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Tax 2012Tax 2012 2. Tax 2012 Accounting Periods and Methods Table of Contents Introduction Useful Items - You may want to see: Accounting Periods Accounting MethodsCash Method Accrual Method Combination Method Inventories Uniform Capitalization Rules Special Methods Change in Accounting Method Introduction You must figure your taxable income and file an income tax return for an annual accounting period called a tax year. Tax 2012 Also, you must consistently use an accounting method that clearly shows your income and expenses for the tax year. Tax 2012 Useful Items - You may want to see: Publication 538 Accounting Periods and Methods See chapter 12 for information about getting publications and forms. Tax 2012 Accounting Periods When preparing a statement of income and expenses (generally your income tax return), you must use your books and records for a specific interval of time called an accounting period. Tax 2012 The annual accounting period for your income tax return is called a tax year. Tax 2012 You can use one of the following tax years. Tax 2012 A calendar tax year. Tax 2012 A fiscal tax year. Tax 2012 Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. Tax 2012 A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. Tax 2012 Calendar tax year. Tax 2012 A calendar tax year is 12 consecutive months beginning January 1 and ending December 31. Tax 2012 You must adopt the calendar tax year if any of the following apply. Tax 2012 You do not keep books. Tax 2012 You have no annual accounting period. Tax 2012 Your present tax year does not qualify as a fiscal year. Tax 2012 Your use of the calendar tax year is required under the Internal Revenue Code or the Income Tax Regulations. Tax 2012 If you filed your first income tax return using the calendar tax year and you later begin business as a sole proprietor, you must continue to use the calendar tax year unless you get IRS approval to change it or are otherwise allowed to change it without IRS approval. Tax 2012 For more information, see Change in tax year, later. Tax 2012 If you adopt the calendar tax year, you must maintain your books and records and report your income and expenses for the period from January 1 through December 31 of each year. Tax 2012 Fiscal tax year. Tax 2012 A fiscal tax year is 12 consecutive months ending on the last day of any month except December. Tax 2012 A 52-53-week tax year is a fiscal tax year that varies from 52 to 53 weeks but does not have to end on the last day of a month. Tax 2012 If you adopt a fiscal tax year, you must maintain your books and records and report your income and expenses using the same tax year. Tax 2012 For more information on a fiscal tax year, including a 52-53-week tax year, see Publication 538. Tax 2012 Change in tax year. Tax 2012 Generally, you must file Form 1128, Application To Adopt, Change, or Retain a Tax Year, to request IRS approval to change your tax year. Tax 2012 See the Instructions for Form 1128 for exceptions. Tax 2012 If you qualify for an automatic approval request, a user fee is not required. Tax 2012 If you do not qualify for automatic approval, a ruling must be requested. Tax 2012 See the instructions for Form 1128 for information about user fees if you are requesting a ruling. Tax 2012 Accounting Methods An accounting method is a set of rules used to determine when and how income and expenses are reported. Tax 2012 Your accounting method includes not only the overall method of accounting you use, but also the accounting treatment you use for any material item. Tax 2012 You choose an accounting method for your business when you file your first income tax return that includes a Schedule C for the business. Tax 2012 After that, if you want to change your accounting method, you must generally get IRS approval. Tax 2012 See Change in Accounting Method, later. Tax 2012 Kinds of methods. Tax 2012 Generally, you can use any of the following accounting methods. Tax 2012 Cash method. Tax 2012 An accrual method. Tax 2012 Special methods of accounting for certain items of income and expenses. Tax 2012 Combination method using elements of two or more of the above. Tax 2012 You must use the same accounting method to figure your taxable income and to keep your books. Tax 2012 Also, you must use an accounting method that clearly shows your income. Tax 2012 Business and personal items. Tax 2012 You can account for business and personal items under different accounting methods. Tax 2012 For example, you can figure your business income under an accrual method, even if you use the cash method to figure personal items. Tax 2012 Two or more businesses. Tax 2012 If you have two or more separate and distinct businesses, you can use a different accounting method for each if the method clearly reflects the income of each business. Tax 2012 They are separate and distinct only if you maintain complete and separate books and records for each business. Tax 2012 Cash Method Most individuals and many sole proprietors with no inventory use the cash method because they find it easier to keep cash method records. Tax 2012 However, if an inventory is necessary to account for your income, you must generally use an accrual method of accounting for sales and purchases. Tax 2012 For more information, see Inventories, later. Tax 2012 Income Under the cash method, include in your gross income all items of income you actually or constructively receive during your tax year. Tax 2012 If you receive