reporting. Irs free file fillable forms   Under the alternative method, generally include an advance payment in income in the earlier tax year in which you: Include advance payments in gross receipts under the method of accounting you use for tax purposes, or Include any part of advance payments in income for financial reports under the method of accounting used for those reports. Irs free file fillable forms Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Irs free file fillable forms Example 1. Irs free file fillable forms You are a retailer. Irs free file fillable forms You use an accrual method of accounting and account for the sale of goods when you ship the goods. Irs free file fillable forms You use this method for both tax and financial reporting purposes. Irs free file fillable forms You can include advance payments in gross receipts for tax purposes in either: (a) the tax year in which you receive the payments; or (b) the tax year in which you ship the goods. Irs free file fillable forms However, see Exception for inventory goods, later. Irs free file fillable forms Example 2. Irs free file fillable forms You are a calendar year taxpayer. Irs free file fillable forms You manufacture household furniture and use an accrual method of accounting. Irs free file fillable forms Under this method, you accrue income for your financial reports when you ship the furniture. Irs free file fillable forms For tax purposes, you do not accrue income until the furniture has been delivered and accepted. Irs free file fillable forms In 2012, you received an advance payment of $8,000 for an order of furniture to be manufactured for a total price of $20,000. Irs free file fillable forms You shipped the furniture to the customer in December 2012, but it was not delivered and accepted until January 2013. Irs free file fillable forms For tax purposes, you include the $8,000 advance payment in gross income for 2012; and include the remaining $12,000 of the contract price in gross income for 2013. Irs free file fillable forms Information schedule. Irs free file fillable forms   If you use the alternative method of reporting advance payments, you must attach a statement with the following information to your tax return each year. Irs free file fillable forms Total advance payments received in the current tax year. Irs free file fillable forms Total advance payments received in earlier tax years and not included in income before the current tax year. Irs free file fillable forms Total payments received in earlier tax years included in income for the current tax year. Irs free file fillable forms Exception for inventory goods. Irs free file fillable forms   If you have an agreement to sell goods properly included in inventory, you can postpone including the advance payment in income until the end of the second tax year following the year you receive an advance payment if, on the last day of the tax year, you meet the following requirements. Irs free file fillable forms You account for the advance payment under the alternative method (discussed earlier). Irs free file fillable forms You have received a substantial advance payment on the agreement (discussed next). Irs free file fillable forms You have enough substantially similar goods on hand, or available through your normal source of supply, to satisfy the agreement. Irs free file fillable forms These rules also apply to an agreement, such as a gift certificate, that can be satisfied with goods that cannot be identified in the tax year you receive an advance payment. Irs free file fillable forms   If you meet these conditions, all advance payments you receive by the end of the second tax year, including payments received in prior years but not reported, must be included in income by the second tax year following the tax year of receipt of substantial advance payments. Irs free file fillable forms You must also deduct in that second year all actual or estimated costs for the goods required to satisfy the agreement. Irs free file fillable forms If you estimated the cost, you must take into account any difference between the estimate and the actual cost when the goods are delivered. Irs free file fillable forms Note. Irs free file fillable forms You must report any advance payments you receive after the second year in the year received. Irs free file fillable forms No further deferral is allowed. Irs free file fillable forms Substantial advance payments. Irs free file fillable forms   Under an agreement for a future sale, you have substantial advance payments if, by the end of the tax year, the total advance payments received during that year and preceding tax years are equal to or more than the total costs reasonably estimated to be includible in inventory because of the agreement. Irs free file fillable forms Example. Irs free file fillable forms You are a calendar year, accrual method taxpayer who accounts for advance payments under the alternative method. Irs free file fillable forms In 2008, you entered into a contract for the sale of goods properly includible in your inventory. Irs free file fillable forms The total contract price is $50,000 and you estimate that your total inventoriable costs for the goods will be $25,000. Irs free file fillable forms You receive the following advance payments under the contract. Irs free file fillable forms 2009 $17,500 2010 10,000 2011 7,500 2012 5,000 2013 5,000 2014 5,000 Total contract price $50,000   Your customer asked you to deliver the goods in 2015. Irs free file fillable forms In your 