Publication 538 - Accounting Periods And Methods (Page 11 of 19) in pdf

Example 2. You are a calendar year tax-

mated to be includible in inventory because of

Example. You are a calendar year tax-

payer. You manufacture household furniture

the agreement.

payer. You buy office supplies in December

and use an accrual method of accounting.

2002. You receive the supplies and the bill in

Example. You are a calendar year, accrual

Under this method, you accrue income for your

December, but you pay the bill in January 2003.

method taxpayer who accounts for advance

financial reports when you ship the furniture. For

You can deduct the expense in 2002 because all

tax purposes, you do not accrue income until the

payments under the alternative method. In

events have occurred to fix the fact of liability,

furniture has been delivered and accepted.

1999, you entered into a contract for the sale of

the liability can be determined, and economic

goods properly includible in your inventory. The

performance occurred in 2002.

In 2002, you received an advance payment

total contract price is $50,000 and you estimate

Your office supplies may qualify as a recur-

of $8,000 for an order of furniture to be manufac-

that your total inventoriable costs for the goods

ring item, discussed later. If so, you can deduct

tured for a total price of $20,000. You shipped

will be $25,000. You receive the following ad-

them in 2002, even if the supplies are not deliv-

the furniture to the customer in December 2002,

vance payments under the contract.

ered until 2003 (when economic performance

but it was not delivered and accepted until Janu-

occurs).

ary 2003. For tax purposes, you include the

1999 . . . . . . . . . . . . . . . . . . . . .

$17,500

$8,000 advance payment in gross income for

2000 . . . . . . . . . . . . . . . . . . . . .

10,000

Workers’ compensation and tort liability. If

2002 and you include the remaining $12,000 of

2001 . . . . . . . . . . . . . . . . . . . . .

7,500

you are required to make payments under work-

the contract price in gross income for 2003.

2002 . . . . . . . . . . . . . . . . . . . . .

5,000

ers’ compensation laws or in satisfaction of any

Information schedule. If you use the alter-

2003 . . . . . . . . . . . . . . . . . . . . .

5,000

tort liability, economic performance occurs as

2004 . . . . . . . . . . . . . . . . . . . . .

5,000

native method of reporting advance payments,

you make the payments. If you are required to

Total contract price . . . . . . . . . .

$50,000

you must attach a statement with the following

make payments to a special designated settle-

information to your tax return each year.

ment fund established by court order for a tort

Your customer asked you to deliver the

•

liability, economic performance occurs as you

goods in 2005. In your 2000 closing inventory,

Total advance payments received in the

make the payments.

you had on hand enough of the type of goods

current tax year.

specified in the contract to satisfy the contract.

•

Taxes. Economic performance generally oc-

Total advance payments received in ear-

Since the advance payments you had received

curs as estimated income tax, property taxes,

lier tax years and not included in income

by the end of 2000 were more than the costs you

employment taxes, etc. are paid. However, you

before the current tax year.

estimated, the payments are substantial ad-

can elect to treat taxes as a recurring item,

•

vance payments.

Total payments received in earlier tax

discussed later. You can also elect to ratably

Include in income for 2002 all payments you

years included in income for the current

accrue real estate taxes. See chapter 6 of Publi-

receive by the end of 2002, the second tax year

tax year.

cation 535 for information about real estate

following the tax year in which you received

taxes.

substantial advance payments. You must in-

Exception for inventory goods. If you have

clude $40,000 in sales for 2002 and include in

Interest. Economic performance occurs with

an agreement to sell goods properly included in

inventory the cost of the goods (or similar goods)

the passage of time (as the borrower uses, and

inventory, you can postpone including the ad-

on hand. If no such goods are on hand, then

the lender forgoes use of, the lender’s money)

vance payment in income until the end of the

estimate the cost necessary to satisfy the con-

rather than as payments are made.

second tax year following the year you receive

tract.

an advance payment if, on the last day of the tax

No further deferral is allowed. You must in-

Compensation for services. Generally, eco-

year, you meet the following requirements.

clude in gross income the advance payment you

nomic performance occurs as an employee ren-

•

receive each remaining year of the contract.

ders service to the employer. However,

You account for the advance payment

Take into account the difference between any

deductions for compensation or other benefits

under the alternative method.

estimated cost of goods sold and the actual cost

paid to an employee in a year subsequent to

•

You have received a substantial advance

when you deliver the goods in 2005.

economic performance are subject to the rules

payment on the agreement (discussed

governing deferred compensation, deferred

IRS approval. You must file Form 3115 to get

next).

benefits, and funded welfare benefit plans. For

IRS approval to change your method of account-

•

information on employee benefit programs, see

You have enough substantially similar

ing for advance payments for sales.

Publication 15 – B, Employer’s Tax Guide to

goods on hand, or available through your

Fringe Benefits.

normal source of supply, to satisfy the

Expenses

agreement.

Vacation pay. You can take a current de-

duction for vacation pay earned by your employ-

These rules also apply to an agreement, such as

Under an accrual method of accounting, you

ees if you pay it during the year or, if the amount

a gift certificate, that can be satisfied with goods

generally deduct or capitalize a business ex-

is vested, within 2

months after the end of the

pense when both the following apply.

that cannot be identified in the tax year you

year. If you pay it later than this, you must

receive an advance payment.

1) The all-events test has been met. The test

deduct it in the year actually paid. An amount is

If you meet these conditions, all advance pay-

is met when:

vested if your right to it cannot be nullified or

ments you receive by the end of the second tax

cancelled.

a) All events have occurred that fix the

year, including payments received the prior

fact of liability, and

years but not reported, must be included in in-

Exception for recurring items. An exception

come by the second tax year following the tax

to the economic performance rule allows certain

b) The liability can be determined with

year of receipt of substantial advance payments.

recurring items to be treated as incurred during

reasonable accuracy.

You must also deduct in that second year all

the tax year even though economic performance

actual or estimated costs for the goods required

has not occurred. The exception applies if all the

2) Economic performance has occurred.

to satisfy the agreement. If you estimate the

following requirements are met.

cost, you must take any difference between the

1) The all-events test, discussed earlier, is

estimate and the actual cost into account when

Economic Performance

met.

the goods are delivered.

You must report any advance payments you

2) Economic performance occurs by the ear-

You generally cannot deduct or capitalize a

receive after the second year in the year re-

lier of the following dates.

business expense until economic performance

ceived. No further deferral is allowed.

occurs. If your expense is for property or serv-

a) 8

months after the close of the year.

Substantial advance payments. Under an

ices provided to you, or for your use of property,

agreement for a future sale, you have substan-

economic performance occurs as the property

b) The date you file a timely return (includ-

tial advance payments if, by the end of the tax

or services are provided or the property is used.

ing extensions) for the year.

year, the total advance payments received dur-

If your expense is for property or services you

ing that year and preceding tax years are equal

provide to others, economic performance oc-

3) The item is recurring in nature and you

to or more than the total costs reasonably esti-

curs as you provide the property or services.

consistently treat similar items as incurred

Page 11

Publication 538 - Accounting Periods And Methods Page 11

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