Accounting

<div class="Section1"><br /> <br /> <em>Editor&rsquo;s Note:</em> The 2017 tax reform legislation expanded the gross receipts test discussed below to include entities with annual gross receipts that do not exceed $30 million in 2024 ($29 million in 2023) (as indexed for inflation). See heading below.<br /> <br /> Yes, with some exceptions. Generally, C corporations, partnerships in which a C corporation is a partner and tax shelter arrangements (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8687">8687</a>) are required to use the accrual basis method of accounting.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> However, several exceptions exist to permit certain C corporations and partnerships with C corporation shareholders to use the cash basis method. Farming businesses<a href="#_ftn2" name="_ftnref2">²</a> that are organized as C corporations are permitted to use the cash basis method of accounting. Similarly, small businesses organized as C corporations are permitted to use the cash basis method if the corporation (or partnership with C corporation shareholder) has annual gross receipts that do not exceed $30 million (for 2024).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Revenue Procedure 2018-40 provides the procedures by which small businesses that satisfy the newly expanded gross receipts test can obtain automatic consent to change to the cash basis accounting method for tax years beginning after December 31, 2017. The guidance provides information as to which sections of Form 3115 the taxpayer is required to complete, and also provides that only one Form 3115 must be filed if the taxpayer is making concurrent accounting changes. Further, the guidance provides that it is a modification to previously existing guidance in Revenue Procedures 2015-13 and 2018-31, and that the procedures in those releases will continue to apply unless otherwise noted.<br /> <br /> <hr><br /> <br /> Certain personal service corporations are also permitted to use the cash basis method of accounting. Further, the IRS has specifically determined that the prohibition on C corporations using the cash basis accounting method does not apply to limited liability companies.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Generally, taxpayers that maintain inventory are required to use the accrual basis method with respect to purchases and sales of that inventory unless the taxpayer obtains the IRS&rsquo; consent to use the cash basis method. Typically, the IRS will consent to such a change if the cash basis method clearly reflects the taxpayer&rsquo;s income.<a href="#_ftn5" name="_ftnref5">⁵</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9058">9058</a> for a more specific discussion of the methods that may be used to account for inventory.<br /> <br /> Prior to the 2017 tax reform legislation, the cash basis method could also be used by most other taxpayers whose average annual gross receipts did not exceed $1 million<a href="#_ftn6" name="_ftnref6">⁶</a> and could be used by select taxpayers whose average annual gross receipts did not exceed $10 million.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <p style="text-align: center;"><strong>The 2017 Tax Reform Legislation</strong></p><br /> The 2017 tax reform legislation provides that the cash method of accounting can be used by taxpayers that satisfy the gross receipts test regardless of whether the purchase, production or sale of merchandise is an income producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $29 million (in 2023) for the three prior tax years (the &ldquo;gross receipts test&rdquo;) to use the cash method. The $25 million amount is indexed for inflation beginning after 2018, to $27 million in 2022 and $26 million in 2021.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> As under prior law, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other pass-through entities are allowed to use the cash method without regard to whether they meet the gross receipts test, so long as the use of such method clearly reflects income.<br /> <br /> Taxpayers who meet the gross receipts test are also exempt from the application of IRC Section 263A uniform capitalization rules.<a href="#_ftn9" name="_ftnref9">⁹</a> Previously existing exemptions that are not based on the taxpayer&rsquo;s gross receipts continue to apply.<br /> <br /> These changes would be considered a change in accounting method that is made with the consent of the Treasury Secretary for IRC Section 481 purposes.<a href="#_ftn10" name="_ftnref10">¹⁰</a> The new rules are effective for tax years beginning after December 31, 2017.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 448(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 263A.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect;&sect; 448(b), 448(c), as amended by Pub. Law No. 115-97, Rev. Proc. 2023-34.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Let. Ruls. 9328005, 9321007.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. &sect; 1.446-1(c)(2)(i).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. Rev Proc. 2001-10, 2001-2 IRB 272.