2010 closing inventory, you had on hand enough of the type of goods specified in the contract to satisfy the contract. Irs free file fillable forms Since the advance payments you had received by the end of 2010 were more than the costs you estimated, the payments are substantial advance payments. Irs free file fillable forms   For 2012, include in income all payments you received by the end of 2012, the second tax year following the tax year in which you received substantial advance payments. Irs free file fillable forms You must include $40,000 in sales for 2012 (the total amounts received from 2009 through 2012) and include in inventory the cost of the goods (or similar goods) on hand. Irs free file fillable forms If no such goods are on hand, then estimate the cost necessary to satisfy the contract. Irs free file fillable forms   No further deferral is allowed. Irs free file fillable forms You must include in gross income the advance payment you receive each remaining year of the contract. Irs free file fillable forms Take into account the difference between any estimated cost of goods sold and the actual cost when you deliver the goods in 2015. Irs free file fillable forms IRS approval. Irs free file fillable forms   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payments for sales. Irs free file fillable forms Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply. Irs free file fillable forms The all-events test has been met. Irs free file fillable forms The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Irs free file fillable forms Economic performance has occurred. Irs free file fillable forms Economic Performance Generally, you cannot deduct or capitalize a business expense until economic performance occurs. Irs free file fillable forms If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used. Irs free file fillable forms If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Irs free file fillable forms Example. Irs free file fillable forms You are a calendar year taxpayer. Irs free file fillable forms You buy office supplies in December 2012. Irs free file fillable forms You receive the supplies and the bill in December, but you pay the bill in January 2013. Irs free file fillable forms You can deduct the expense in 2012 because all events have occurred to fix the liability, the amount of the liability can be determined, and economic performance occurred in 2012. Irs free file fillable forms Your office supplies may qualify as a recurring item, discussed later. Irs free file fillable forms If so, you can deduct them in 2012, even if the supplies are not delivered until 2013 (when economic performance occurs). Irs free file fillable forms Workers' compensation and tort liability. Irs free file fillable forms   If you are required to make payments under workers' compensation laws or in satisfaction of any tort liability, economic performance occurs as you make the payments. Irs free file fillable forms If you are required to make payments to a special designated settlement fund established by court order for a tort liability, economic performance occurs as you make the payments. Irs free file fillable forms Taxes. Irs free file fillable forms   Economic performance generally occurs as estimated income tax, property taxes, employment taxes, etc. Irs free file fillable forms are paid. Irs free file fillable forms However, you can elect to treat taxes as a recurring item, discussed later. Irs free file fillable forms You can also elect to ratably accrue real estate taxes. Irs free file fillable forms See chapter 5 of Publication 535 for information about real estate taxes. Irs free file fillable forms Other liabilities. Irs free file fillable forms   Other liabilities for which economic performance occurs as you make payments include liabilities for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, and warranty and service contracts. Irs free file fillable forms Interest. Irs free file fillable forms   Economic performance occurs with the passage of time (as the borrower uses, and the lender forgoes use of, the lender's money) rather than as payments are made. Irs free file fillable forms Compensation for services. Irs free file fillable forms   Generally, economic performance occurs as an employee renders service to the employer. Irs free file fillable forms However, deductions for compensation or other benefits paid to an employee in a year subsequent to economic performance are subject to the rules governing deferred compensation, deferred benefits, and funded welfare benefit plans. Irs free file fillable forms For information on employee benefit programs, see Publication 15-B, Employer's Tax Guide to Fringe Benefits. Irs free file fillable forms Vacation pay. Irs free file fillable forms   You can take a current deduction for vacation pay earned by your employees if you pay it during the year or, if the amount is vested, within 2½ months after the end of the year. Irs free file fillable forms If you pay it later than this, you must deduct it in the year actually paid. Irs free file fillable forms An amount is vested if your right to it cannot be nullified or cancelled. Irs free file fillable forms Exception for recurring items. Irs free file fillable forms   An exception to the economic performance rule allows certain recurring items to be treated as incurred during the tax year even though economic performance has not occurred. Irs free file fillable forms The exception applies if all the following requirements are met. Irs free file fillable