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A business reports its income and expenses using various accounting methods and rules. Some accounting rules supplement the basic accounting method of the business — typically the cash method or the accrual method. Certain recent developments add flexibility in using and changing accounting methods, making tax reporting easier. CASH METHOD More Small Businesses Can Use the Cash Method. The IRS has liberalized the rules allowing more small businesses to use the cash method of accounting (News Release 2001-114, Dec. 10, 2001, introducing Notice 2001-76, IRB 2001-52, 613; modifying Rev. Proc. 99-49, 1999-2 CB 725). Use of the cash method greatly simplifies how a business reports its income and expenses. In 2000, the IRS allowed businesses with gross receipts of $1 million or less to make the changeover. It has now greatly expanded eligibility for switching to the cash method and, as a result, it is estimated that as many as 500,000 small businesses will be able to make the changeover from the accrual method to the cash method, making accounting for their income and expenses for tax purposes much simpler. Only eligible small businesses can make the change. These include businesses with average annual gross receipts of more than $1 million but not more than $10 million for the prior three years that had been using the accrual method and meet one of the following four safe harbors: 1) The principal business activity is not retailing, wholesaling, manufacturing, mining, publishing or sound recording. The principal business activity is determined by reference to codes in the North American Industry Classification System (NAICS) published by the Department of Commerce (www.census.gov). 2) The principal business activity is the provision of services. For example, a publisher may be eligible to make the changeover, even though the publishing business is one of the proscribed codes, if its principal business activity is the sale of advertising space. 3) The principal business is custom manufacturing. 4) Any separate and distinct businesses that meets any of the above three safe harbors can use the cash method regardless of the taxpayer’s principal business activity. However, these new rules do not apply to certain businesses that are precluded from using the cash method. These include corporations and partnerships with corporate partners having gross receipts of more than $5 million; such businesses are required to use the accrual method. The IRS has provided automatic consent procedures that changes to the cash method. All that is required is to attach Form 3115, Change in Accounting Method, to the return for the year of the change (i.e., to the 2001 return if the change is effective for 2001). Businesses making the changeover must also take into account any adjustments to income resulting from the switch to the cash method. The adjustments result from differences in accounting for inventory using the cost of goods sold under the accrual method versus treating inventory as currently deductible material and supplies under the cash method. Generally, the adjustment period is four years for both negative or positive adjustments. But under a de minimis rule, adjustments of less than $25,000 can be taken into account in total in the year of change — on 2001 returns. IRS’ CONSENT NEEDED Generally, a change in accounting method requires the consent of the IRS. Consent is obtained by filing a timely request for a change in accounting method. However, the IRS has granted automatic consent to various changes. Recently, it amended its list of situations in which it will grant automatic consent to change accounting method (Rev. Proc. 2002-9, IRB 2002-3, 327, superseding Rev. Proc. 99-49). Some of the new automatic consent changes include: � An attorney with a contingency fee arrangement who advances money to clients and wants to change the treatment of these advances from deductible business expenses to loans. � A business changing its accounting method for costs incurred in obtaining, maintaining, and renewing incentive stock options. � A taxpayer switching from including a Commodity Credit Loan in income to treating it as loan. A taxpayer cannot rely on the automatic consent procedure if the taxpayer is already under examination, before an appeals office or before a federal court. Also, a taxpayer cannot rely on the automatic consent procedure if it is a partnership or S corporation, a corporation that is or was a member of a consolidated group under examination or if the taxpayer made the same accounting change within the past five years. RESTAURANTS AND TAVERNS Simplified Accounting Method for Restaurant and Tavern Operators. The IRS has also provided a simplifies accounting method for restaurant and tavern operators (Rev. Proc. 2002-12, IRB 2002-3, 374). The change affects so-called “smallwares” — glasses, places and other items used for food and beverage preparation, storage and service. Until now it has been unclear whether smallwares can be currently deducted as an ordinary business expense or whether such items must be capitalized. Regulations permit such items to be treated the same as other supplies and materials – currently expensed to the extent they are in fact consumed and used in the course of the year (Reg. �1.162-3). Under the revenue procedure, smallwares are considered to be used within the year if they are received at the restaurant and available for use. Taxpayers can request automatic consent to make this change of accounting. The new rule applies to tax years ending on or after Dec. 31, 2001. Note: The expensing option for smallwares does not apply to smallwares that are part of startup expenditures. They are referred to as opening package costs purchased prior to the opening of a restaurant or tavern. Sidney Kess, CPA-attorney, is a consulting editor to CCH Inc., an author and a lecturer.

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