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. Rev. Proc. 2002-28, 2002-18, IRB 815.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>. IRC &sect; 448(c).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>. IRC &sect; 263A(i).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>. IRC &sect; 448(d)(7).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> <em>Editor’s Note:</em> The 2017 tax reform legislation provides that the cash method of accounting can be used by taxpayers that satisfy the gross receipts test regardless of whether the purchase, production or sale of merchandise is an income producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $30 million (in 2024) for the three prior tax years (the “gross receipts test”) to use the cash method. The $25 million amount is indexed for inflation beginning after 2018 and was $29 million for 2023.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> The cash basis method of accounting is the most widely used accounting method for individual taxpayers, and is often used by many business entities, as well.<a href="#_ftn2" name="_ftnref2">²</a> Cash basis taxpayers recognize all gross income, whether in the form of cash, property or services, in the year that the income is actually or constructively received.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> “Constructive receipt” is considered to have occurred when income is made available to a taxpayer without restrictions.<a href="#_ftn4" name="_ftnref4">⁴</a> For example, a cash basis taxpayer cannot avoid reporting income simply because he refused to deposit a check. Conversely, if a taxpayer’s employer provides the taxpayer with a stock bonus, but conditions are imposed so that the bonus is not available to the taxpayer until a future date, the corporation’s reporting such bonus on its books does not constitute constructive receipt on the part of the taxpayer-employee.<br /> <br /> Similarly, a taxpayer is entitled to claim any deductions for the year in which the expenses that gave rise to the deduction were actually paid.<a href="#_ftn5" name="_ftnref5">⁵</a> There is no “constructive payment” type doctrine that corresponds to the constructive receipt doctrine discussed above, however.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> Though a cash basis taxpayer’s receipt of income in the form of cash is simple to recognize, complications may arise when the income is received in the form of non-cash property or a right to receive income based on future services. As such, the IRS has developed the doctrines of “cash equivalence” and “economic benefit” to address the receipt of property and services. When income is received in the form of property, the cash basis taxpayer must include the fair market value of such property in income if rights to the income are (1) freely transferable, (2) readily marketable and (3) immediately convertible into cash.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> On the other hand, if a taxpayer contracts to perform services for a specified amount of income that will be received in installments over the period of service, the taxpayer does not report the value of the installment payments in the year the contract is entered. This is because the taxpayer does not receive a cash equivalent at the time of contracting, but rather obtains only the right to receive such cash payments in the future dependent on performance of the required services.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> Under the economic benefit theory, a taxpayer is required to recognize income if an economic benefit has been conferred upon the taxpayer, even if the taxpayer has no ability to currently access the cash or non-cash property providing such benefit.<a href="#_ftn9" name="_ftnref9">⁹</a> For the cash basis taxpayer to recognize income under the economic benefit theory, the property must be transferred for the benefit of the taxpayer<a href="#_ftn10" name="_ftnref10">¹⁰</a> and confer vested, nonforfeitable rights<a href="#_ftn11" name="_ftnref11">¹¹</a> to the taxpayer. For example, a taxpayer was required to recognize income when his employer transferred certain amounts into a trust for his future benefit where the employer’s payment was irrevocable, even though the taxpayer was not currently able to access the funds in the trust.<a href="#_ftn12" name="_ftnref12">¹²</a> Therefore, unlike the cash equivalence theory, the property that is irrevocably transferred and held for the taxpayer’s benefit does not have to be transferrable by the taxpayer.<a href="#_ftn13" name="_ftnref13">¹³</a> The taxpayer is required to include the fair market value of non-cash property, or present value of any cash, that is transferred in income for the year such property or cash is transferred.<a href="#_ftn14" name="_ftnref14">¹⁴</a><br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> Generally speaking, the cash basis method of accounting works best for organizations that prefer simplicity over predictability. Cash basis is like balancing a checkbook; if the money is there, then the money affects the tax obligations. Large and unanticipated increases in revenues can lead to large tax obligations—and potentially large cash outflows—that small business owners may not be prepared for. Quarterly estimated tax payments may be more difficult to predict in a cash basis business with large, infrequent sales.