Publication 538 - Accounting Periods And Methods (Page 9 of 19) in pdf

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Special methods of accounting for certain

chandise, you must keep an inventory and use

A partnership with a corporation (other

items of income and expenses.

an accrual method for sales and purchases of

than an S corporation) as a partner, and

merchandise. See Exceptions under Invento-

with the partnership having average an-

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Combination (hybrid) method using ele-

ries, later, for exceptions to this rule.

nual gross receipts exceeding $5 million.

ments of two or more of the above.

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A tax shelter.

The cash and accrual methods of accounting

Income

are explained later.

Exceptions

Under the cash method, you include in your

Special methods. This publication does not

gross income all items of income you actually or

discuss special methods of accounting for cer-

The following entities can use the cash method

constructively receive during the tax year. If you

tain items of income or expenses. For informa-

of accounting.

receive property and services, you must include

tion on reporting income using one of the

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their fair market value in income.

A family corporation with gross receipts of

long-term contract methods, see section 460

$25 million or less for each prior tax year

and its regulations. Publication 535, Business

Constructive receipt. Income is construc-

beginning after 1985.

Expenses, discusses methods for deducting

tively received when an amount is credited to

amortization and depletion. The following publi-

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Any corporation or partnership, other than

your account or made available to you without

cations also discuss special methods of report-

a tax shelter, that meets the gross receipts

restriction. You need not have possession of it. If

ing income or expenses.

test for all tax years after 1985.

you authorize someone to be your agent and

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Publication 225, Farmer’s Tax Guide.

receive income for you, you are considered to

A qualified personal service corporation.

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have received it when your agent receives it.

Publication 537, Installment Sales.

Income is not constructively received if your

See chapter 3 in Publication 225 for more

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Publication 946, How To Depreciate Prop-

control of its receipt is subject to substantial

information on family corporations.

erty.

restrictions or limitations.

Gross receipts test. Any corporation or part-

Combination (hybrid) method. Generally,

Example 1. Interest is credited to your bank

nership, other than a tax shelter, that meets the

you can use any combination of cash, accrual,

account in December 2002, but you do not with-

gross receipts test for all tax years after 1985

and special methods of accounting if the combi-

draw it or enter it into your passbook until 2003.

can use the cash method. A corporation or a

nation clearly shows income and you use it con-

You must include the amount in gross income

partnership meets the test if its average annual

sistently. However, the following restrictions

for 2002, not 2003.

gross receipts are $5 million or less for the 3 tax

apply.

years ending with the prior tax year (or the pe-

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Example 2. You have interest coupons that

riod of existence, if shorter). Generally, a part-

If an inventory is necessary to account for

mature and become payable in 2002, but you do

nership applies the test at the partnership level.

your income, you must use an accrual

not cash them until 2003. You must include the

Gross receipts for a short tax year are annual-

method for purchases and sales. See,

interest in gross income for 2002, the year of

ized.

however, Exceptions under Inventories,

constructive receipt. You must include the inter-

later. You can use the cash method for all

Aggregation rules. Organizations that are

est in your 2002 income, even if you later ex-

other items of income and expenses. See

members of an affiliated service group or a con-

change the coupons for other property, instead

Inventories, later.

trolled group of corporations treated as a single

of cashing them.

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employer for tax purposes are required to aggre-

If you use the cash method for figuring

Delaying receipt of income. You cannot

gate their gross receipts to determine whether

your income, you must use the cash

hold checks or postpone taking possession of

the gross receipts test is met.

method for reporting your expenses.

similar property from one tax year to another to

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Change to accrual method. A corporation

If you use an accrual method for reporting

avoid paying tax on the income. You must report

or partnership that fails to meet the gross re-

your expenses, you must use an accrual

the income in the year the property is received or

ceipts test for any tax year must change to an

method for figuring your income.

made available to you without restriction.

accrual method of accounting, effective for the

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Any combination that includes the cash

tax year in which the entity fails to meet this test.

Expenses

method is treated as the cash method.

Qualified personal service corporation. A

Under the cash method, you generally deduct

personal service corporation that meets the fol-

Business and personal items. You can ac-

expenses in the tax year in which you actually

lowing function and ownership tests can use the

count for business and personal items using

pay them. This includes business expenses for

cash method.

different accounting methods. For example, you

which you contest liability. However, you may

can figure your business income under an ac-

Function test. A corporation meets the

not be able to deduct an expense paid in ad-

crual method, even if you use the cash method

function test if at least 95% of its activities are in

vance or you may be required to capitalize cer-

to figure personal items.

the performance of services in the fields of

tain costs, as explained later under Uniform

health, veterinary services, law, engineering (in-

Capitalization Rules.

Two or more businesses. If you operate two

cluding surveying and mapping), architecture,

or more separate and distinct businesses, you

accounting, actuarial science, performing arts,

Expense paid in advance. An expense you

can use a different accounting method for each.

or consulting.

pay in advance can be deducted only in the year

No business is separate and distinct, however,

to which it applies.

unless a complete and separate set of books

Ownership test. A corporation meets the

and records is maintained for the business.

ownership test if at least 95% of its stock is

Example. You are a calendar year taxpayer

owned, directly or indirectly, at all times during

If you use different accounting methods to

and you pay $1,000 in 2002 for a business

the year by one of the following.

create or shift profits or losses between busi-

insurance policy that is effective for one year,

nesses (for example, through inventory adjust-

beginning July 1st. You can deduct $500 in 2002

1) Employees performing services for the

ments, sales, purchases, or expenses) so that

and $500 in 2003.

corporation in a field qualifying under the

income is not clearly reflected, the businesses

function test.

will not be considered separate and distinct.

Excluded Entities

2) Retired employees who had performed

services in those fields.

The following entities cannot use the cash

method, including any combination of methods

Cash Method

3) The estate of an employee described in (1)

that includes the cash method.

or (2).

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A corporation (other than an S corpora-

4) Any other person who acquired the stock

Most individuals and many small businesses

use the cash method of accounting. Generally,

tion) with average annual gross receipts

by reason of the death of an employee

however, if you produce, purchase, or sell mer-

exceeding $5 million.

referred to in (1) or (2), but only for the

Page 9

Publication 538 - Accounting Periods And Methods Page 9

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