property or services, you must include their fair market value in income. Tax 2012 Example. Tax 2012 On December 30, 2012, Mrs. Tax 2012 Sycamore sent you a check for interior decorating services you provided to her. Tax 2012 You received the check on January 2, 2013. Tax 2012 You must include the amount of the check in income for 2013. Tax 2012 Constructive receipt. Tax 2012 You have constructive receipt of income when an amount is credited to your account or made available to you without restriction. Tax 2012 You do not need to have possession of it. Tax 2012 If you authorize someone to be your agent and receive income for you, you are treated as having received it when your agent received it. Tax 2012 Example. Tax 2012 Interest is credited to your bank account in December 2013. Tax 2012 You do not withdraw it or enter it into your passbook until 2014. Tax 2012 You must include it in your gross income for 2013. Tax 2012 Delaying receipt of income. Tax 2012 You cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. Tax 2012 You must report the income in the year the property is received or made available to you without restriction. Tax 2012 Example. Tax 2012 Frances Jones, a service contractor, was entitled to receive a $10,000 payment on a contract in December 2013. Tax 2012 She was told in December that her payment was available. Tax 2012 At her request, she was not paid until January 2014. Tax 2012 She must include this payment in her 2013 income because it was constructively received in 2013. Tax 2012 Checks. Tax 2012 Receipt of a valid check by the end of the tax year is constructive receipt of income in that year, even if you cannot cash or deposit the check until the following year. Tax 2012 Example. Tax 2012 Dr. Tax 2012 Redd received a check for $500 on December 31, 2013, from a patient. Tax 2012 She could not deposit the check in her business account until January 2, 2014. Tax 2012 She must include this fee in her income for 2013. Tax 2012 Debts paid by another person or canceled. Tax 2012 If your debts are paid by another person or are canceled by your creditors, you may have to report part or all of this debt relief as income. Tax 2012 If you receive income in this way, you constructively receive the income when the debt is canceled or paid. Tax 2012 For more information, see Canceled Debt under Kinds of Income in chapter 5. Tax 2012 Repayment of income. Tax 2012 If you include an amount in income and in a later year you have to repay all or part of it, you can usually deduct the repayment in the year in which you make it. Tax 2012 If the amount you repay is over $3,000, a special rule applies. Tax 2012 For details about the special rule, see Repayments in chapter 11 of Publication 535, Business Expenses. Tax 2012 Expenses Under the cash method, you generally deduct expenses in the tax year in which you actually pay them. Tax 2012 This includes business expenses for which you contest liability. Tax 2012 However, you may not be able to deduct an expense paid in advance or you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules. Tax 2012 Expenses paid in advance. Tax 2012 You can deduct an expense you pay in advance only in the year to which it applies. Tax 2012 Example. Tax 2012 You are a calendar year taxpayer and you pay $1,000 in 2013 for a business insurance policy effective for one year, beginning July 1. Tax 2012 You can deduct $500 in 2013 and $500 in 2014. Tax 2012 Accrual Method Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. Tax 2012 The purpose of an accrual method of accounting is to match income and expenses in the correct year. Tax 2012 Income—General Rule Under an accrual method, you generally include an amount in your 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. Tax 2012 Example. Tax 2012 You are a calendar year accrual method taxpayer. Tax 2012 You sold a computer on December 28, 2013. Tax 2012 You billed the customer in the first week of January 2014, but you did not receive payment until February 2014. Tax 2012 You must include the amount received for the computer in your 2013 income. Tax 2012 Income—Special Rules The following are special rules that apply to advance payments, estimating income, and changing a payment schedule for services. Tax 2012 Estimated income. Tax 2012 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 in which you make the determination. Tax 2012 Change in payment schedule for services. Tax 2012 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 lower rate until you complete the services and then receive the difference. Tax 2012 Advance payments for services. Tax 2012 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. Tax 2012 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. Tax 2012 However, you cannot postpone including any payment beyond that tax year. Tax 2012 For more information, see Advance Payment for Services under Accrual Method in Publication 538. Tax 2012 That publication also explains special rules for reporting the following types of income. Tax 2012 Advance payments for service agreements. Tax 2012 Prepaid rent. Tax 2012 Advance payments for sales. Tax 2012 Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods you hold primarily for sale to your customers in the ordinary course of your business. Tax 2012 If the advance payments are for contracts involving both the sale and service of goods, it may be necessary to treat them as two agreements. Tax 2012 An agreement includes a gift certificate that can be redeemed for goods. Tax 