When starting a business, you have to determine the
method you are going to use for accounting and paying taxes. The two
choices are the cash method and the accrual method.
Cash Method
If
you are looking for simplicity, the cash method is probably your best
accounting choice. Generally, income and deductions can be claimed when
payment is actually received or made. This is best shown with an
example.
I open a small business and have to
order business cards and stationary. I receive the products and pay the
invoice on November 18, 2009. Under the cash method, I can deduct the
cost on my 2009 tax return.
Some businesses are
restricted from using the cash method. C corporations may only use the
cash method if they have less than $5 million in gross revenues for a
particular year. Professional Service Corporations can use the cash
method without limit, while farming corporations can due so if gross
revenues are less than $25 million. Tax shelters are prohibited from
using the cash method.
Accrual Method
The
Accrual Method of accounting is a bit more complex. Under this method,
the focus in on the date the expense is incurred, not paid. Although
this may seem a small difference, it can play havoc with your books and
piece of mind.
Using our previous example, assume
I order business cards and stationary on the December 18, 2009. I
receive the products on December 30th, but don’t pay the invoice until
January 20, 2010. When can the expense be claimed? It depends on when
economic performance occurred.
Generally,
economic performance occurs when goods or services are provided to you.
In the above example, economic performance would arguably occur when the
business cards and stationary were delivered with the invoice on
December 30th. Thus, I would be able to deduct the expense for the 2009
tax year.
In Closing
As
you can see, the cash method is the easier of the two accounting
methods. To determine the best method for your business, speak with a
tax professional.