Another business-classification issue the IRS has been pursuing aggressively in recent
years is the distinction between cash and accrual-basis accounting methods. Many small
businesses prefer the cash method because it makes bookkeeping simpler and tends to match
the income base for tax computations with the tax liability. In other words, when
you receive the money you owe the taxes -- when you pay the expense you receive the tax
deduction. However, the IRS rule says that if you have inventory of any kind
related to sales, you cannot use a cash system.
What if you have been using the wrong method (cash or accrual)? It is better to
correct it now, preemptively, before the IRS discovers you.
The alternative (waiting for the IRS to spot the error, rule on it, charge you a penalty and interest, and demand the entire amount immediately) is not appealing.
The type of business you are in will govern whether you may use the cash method, or whether the IRS requires the accrual method. You may discover that you use a hybrid method - which is one of the IRS approved methods. Furthermore, a single business transaction may produce results of an accrual methods, or produce a combination of the two methods. Congress is continually changing the tax law, and what works one year may not work the next - so it is important to seek the advice of an accountant such as Bob Parrish CPA, P.C.
For example, Congress is currently requiring some taxpayers to pay tax on profits from installment sales in the year the asset is sold on the installment basis. Combine this with the recapture of depreciation, a large capital gain or other large profit, and you may find yourself in a position of owning more tax than the cash you receive from the down payment and first year payments in the first year. This may require the adjusting of the down payment, the monthly payments, the interest rate and perhaps the sales price. Let Bob Parrish CPA PC project your after tax cash flow before signing the contract.