forms The all-events test, discussed earlier, is met. Irs free file fillable forms Economic performance occurs by the earlier of the following dates. Irs free file fillable forms 8½ months after the close of the year. Irs free file fillable forms The date you file a timely return (including extensions) for the year. Irs free file fillable forms The item is recurring in nature and you consistently treat similar items as incurred in the tax year in which the all-events test is met. Irs free file fillable forms Either: The item is not material, or Accruing the item in the year in which the all-events test is met results in a better match against income than accruing the item in the year of economic performance. Irs free file fillable forms This exception does not apply to workers' compensation or tort liabilities. Irs free file fillable forms Amended return. Irs free file fillable forms   You may be able to file an amended return and treat a liability as incurred under the recurring item exception. Irs free file fillable forms You can do so if economic performance for the liability occurs after you file your tax return for the year, but within 8½ months after the close of the tax year. Irs free file fillable forms Recurrence and consistency. Irs free file fillable forms   To determine whether an item is recurring and consistently reported, consider the frequency with which the item and similar items are incurred (or expected to be incurred) and how you report these items for tax purposes. Irs free file fillable forms A new expense or an expense not incurred every year can be treated as recurring if it is reasonable to expect that it will be incurred regularly in the future. Irs free file fillable forms Materiality. Irs free file fillable forms   Factors to consider in determining the materiality of a recurring item include the size of the item (both in absolute terms and in relation to your income and other expenses) and the treatment of the item on your financial statements. Irs free file fillable forms   An item considered material for financial statement purposes is also considered material for tax purposes. Irs free file fillable forms However, in certain situations an immaterial item for financial accounting purposes is treated as material for purposes of economic performance. Irs free file fillable forms Matching expenses with income. Irs free file fillable forms   Costs directly associated with the revenue of a period are properly allocable to that period. Irs free file fillable forms To determine whether the accrual of an expense in a particular year results in a better match with the income to which it relates, generally accepted accounting principles (GAAP; visit www. Irs free file fillable forms fasab. Irs free file fillable forms gov/accepted. Irs free file fillable forms html) are an important factor. Irs free file fillable forms   For example, if you report sales income in the year of sale, but you do not ship the goods until the following year, the shipping costs are more properly matched to income in the year of sale than the year the goods are shipped. Irs free file fillable forms Expenses that cannot be practically associated with income of a particular period, such as advertising costs, should be assigned to the period the costs are incurred. Irs free file fillable forms However, the matching requirement is considered met for certain types of expenses. Irs free file fillable forms These expenses include taxes, payments under insurance, warranty, and service contracts, rebates, refunds, awards, prizes, and jackpots. Irs free file fillable forms Expenses Paid in Advance An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Irs free file fillable forms Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Irs free file fillable forms 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Irs free file fillable forms If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must get IRS approval before using the general rule and/or the 12-month rule. Irs free file fillable forms See Change in Accounting Method, later, for information on how to get IRS approval. Irs free file fillable forms See Expense paid in advance under Cash Method, earlier, for examples illustrating the application of the general and 12-month rules. Irs free file fillable forms Related Persons Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Irs free file fillable forms Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. Irs free file fillable forms See section 267 of the Internal Revenue Code and Publication 542, Corporations, for the definition of related person. Irs free file fillable forms Inventories An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Irs free file fillable forms If you must account for an inventory in your business, you must use an accrual method of accounting for your purchases and sales. Irs free file fillable forms However, see Exceptions, next. Irs free file fillable forms See also Accrual Method, earlier. Irs free file fillable forms To figure taxable income, you must value your inventory at the beginning and end of each tax year. Irs free file fillable forms To determine the value, you need a method for identifying the items in your inventory and a method for valuing these items. Irs free file fillable forms See Identifying Cost and Valuing Inventory, later. Irs free file fillable forms The rules for valuing inventory are not the same for all businesses. Irs free file fillable forms The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Irs free file fillable