<br /> <br /> <hr /><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 448(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 446(c)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.446-1(c)(1)(i).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.451-2(a).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. § 1.461-1(a)(1).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. See <em>Massachusetts Mutual Life Insurance Co. v. U.S.</em>, 288 U.S. 269 (1933).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. See Rev. Rul. 73-173, 1973-1 CB 40.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>. Rev. Rul. 73-173; <em>Shuster v. Helvering</em>, 121 F.2d 643 (2d Cir. 1941).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>. See <em>Spoul v. Comm.</em>, 16 TC 244 (1951). See also <em>Thomas v. U.S.</em>, 45 F. Supp. 2d 618 (S.D. Ohio 1999).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>. Compare <em>Sproull</em>, and <em>Jacuzzi v. Comm.</em>, 61 TC 262 (1973) (economic benefit upon transfer to trust), with <em>Casale v. Comm.</em>, 247 F.2d 440, 445 (2d Cir. 1957) (no economic benefit); <em>Centre v. Comm.</em>, 55 TC 16 (1970); Rev. Rul. 72-25, 1972-1 CB 127 (no economic benefit).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>. See <em>e.g., Robertson vs. Comm.</em>, 6 TC 1060 (1946), <em>acq.</em> 1946-2 CB 4.<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>. <em>Jacuzzi v. Comm.</em>, 61 TC 262 (1973).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>. <em>Hackett v. Comm.</em>, 159 F.2d 121 (1st Cir. 1946); <em>Brodie v. Comm.</em>, 1 TC 275 (1942).<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>. <em>212 Corp. v. Comm.</em>, 70 TC 788 (1978); <em>Bell Est. v. Comm.</em>, 60 TC 469 (1973).<br /> <br /> </div>

<div class="Section1">A taxpayer may adopt an accounting period that is less than a full 12 month period, known as a short period, in certain limited circumstances.<a href="#_ftn1" name="_ftnref1">¹</a> A taxpayer may adopt a short period if:<br /> <p style="padding-left: 40px">(1) The taxpayer&rsquo;s short period has been specifically approved by the IRS;<a href="#_ftn2" name="_ftnref2">²</a> or</p><br /> <p style="padding-left: 40px">(2) The taxpayer was only in existence during part of what would otherwise constitute the applicable accounting period.<a href="#_ftn3" name="_ftnref3">³</a></p><br /> If a taxpayer obtains approval to adopt a short period under (1), above, the taxpayer must annualize taxable income by determining annual income and dividing that amount by the number of months in the short period.<a href="#_ftn4" name="_ftnref4">⁴</a> Further, if the taxpayer is an individual, the amount of the taxpayer&rsquo;s personal exemption must be reduced so that it bears the same ratio to the full exemption as the number of months in the short period bears to 12 (although the personal exemption was suspended for 2018025).<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> Option (2), above, generally occurs in situations where a business entity only operated for a portion of the otherwise required tax year. For example, a business that liquidates before the close of its tax year is entitled to use the period of its existence during that accounting period as its short accounting period.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 443(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 443(a)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 443(a)(2).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 443(b)(1).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC &sect; 443(c).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. See IRC &sect;&sect; 708 (termination of partnerships) and 1362 (termination of S corporation status).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> An S corporation is generally required to adopt a calendar year accounting period (meaning that its tax year ends on December 31, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9036">9036</a>) unless it can establish a valid business purpose for adopting an alternate accounting period.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> The business purpose test, applicable in the context of both partnerships and S corporations, is discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9040">9040</a>.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 1378(b).<br /> <br /> </div></div><br />

<div class="Section1">In situations where the installment method applies, the taxpayer is required to use the installment method unless an election is made to opt out of this treatment. If the taxpayer does not affirmatively elect out, the installment method is the default method of accounting for transactions covered by the installment sale rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9051">9051</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9053">9053</a>). The opt-out election must be made on or before the due date for filing the taxpayer&rsquo;s return for the year. Once the election is made, the taxpayer may only revoke the election with the IRS&rsquo; consent.<a href="#_ftn1" name="_ftnref1">¹</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 453(d).<br /> <br /> </div></div><br />

