By Richard A. Chapo
When starting a business, you have to determine the method youare going to use for accounting and paying taxes. The twochoices are the cash method and the accrual method.
Cash Method
If you are looking for simplicity, the cash method is probablyyour best accounting choice. Generally, income and deductionscan be claimed when payment is actually received or made. Thisis best shown with an example.
I open a small business and have to order business cards andstationary. I receive the products and pay the invoice onNovember 18, 2005. Under the cash method, I can deduct the coston my 2005 tax return.
Some businesses are restricted from using the cash method. Ccorporations may only use the cash method if they have less than$5 million in gross revenues for a particular year. ProfessionalService Corporations can use the cash method without limit,while farming corporations can due so if gross revenues are lessthan $25 million. Tax shelters are prohibited from using thecash method.
Accrual Method
The Accrual Method of accounting is a bit more complex. Underthis method, the focus in on the date the expense is incurred,not paid. Although this may seem a small difference, it can playhavoc with your books and piece of mind.
Using our previous example, assume I order business cards andstationary on the December 18, 2005. I receive the products onDecember 30th, but don't pay the invoice until January 20, 2006.When can the expense be claimed? It depends on when economicperformance occurred.
Generally, economic performance occurs when goods or servicesare provided to you. In the above example, economic performancewould arguably occur when the business cards and stationary weredelivered with the invoice on December 30th. Thus, I would beable to deduct the expense for the 2005 tax year.
In Closing
As you can see, the cash method is the easier of the twoaccounting methods. To determine the best method for yourbusiness, speak with a tax professional.
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