forms Your inventory practices must be consistent from year to year. Irs free file fillable forms The rules discussed here apply only if they do not conflict with the uniform capitalization rules of section 263A and the mark-to-market rules of section 475. Irs free file fillable forms Exceptions The following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. Irs free file fillable forms These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later). Irs free file fillable forms A qualifying taxpayer under Revenue Procedure 2001-10 on page 272 of Internal Revenue Bulletin 2001-2, available at www. Irs free file fillable forms irs. Irs free file fillable forms gov/pub/irs-irbs/irb01–02. Irs free file fillable forms pdf. Irs free file fillable forms A qualifying small business taxpayer under Revenue Procedure 2002-28, on page 815 of Internal Revenue Bulletin 2002-18, available at www. Irs free file fillable forms irs. Irs free file fillable forms gov/pub/irs-irbs/irb02–18. Irs free file fillable forms pdf. Irs free file fillable forms In addition to the information provided in this publication, you should see the revenue procedures referenced in the list, above, and the instructions for Form 3115 for information you will need to adopt or change to these accounting methods (see Changing methods, later). Irs free file fillable forms Qualifying taxpayer. Irs free file fillable forms   You are a qualifying taxpayer under Revenue Procedure 2001-10 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 17, 1998 (see Gross receipts test for qualifying taxpayers, next). Irs free file fillable forms Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $1 million or less. Irs free file fillable forms You are not a tax shelter as defined under section 448(d)(3) of the Internal Revenue Code. Irs free file fillable forms Gross receipts test for qualifying taxpayers. Irs free file fillable forms   To determine if you meet the gross receipts test for qualifying taxpayers, use the following steps: Step 1. Irs free file fillable forms List each of the test years. Irs free file fillable forms For qualifying taxpayers under Revenue Procedure 2001-10, the test years are each prior tax year ending on or after December 17, 1998. Irs free file fillable forms Step 2. Irs free file fillable forms Determine your average annual gross receipts for each test year listed in Step 1. Irs free file fillable forms Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Irs free file fillable forms Step 3. Irs free file fillable forms You meet the gross receipts test for qualifying taxpayers if your average annual gross receipts for each test year listed in Step 1 is $1 million or less. Irs free file fillable forms Qualifying small business taxpayer. Irs free file fillable forms   You are a qualifying small business taxpayer under Revenue Procedure 2002-28 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 31, 2000 (see Gross receipts test for qualifying small business taxpayers, next). Irs free file fillable forms Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $10 million or less. Irs free file fillable forms You are not prohibited from using the cash method under section 448 of the Internal Revenue Code. Irs free file fillable forms Your principle business activity is an eligible business. Irs free file fillable forms See Eligible business, later. Irs free file fillable forms You have not changed (or have not been required to change) from the cash method because you became ineligible to use the cash method under Revenue Procedure 2002-28. Irs free file fillable forms Note. Irs free file fillable forms Revenue Procedure 2002-28 does not apply to a farming business of a qualifying small business taxpayer. Irs free file fillable forms A taxpayer engaged in the trade or business of farming generally is allowed to use the cash method for any farming business. Irs free file fillable forms See Special rules for farming businesses under Cash Method, earlier. Irs free file fillable forms Gross receipts test for qualifying small business taxpayers. Irs free file fillable forms   To determine if you meet the gross receipts test for qualifying small business taxpayers, use the following steps: Step 1. Irs free file fillable forms List each of the test years. Irs free file fillable forms For qualifying small business taxpayers under Revenue Procedure 2002-28, the test years are each prior tax year ending on or after December 31, 2000. Irs free file fillable forms Step 2. Irs free file fillable forms Determine your average annual gross receipts for each test year listed in Step 1. Irs free file fillable forms Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Irs free file fillable forms Step 3. Irs free file fillable forms You meet the gross receipts test for qualifying small business taxpayers if your average annual gross receipts for each test year listed in Step 1 is $10 million or less. Irs free file fillable forms Eligible business. Irs free file fillable forms   An eligible business is any business for which a qualified small business taxpayer can use the cash method and choose to not keep an inventory. Irs free file fillable forms You have an eligible business if you meet any of the following requirements. Irs free file fillable forms Your principal business activity is described in a North American Industry Classification System (NAICS) code other than any of the following NAICS subsector codes: NAICS codes 211 and 212 (mining activities). Irs free file fillable forms NAICS codes 31-33 (manufacturing). Irs