2012 Treat amounts that are due and payable as amounts you received. Tax 2012 You generally include an advance payment in income for the tax year in which you receive it. Tax 2012 However, you can use an alternative method. Tax 2012 For information about the alternative method, see Publication 538. Tax 2012 Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply. Tax 2012 The all-events test has been met. Tax 2012 The test has been met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Tax 2012 Economic performance has occurred. Tax 2012 Economic performance. Tax 2012 You generally cannot deduct or capitalize a business expense until economic performance occurs. Tax 2012 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 as the property is used. Tax 2012 If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Tax 2012 An exception allows certain recurring items to be treated as incurred during a tax year even though economic performance has not occurred. Tax 2012 For more information on economic performance, see Economic Performance under Accrual Method in Publication 538. Tax 2012 Example. Tax 2012 You are a calendar year taxpayer and use an accrual method of accounting. Tax 2012 You buy office supplies in December 2013. Tax 2012 You receive the supplies and the bill in December, but you pay the bill in January 2014. Tax 2012 You can deduct the expense in 2013 because all events that fix the fact of liability have occurred, the amount of the liability could be reasonably determined, and economic performance occurred in that year. Tax 2012 Your office supplies may qualify as a recurring expense. Tax 2012 In that case, you can deduct them in 2013 even if the supplies are not delivered until 2014 (when economic performance occurs). Tax 2012 Keeping inventories. Tax 2012 When the production, purchase, or sale of merchandise is an income-producing factor in your business, you must generally take inventories into account at the beginning and the end of your tax year. Tax 2012 If you must account for an inventory, you must generally use an accrual method of accounting for your purchases and sales. Tax 2012 For more information, see Inventories , later. Tax 2012 Special rule for related persons. Tax 2012 You cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until you make the payment and the corresponding amount is includible in the related person's gross income. Tax 2012 Determine the relationship, for this rule, as of the end of the tax year for which the expense or interest would otherwise be deductible. Tax 2012 If a deduction is not allowed under this rule, the rule will continue to apply even if your relationship with the person ends before the expense or interest is includible in the gross income of that person. Tax 2012 Related persons include members of your immediate family, including only brothers and sisters (either whole or half), your spouse, ancestors, and lineal descendants. Tax 2012 For a list of other related persons, see section 267 of the Internal Revenue Code. Tax 2012 Combination Method You can generally use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. Tax 2012 However, the following restrictions apply. Tax 2012 If an inventory is necessary to account for your income, you must generally use an accrual method for purchases and sales. Tax 2012 (See, however, Inventories, later. Tax 2012 ) You can use the cash method for all other items of income and expenses. Tax 2012 If you use the cash method for figuring your income, you must use the cash method for reporting your expenses. Tax 2012 If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Tax 2012 If you use a combination method that includes the cash method, treat that combination method as the cash method. Tax 2012 Inventories Generally, if you produce, purchase, or sell merchandise in your business, you must keep an inventory and use the accrual method for purchases and sales of merchandise. Tax 2012 However, the following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. Tax 2012 These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later). Tax 2012 A qualifying taxpayer under Revenue Procedure 2001-10 in Internal Revenue Bulletin 2001-2. Tax 2012 A qualifying small business taxpayer under Revenue Procedure 2002-28 in Internal Revenue Bulletin 2002-18. Tax 2012 Qualifying taxpayer. Tax 2012 You are a qualifying taxpayer if: Your average annual gross receipts for each prior tax year ending on or after December 17, 1998, is $1 million or less. Tax 2012 (Your average annual gross receipts for a tax year is figured by adding the gross receipts for that tax year and the 2 preceding tax years and dividing by 3. Tax 2012 ) Your business is not a tax shelter, as defined under section 448(d)(3) of the Internal Revenue Code. Tax 2012 Qualifying small business taxpayer. Tax 2012 You are a qualifying small business taxpayer if: Your average annual gross receipts for each prior tax year ending on or after December 31, 2000, is more than $1 million but not more than $10 million. Tax 2012 (Your average annual gross receipts for a tax year is figured by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Tax 2012 ) You are not prohibited from using the cash method under section 448 of the Internal Revenue Code. Tax 2012 Your principal business activity is an eligible business (described in Publication 538 and Revenue Procedure 2002-28). Tax 2012 Business not owned or not in existence for 3 years. Tax 2012 If you did not own your business for all of the 3-tax-year