Software Club 210: Light Red/Club_Software_210_Light_Red_Micro_Star_1997.iso/sba/f306.sbe

Text File | 1997-01-01 | 30KB | 840 lines

@Q01

     ┌─────────────────────────────────────────────────┐
     │ WHAT TAX ACCOUNTING METHOD MAY MY BUSINESS USE? │
     └─────────────────────────────────────────────────┘

Every new business (or newly-incorporated existing business)
must choose an overall tax accounting method -- generally
the cash method, accrual method, or one of the long-term
contract methods of accounting (percentage-of-completion or
completed contract).  As a rule, any business can use the
accrual method. Only certain types of businesses and taxpayers
are allowed to use the cash method of accounting, however,
and the use of long-term contract methods is strictly limited
(or even forbidden, in the case of the completed contract
method, for most large taxpayers).  It is usually quite
difficult to change accounting methods, once your company has
already adopted a method of accounting for tax purposes.

 QUESTION:  Has your company already filed at least one tax
 return (and thereby already elected an accounting method)?
@YN
01\Q02
02\Q03

@Q02

CONCLUSION:  Then you are probably stuck with your existing
method of accounting, for tax purposes.  It is possible,
of course to apply to the IRS for permission to change to
another permissible method of accounting, but don't count
on getting IRS approval any time soon if the change would
appear to be beneficial to you for tax purposes.  Certain
warm places in the universe may freeze over first.

However, the IRS will generally permit a "cash-basis"
taxpayer (one using the cash method) to switch to the accrual
basis of accounting on an expedited basis, without actually
having to receive IRS approval, by filing a Form 3115 with
the IRS, stating that one agrees to all the provisions of
Rev. Proc. 85-37 (or Rev. Proc. 85-36, if your business uses
inventories), and if one complies with certain other IRS
requirements regarding the change of method.

While many taxpayers will find the cash method is better for
them than the accrual method, the accrual method may actually
be preferable in a few situations.  For example, if your
business makes most of its sales for cash, rather than on
credit, and has relatively low levels of accounts receivable
outstanding at the end of each year, compared to its accounts
payable for expenses, then you might want to consider
applying to the IRS to change over to the accrual method.

@STOP

@Q03

QUESTION:  Which overall method of accounting do you want
           to know if your new business can adopt?

           1 - Cash method
           2 - Accrual method
           3 - Percentage-of-completion (long-term contract)
           4 - Completed contract (long-term contract)

@MC\04
01\Q04
02\Q13
03\Q14
04\Q17

@Q04

The cash method is often desirable, if you are permitted to
use it.  On the one hand, it gives you flexibility in shifting
income between taxable years, by either paying or not paying
various accrued expenses shortly before year-end.  Also, if
you anticipate that your firm will generally have more
accounts receivable at the end of each tax year than accounts
payable, the cash method will generally result in a deferral
of taxes for you, as compared to the accrual method.

However, the cash method is not allowed as the overall
accounting method where the production, purchase, or sale of
merchandise is a significant income-producing factor in the
business, thus requiring the use of inventories, and therefore
the accrual method of accounting, unless the IRS consents to
use of another method.  (Which is not likely.)

  QUESTION:  Is the production, purchase, or sale of
             merchandise a significant income-producing
             factor in your business?
@YN
01\Q05
02\Q06

@Q05

CONCLUSION:  Then you cannot use the cash method as the main
or overall method of accounting for your businesses (for tax
purposes).  A business that is required to use inventories
must use the accrual method of accounting, generally.

(However, it may be possible to use a hybrid method of
accounting, such as one where you use the cash method for the
service portion of your business and the accrual method with
respect to purchases and sales of goods from inventory.)

Note that if your firm carries on two or more separate trades
or businesses, you may be able to use different methods of
accounting for the different businesses, so long as each
separate business elects a method of accounting that is
permissible for its particular type of operation.

@STOP

@Q06

  QUESTION:  Is your business a "C corporation," or a
             partnership that has a C corporation as one
             of its partners?

@YN
01\Q08
02\Q07

@Q07

CONCLUSION:  Then it appears that your new business should
be able to use the cash method of accounting.  (This will
also be true in the case of a new business entity, if, for
example your existing business has just been incorporated
as an S corporation to continue to carry on a previously
operating partnership or sole proprietorship, and thus gets
to newly elect an accounting method on its first tax return
as a corporation.)

Most service businesses, or businesses that do not have
inventories, are allowed to use the cash method of
accounting, except that most C corporations with average
annual gross receipts of $5 million or more cannot use the
cash method, in general.

@STOP

@Q08

Large C corporations, or large partnerships with C
corporations as partners, are generally not allowed to
use the cash method of accounting.

However, there are exceptions for small C corporations (or
partnerships with C corporations for partners).   "Small"
corporations or partnerships are those with average annual
gross receipts for the three preceding years of no more
than $5 million a year.

  QUESTION:  Has your corporation (or partnership) had
             average annual gross receipts of more than $5
             million a year for the last 3 years?  (Certain
             closely-linked entities may have to be counted
             as one business, for purposes of computing
             annual gross receipts.)

@YN
01\Q10
02\Q09

@Q09

CONCLUSION:  Then your business should be able to elect the
cash method of tax accounting (at least for now).

It appears that your C corporation or partnership qualifies
for the small firm exception to the limitation on use of the
cash method.

@STOP

@Q10

Then you PROBABLY cannot use the cash method of accounting
for your C corporation (or partnership).  However, certain
special types of C corporations with average annual gross
receipts of over $5 million may still qualify for use of the
cash method (as well as partnerships whose C corporation
partners are "qualified personal service corporations"):

       .  "Qualified personal service corporations"; or

       .  Farming businesses (which does not include firms
          that process farm products).

(You may want to select Consulting Topic on "Personal Service
Corporations," to see if your C corporation is treated as a
"qualified personal service corporation" for tax purposes).

QUESTION:  Is your C corporation (or the C corporations that
  are partners in your partnership) a "qualified personal
  service corporation"?  (Or is it in the farming business?)
@YN
01\Q11
02\Q12

@Q11

CONCLUSION:  It appears that your firm should be entitled to
utilize the cash method of accounting, at least for now,
since you have indicated that either:

      .  Your C corporation is a "Qualified Personal Service
         Corporation" as defined by the tax laws; or

      .  Your business is a partnership with one or more
         C corporations as partners, and each such
         corporate partner is a "Qualified Personal
         Service Corporation"; or

      .  Your C corporation (or partnership) is engaged in
         the business of farming.

Note, however (for example), that if during a particular tax
year, a "qualified personal service corporation" ("QPSC")
were to cease to meet the definition of a QPSC at