free file fillable forms NAICS code 42 (wholesale trade). Irs free file fillable forms NAICS codes 44-45 (retail trade). Irs free file fillable forms NAICS codes 5111 and 5122 (information industries). Irs free file fillable forms Your principal business activity is the provision of services, including the provision of property incident to those services. Irs free file fillable forms Your principal business activity is the fabrication or modification of tangible personal property upon demand in accordance with customer design or specifications. Irs free file fillable forms   Information about the NAICS codes can be found at http://www. Irs free file fillable forms census. Irs free file fillable forms gov/naics or in the instructions for your federal income tax return. Irs free file fillable forms Gross receipts. Irs free file fillable forms   In general, gross receipts must include all receipts from all your trades or businesses that must be recognized under the method of accounting you used for that tax year for federal income tax purposes. Irs free file fillable forms See the definit
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Irs free file fillable forms 13. Irs free file fillable forms   Payment of Taxes Table of Contents How To Make Deposits When To Make Deposits Amount of DepositsSafe Harbor Rule Generally, semimonthly deposits of excise taxes are required. Irs free file fillable forms A semimonthly period is the first 15 days of a month (the first semimonthly period) or the 16th through the last day of a month (the second semimonthly period). Irs free file fillable forms However, no deposit is required for the situations listed below; the taxes are payable with Form 720. Irs free file fillable forms The net liability for taxes listed in Part I (Form 720) does not exceed $2,500 for the quarter. Irs free file fillable forms The gas guzzler tax is being paid on a one-time filing. Irs free file fillable forms The liability is for taxes listed in Part II (Form 720), except for the floor stocks tax which generally requires a single deposit. Irs free file fillable forms How To Make Deposits Electronic deposit requirement. Irs free file fillable forms   You must use electronic funds transfer to make excise tax deposits. Irs free file fillable forms Generally, electronic funds transfers are made using the Electronic Federal Tax Payment System (EFTPS). Irs free file fillable forms If you do not want to use EFTPS, you can arrange for your tax professional, financial institution, payroll service, or other trusted third party to make deposits on your behalf. Irs free file fillable forms Also, you may arrange for your financial institution to initiate a same-day wire payment on your behalf. Irs free file fillable forms   EFTPS is a free service provided by the Department of Treasury. Irs free file fillable forms Services provided by your tax professional, financial institution, payroll service, or other third party may have a fee. Irs free file fillable forms To get more information about EFTPS or to enroll in EFTPS, visit www. Irs free file fillable forms eftps. Irs free file fillable forms gov or call 1-800-555-4477. Irs free file fillable forms Additional information about EFTPS is also available in Publication 966, Electronic Federal Tax Payment System: A Guide to Getting Started. Irs free file fillable forms    Depositing on time. Irs free file fillable forms For EFTPS deposits to be on time, you must initiate the transaction at least 1 day before the date the deposit is due (before 8:00 p. Irs free file fillable forms m. Irs free file fillable forms Eastern time). Irs free file fillable forms You will automatically be enrolled in EFTPS when you apply for an EIN. Irs free file fillable forms You will receive a separate mailing containing instructions for activating your EFTPS enrollment after you receive your EIN. Irs free file fillable forms When To Make Deposits There are two methods for determining deposits: the regular method and the alternative method. Irs free file fillable forms The regular method applies to all taxes in Part I of Form 720 except for communications and air transportation taxes if deposits are based on amounts billed or tickets sold, rather than on amounts actually collected. Irs free file fillable forms See Alternative method below. Irs free file fillable forms If you are depositing more than one tax under a method, combine all the taxes under the method and make one deposit for the semimonthly period. Irs free file fillable forms Regular method. Irs free file fillable forms   The deposit of tax for a semimonthly period is due by the 14th day following that period. Irs free file fillable forms Generally, this is the 29th day of a month for the first semimonthly period and the 14th day of the following month for the second semimonthly period. Irs free file fillable forms If the 14th or the 29th day falls on a Saturday, Sunday, or legal holiday, you must make the deposit by the immediately preceding day that is not a Saturday, Sunday, or legal holiday. Irs free file fillable forms Alternative method (IRS Nos. Irs free file fillable forms 22, 26, 27, and 28). Irs free file fillable forms   Deposits of communications and air transportation taxes may be based on taxes included in amounts billed or tickets sold during a semimonthly period instead of on taxes actually collected during the period. Irs free file fillable forms Under the alternative method, the tax included in amounts billed or tickets sold during a semimonthly period is considered