<div class="Section1">A partnership is one of the entities that is generally required to adopt a particular accounting period as specified under the regulations.<a href="#_ftn1" name="_ftnref1">¹</a> A partnership&rsquo;s accounting period is determined by reference to the partner&rsquo;s required accounting period(s).<a href="#_ftn2" name="_ftnref2">²</a> The partnership&rsquo;s &ldquo;required taxable year&rdquo; can either be:<br /> <p style="padding-left: 40px">(1) The tax year of the majority partnership interest;</p><br /> <p style="padding-left: 40px">(2) The tax year of all the principal partners; or</p><br /> <p style="padding-left: 40px">(3) If it cannot be established based on the majority partnership interest or principal partners, a calendar year.<a href="#_ftn3" name="_ftnref3">³</a></p><br /> For these purposes, when a partnership&rsquo;s accounting period is determined by reference to the majority interest, it means that it is determined based on the tax year of a partner or group of partners having an aggregate interest in partnership profits or capital of more than 50 percent.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> A &ldquo;principal partner&rdquo; is a partner who has an interest of five percent or more in partnership profits or capital.<a href="#_ftn5" name="_ftnref5">⁵</a> Once it is established that a partner is a principal partner, that principal partner is required to maintain the same calendar year established by the partnership unless that principal partner is able to demonstrate a valid business purpose for the deviation.<br /> <br /> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9040">9040</a> for a discussion of the business purpose test that must be satisfied to allow a principal partner to adopt an alternate accounting period. This business purpose test must also be satisfied in order for the partnership to adopt an accounting period that deviates from the requirements set forth in (1)-(3), above.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. &sect; 1.1441-4(b)(2)(i)(G), IRC &sect; 706.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect;&sect; 444, 706.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 706(b). See also Treas. Reg. &sect; 1.706-1(b)(2).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 706(b)(4).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC &sect; 706(b)(3).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Yes. The IRS has released guidance providing that small business taxpayers (see below) may make certain tangible property changes in methods of accounting in order to take into account only amounts paid or incurred, and dispositions made, in tax years beginning on or after January 1, 2014. For the tax year beginning on or after January 1, 2014, small business taxpayers are permitted to make such changes without filing Form 3115.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> For purposes of this exception, a &ldquo;small business taxpayer&rdquo; is a taxpayer with one or more distinct trades or businesses that has:<br /> <p style="padding-left: 40px">(1) Total assets of less than $10 million as of the first day of the tax year for which a change in accounting method under the final tangible property regulations and related guidance is effective; or</p><br /> <p style="padding-left: 40px">(2) Average annual gross receipts of $30 million (in 2024) (the amount is adjusted annually for inflation, it was $29 million in 2023, $27 million in 2022, $26 million in 2019021, $25 million in 2018 and $10 million prior to 2018) or less for the prior three tax years.</p><br /> This exception applies only to small business taxpayers electing to make changes in accounting methods in order to prospectively apply the final tangible property regulations. While these taxpayers are still permitted to file the Form 3115 in order to make this change, the IRS guidance allows small business taxpayers to simply make the change on a federal income tax return. This guidance is meant to ease the burden of changing accounting methods for small business taxpayers by effectively allowing them to make the change on a cut-off basis.<br /> <br /> If a small business taxpayer has already filed a Form 3115 with respect to accounting changes applying the tangible property regulations, the taxpayer may withdraw the form by filing an amended return on or before the due date of the original tax return (including extensions).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Proc. 20150, modifying Rev. Proc. 2015-14.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Rev. Proc. 20150.