An accounting method is a set of rules used to determine when and how income and expenses are reported on your U.S. company tax return. The accounting method includes not only the company’s overall method of accounting, but also the accounting treatment the company use for any material item. The U.S. company chooses an accounting method when it file first tax return. If you later want to change your accounting method, you must get IRS approval.
Generally, you can figure your taxable income under accrual method, cash method, special methods of accounting for certain items of income and expenses, or a hybrid method which combines elements of two or more of the above accounting methods. Here we will introduce more on the cash method.
Many small businesses use the cash method of accounting. However, the following entities cannot use the cash method, including any combination of methods that includes the cash method.
A corporation (other than an S corporation) with average annual gross receipts for the 3 preceding tax years exceeding $25 million.
A partnership with a corporation (other than an S corporation) as a partner, with average annual gross receipts for the 3 preceding tax years exceeding $25 million.
A tax shelter, as defined in section 448(d)(3).
Under the cash method, you include in your gross income all items of income you actually or constructively receive during the tax year. If you receive property and services, you must include their fair market value in income.
Income is constructively received when an amount is credited to your account or made available to you without restriction. You do not need to have possession of it. 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. Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations.
Under the cash method, generally, you deduct expenses in the tax year in which you actually pay them. This includes business expenses for which you contest liability. However, you may not be able to deduct an expense paid in advance. Instead, you may be required to capitalize certain costs.
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