collected during the first 7 days of the second following semimonthly period. Irs free file fillable forms The deposit of tax is due by the 3rd banking day after the 7th day of that period. Irs free file fillable forms   For an example of the alternative method, see the Instructions for Form 720. Irs free file fillable forms To use the alternative method, you must keep a separate account of the tax included in amounts billed or tickets sold during the month and report on Form 720 the tax included in amounts billed or tickets sold and not the amount of tax that is actually collected. Irs free file fillable forms For example, amounts billed in December, January, and February are considered collected during January, February, and March and are reported on Form 720 as the tax for the 1st quarter of the calendar year. Irs free file fillable forms The separate account for each month must reflect: All items of tax included in amounts billed or tickets sold during the month, and Other items of adjustment relating to tax for prior months (within the statute of limitations on credits or refunds). Irs free file fillable forms The separate account for any month cannot include an adjustment resulting from a refusal to pay or inability to collect unless the refusal has been reported to the IRS. Irs free file fillable forms See Uncollected Tax Report in chapter 4. Irs free file fillable forms The net amount of tax that is considered collected during the semimonthly period must be either: The net amount of tax reflected in the separate account for the corresponding semimonthly period of the preceding month, or One-half of the net amount of tax reflected in the separate account for the preceding month. Irs free file fillable forms Special rule for deposits of taxes in September. Irs free file fillable forms   See the Instructions for Form 720 for a special rule on deposits made in September. Irs free file fillable forms Amount of Deposits Deposits for a semimonthly period generally must be at least 95% of the net tax liability for that period unless the safe harbor rule (discussed later) applies. Irs free file fillable forms Generally, you do not have to make a deposit for a period in which you incurred no tax liability. Irs free file fillable forms Net tax liability. Irs free file fillable forms   Your net tax liability is your tax liability for the period minus any claims on Schedule C (Form 720) for the period. Irs free file fillable forms You may figure your net tax liability for a semimonthly period by dividing your net liability incurred during the calendar month by two. Irs free file fillable forms If you use this method, you must use it for all semimonthly periods in the calendar quarter. Irs free file fillable forms Do not reduce your liability by any amounts from Form 720X. Irs free file fillable forms Safe Harbor Rule The safe harbor rule applies separately to deposits under the regular method and the alternative method. Irs free file fillable forms Persons who filed Form 720 for the look-back quarter (the 2nd calendar quarter preceding the current quarter) are considered to meet the semimonthly deposit requirement if the deposit for each semimonthly period in the current quarter is at least 1/6 (16. Irs free file fillable forms 67%) of the net tax liability reported for the look-back quarter. Irs free file fillable forms For the semimonthly period for which the additional deposit is required, the additional deposit must be at least 11/90 12. Irs free file fillable forms 23%), 10/90 (11. Irs free file fillable forms 12%) for non-EFTPS, of the net tax liability reported for the look-back quarter. Irs free file fillable forms Also, the total deposit for that semimonthly period must be at least 1/6 (16. Irs free file fillable forms 67%) of the net tax liability reported for the look-back quarter. Irs free file fillable forms Exceptions. Irs free file fillable forms   The safe harbor rule does not apply to: The 1st and 2nd quarters beginning on or after the effective date of an increase in the rate of tax unless the deposit of taxes for each semimonthly period in the calendar quarter is at least 1/6 (16. Irs free file fillable forms 67%) of the tax liability you would have had for the look-back quarter if the increased rate of tax had been in effect for that look-back quarter, Any quarter if liability includes any tax not in effect throughout the look-back quarter, or For deposits under the alternative method, any quarter if liability includes any tax not in effect throughout the look-back quarter and the month preceding the look-back quarter. Irs free file fillable forms Requirements to be met. Irs free file fillable forms   For the safe harbor rule to apply, you must: Make each deposit timely at an authorized financial institution, and Pay any underpayment for the current quarter by the due date of the return. Irs free file fillable forms    The IRS may withdraw the right to make deposits of tax using the safe harbor rule from any person not complying with these rules. Irs free file fillable forms Tax rate increases. Irs free file fillable forms   You must modify the safe harbor rule if there has been an increase in the rate of tax. Irs free file fillable forms You must figure your tax liability in the look-back quarter as if the increased rate had been in effect. Irs free file fillable forms To qualify for the safe harbor rule, your deposits cannot be less than 1/6 of the refigured tax liability. Irs free file fillable forms Prev  Up  Next   Home   More Online Publications