period used in figuring your average annual gross receipts, include the period of any predecessor. Tax 2012 If your business has not been in existence for the 3-tax-year period, base your average on the period it has existed including any short tax years, annualizing the short tax year's gross receipts. Tax 2012 Materials and supplies that are not incidental. Tax 2012 If you account for inventoriable items as materials and supplies that are not incidental, you will deduct the cost of the items you would otherwise include in inventory in the year you sell the items, or the year you pay for them, whichever is later. Tax 2012 If you are a producer, you can use any reasonable method to estimate the raw material in your work in process and finished goods on hand at the end of the year to determine the raw material used to produce finished goods that were sold during the year. Tax 2012 Changing accounting method. Tax 2012 If you are a qualifying taxpayer or qualifying small business taxpayer and want to change to the cash method or to account for inventoriable items as non-incidental materials and supplies, you must file Form 3115, Application for Change in Accounting Method. Tax 2012 See Change in Accounting Method, later. Tax 2012 More information. Tax 2012 For more information about the qualifying taxpayer exception, see Revenue Procedure 2001-10 in Internal Revenue Bulletin 2001-2. Tax 2012 For more information about the qualifying small business taxpayer exception, see Revenue Procedure 2002-28 in Internal Revenue Bulletin 2002-18. Tax 2012 Items included in inventory. Tax 2012 If you are required to account for inventories, include the following items when accounting for your inventory. Tax 2012 Merchandise or stock in trade. Tax 2012 Raw materials. Tax 2012 Work in process. Tax 2012 Finished products. Tax 2012 Supplies that physically become a part of the item intended for sale. Tax 2012 Valuing inventory. Tax 2012 You must value your inventory at the beginning and end of each tax year to determine your cost of goods sold (Schedule C, line 42). Tax 2012 To determine the value of your inventory, you need a method for identifying the items in your inventory and a method for valuing these items. Tax 2012 Inventory valuation rules cannot be the same for all kinds of businesses. Tax 2012 The method you use to value your inventory must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Tax 2012 Your inventory practices must be consistent from year to year. Tax 2012 More information. Tax 2012 For more information about inventories, see Publication 538. Tax 2012 Uniform Capitalization Rules Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for production or resale activities. Tax 2012 Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. Tax 2012 You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Tax 2012 Activities subject to the uniform capitalization rules. Tax 2012 You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit. Tax 2012 Produce real or tangible personal property. Tax 2012 For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property. Tax 2012 Acquire property for resale. Tax 2012 Exceptions. Tax 2012 These rules do not apply to the following property. Tax 2012 Personal property you acquire for resale if your average annual gross receipts are $10 million or less. Tax 2012 Property you produce if you meet either of the following conditions. Tax 2012 Your indirect costs of producing the property are $200,000 or less. Tax 2012 You use the cash method of accounting and do not account for inventories. Tax 2012 For more information, see Inventories, earlier. Tax 2012 Special Methods There are special methods of accounting for certain items of income or expense. Tax 2012 These include the following. Tax 2012 Amortization, discussed in chapter 8 of Publication 535, Business Expenses. Tax 2012 Bad debts, discussed in chapter 10 of Publication 535. Tax 2012 Depletion, discussed in chapter 9 of Publication 535. Tax 2012 Depreciation, discussed in Publication 946, How To Depreciate Property. Tax 2012 Installment sales, discussed in Publication 537, Installment Sales. Tax 2012 Change in Accounting Method Once you have set up your accounting method, you must generally get IRS approval before you can change to another method. Tax 2012 A change in your accounting method includes a change in: Your overall method, such as from cash to an accrual method, and Your treatment of any material item. Tax 2012 To get approval, you must file Form 3115, Application for Change in Accounting Method. Tax 2012 You can get IRS approval to change an accounting method under either the automatic change procedures or the advance consent request procedures. Tax 2012 You may have to pay a user fee. Tax 2012 For more information, see the form instructions. Tax 2012 Automatic change procedures. Tax 2012 Certain taxpayers can presume to have IRS approval to change their method of accounting. Tax 2012 The approval is granted for the tax year for which the taxpayer requests a change (year of change), if the taxpayer complies with the provisions of the automatic change procedures. Tax 2012 No user fee is required for an application filed under an automatic change procedure generally covered in Revenue Procedure 2002-9. Tax 2012 Generally, you must use Form 3115 to request an automatic change. Tax 2012 For more information, see the Instructions for Form 3115. Tax 2012 Prev Up Next Home More Online Publications
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