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> <em>Editor&rsquo;s Note:</em> Under the 2017 tax reform legislation, if the taxpayer uses the accrual method of accounting, the &ldquo;all events test&rdquo; with respect to any item of income is not treated as met any later than when the item (or a portion of it) is taken into account as revenue in a financial statement of the taxpayer.<a href="#_ftn1" name="_ftnref1">¹</a> See below.<br /> <br /> Taxpayers who use the accrual method of accounting generally report income in the year that it is earned, rather than in the year it is received.<a href="#_ftn2" name="_ftnref2">²</a> Under this method, income is recognized in the year when (1) all events have occurred to fix the taxpayer&rsquo;s right to receive the income and (2) the amount of income that the taxpayer will be entitled to receive can be determined with reasonable accuracy. Because the relevant inquiry is when the income is <em>earned</em>, rather than when the income is <em>received</em>, compensation agreed upon with respect to the performance of future services is not recognized until those services have actually been performed (at the time the taxpayer has earned the compensation).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Generally speaking, the accrual method of accounting normalizes, or smooths out, the revenues and expenses of a business, making it easier to do year over year comparisons and forecasts. A company that wins a large deal may get paid an up-front cash amount for products that are delivered for years to come. Accrual tax accounting allows the tax obligations to be paid over longer periods of time, giving the business owner more choice and control over how, and when, taxes are paid.<br /> <br /> <hr><br /> <br /> Pursuant to the &ldquo;all events test,&rdquo;<a href="#_ftn4" name="_ftnref4">⁴</a> income is recognized when all of the events that are required for the taxpayer&rsquo;s right to the income to be vested have occurred so that the amount of the taxpayer&rsquo;s entitlement can be determined with reasonable certainty.<a href="#_ftn5" name="_ftnref5">⁵</a> It is possible for a taxpayer to report income although no payment has yet been received.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> Under the 2017 tax reform legislation, the &ldquo;all events test&rdquo; with respect to any item of income is not treated as met any later than when the item (or a portion of it) is taken into account as revenue in a financial statement of the taxpayer.<a href="#_ftn7" name="_ftnref7">⁷</a> A financial statement, for this purpose, includes one that is prepared in accordance with GAAP and is a 10(k) that will be filed with the SEC, or an audited financial statement used for credit, reporting or other significant non-tax purposes if there is no 10(k) that will be filed with the SEC.<a href="#_ftn8" name="_ftnref8">⁸</a> If the taxpayer does not have a 10(k) or an audited financial statement, any financial statement that is filed with a federal agency for non-tax purposes may be used.<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> If the taxpayer does not have a financial statement upon which the item would be reported, the new rule does not apply. Further, it does not apply with respect to items of income that are received in connection with a mortgage servicing contract.<a href="#_ftn10" name="_ftnref10">¹⁰</a> The amended provision continues to provide that the all events test will be deemed met when all of the events have occurred that fix the right to the income, and the amount can be determined with reasonable accuracy.<a href="#_ftn11" name="_ftnref11">¹¹</a><br /> <br /> As mentioned above, an accrual basis taxpayer&rsquo;s expenses are deductible for the taxable year in which the liability for payment becomes definite and the amounts payable become ascertainable with reasonable certainty, but only to the extent that economic performance with respect to the item has occurred.<a href="#_ftn12" name="_ftnref12">¹²</a><br /> <br /> In general, an accrual basis taxpayer will include amounts in income upon the earliest of the following events: (1) payment is actually received, (2) the income amount becomes due to the taxpayer, (3) the taxpayer earns the income, or (4) title to property has passed to the taxpayer.<a href="#_ftn13" name="_ftnref13">¹³</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9046">9046</a> for a discussion of the treatment of advance payments.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 451(b)(1)(A).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 446(c)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. &sect; 1.451-1(a).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 448(h)(4).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. &sect; 1.446-1(c)(1)(ii).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. <em>Comm. v Hansen</em>, 360 U.S. 446 (1959).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. IRC &sect; 451(b)(1)(A).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>. IRC &sect; 451(b)(3).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>. IRC &sect; 451(b)(3)(A)(iii).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>. IRC &sect; 451(b)(1)(B).