Accounting Methods Introduction

An accounting method is a set of rules used to determine when and how income and expenses are reported. Your accounting method includes not only the overall method of accounting you use, but also the accounting treatment you use for any material item.

You choose your accounting method when you file your first tax return. After that, if you want to change your accounting method, you must first get IRS approval.

Pursuant to Code Section 446(a), each taxpayer must compute his taxable income "under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books." Code Sections 446(c) and 446(d) make clear that the method of accounting that a taxpayer selects generally turns on his form of business organization and the trade or business in which he is involved. A taxpayer engaged in more than one trade or business may use a different method of accounting for each trade or business. However, the IRS will not consider a trade or business to be separate and distinct unless the taxpayer keeps a complete and separate set of books and records for each trade or business. Reg. Section 1.446-1(d)(2).

Kinds of methods. Generally, you can figure your taxable income under any of the following accounting methods.

• Cash method.
• Accrual method.
• Special methods of accounting for certain items of income and expenses.
• Combination method using elements of two or more of the above.

Business and personal items. You can account for business and personal items under different accounting methods. For example, you can figure your business income under an accrual method, even if you use the cash method to figure personal items.

Two or more businesses. If you operate 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. They are separate and distinct if books and records are maintained for each business.

[Accounting Methods Introduction]