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>. IRC &sect; 451(b)(1)(C).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>. IRC &sect; 461(h).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>. IRS Publication 538.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> <em>Editor&rsquo;s Note:</em> The 2017 tax reform legislation expanded the gross receipts test discussed below to include entities with annual gross receipts that do not exceed $25 million in 2018, $26 million in 2019021, $27 million in 2022, $29 million in 2023 and $30 million in 2024. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9048">9048</a>.<br /> <br /> Under IRC Section 446(c), a taxpayer may use any combination of the permissible accounting methods to compute taxable income if the combination clearly reflects the taxpayer&rsquo;s income and is consistently used. For example, a taxpayer is permitted to use the cash basis method to account for income and expenses, but the accrual method to account for purchases and sales. Despite this, a taxpayer is <em>not</em> permitted to use one method to account for income and a different method to account for expenses.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Though the regulations require that a taxpayer use the accrual method to account for purchases and sales if inventories are maintained (but see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9058">9058</a> for a discussion of the changes to inventory accounting made by the 2017 tax law), that taxpayer may wish to use the cash basis method for income and expenses because the required calculation may be simpler.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> A taxpayer is also permitted to use one accounting method to determine tax liability for income arising from a trade or business and another method to account for income that is not related to a trade or business.<a href="#_ftn3" name="_ftnref3">³</a> Taxpayers engaged in different trades or businesses can also use a different method of accounting for each trade or business in which the taxpayer participates.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. &sect; 1.446-1(c)(1)(iv); <em>Grider v Comm.</em>, TC Memo 1999-417.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. &sect;&sect; 1.446-1(a)(4)(i), 1.446-1(c)(2)(i). See also <em>Gustafson v Comm.</em>, TC Memo 1988-82.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. &sect; 1.446-1(c)(1)(iv)(b).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. &sect; 1.446-1(d).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> In cases where a taxpayer does not receive payment immediately after a sale, the taxpayer may be able to recognize the income from those sales over a period of time, rather than when the sale is made. The installment method may be used to account for gains (but not losses) if the taxpayer has sold property and will receive at least one payment with respect to that sale after the close of the tax year in which the sale occurs.<a href="#_ftn1" name="_ftnref1">¹</a> Under the installment method, for each year in which payments are due, the taxpayer will recognize a proportionate amount of the payments as they are actually received over the payment term.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Despite this, a taxpayer is not entitled to use the installment method of accounting if the transaction is a dealer disposition or involves the sale of property that is held as inventory in the ordinary course of the taxpayer&rsquo;s trade or business (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9058">9058</a> for a discussion of inventory accounting).<a href="#_ftn3" name="_ftnref3">³</a> A dealer disposition is a sale of personal property by a person who regularly sells or otherwise disposes of property using an installment plan or a disposition of real property that is held by the taxpayer for sale to customers in the ordinary course of a trade or business.<a href="#_ftn4" name="_ftnref4">⁴</a> Certain farm property and the sale of timeshares and residential lots are excluded from the definition of dealer disposition.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> Section 453 only affects the timing of income recognition and does not impact the characterization of the income (for example, as a capital gain or ordinary income).<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9007">9007</a> for more information on using the installment method of accounting in the context of small business dispositions. Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9053">9053</a> discusses the special rules that apply in the context of related party sales under the installment method.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 453(b)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 453(c).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 453(b)(2).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 453(l).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC &sect; 453(l)(2).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. <em>Murray v. United States</em>, 192 Ct. Cl. 63 (1970).<br /> <br /> </div></div><br />