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Visit www irs gov freefile 1. Visit www irs gov freefile   Importance of Records Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Benefits of Recordkeeping Kinds of Records To Keep How Long To Keep Records Introduction A farmer, like other taxpayers, must keep records to prepare an accurate income tax return and determine the correct amount of tax. Visit www irs gov freefile This chapter explains the benefits of keeping records, what kinds of records you must keep, and how long you must keep them for federal tax purposes. Visit www irs gov freefile Tax records are not the only type of records you need to keep for your farming business. Visit www irs gov freefile You should also keep records that measure your farm's financial performance. Visit www irs gov freefile This publication only discusses tax records. Visit www irs gov freefile The Farm Financial Standards Council has produced a publication that provides a detailed explanation of the recommendations of the Council for financial reporting and analysis. Visit www irs gov freefile For information on recordkeeping, you can purchase and download Financial Guidelines for Agricultural Producers at www. Visit www irs gov freefile ffsc. Visit www irs gov freefile org. Visit www irs gov freefile For more information, contact Countryside Marketing, Inc. Visit www irs gov freefile in the following manner. Visit www irs gov freefile Call 262-253-6902. Visit www irs gov freefile Send a fax to 262-253-6903. Visit www irs gov freefile Write to: Farm Financial Standards Council N78 W14573 Appleton Ave. Visit www irs gov freefile , #287 Menomonee Falls, WI 53051. Visit www irs gov freefile Topics - This chapter discusses: Benefits of recordkeeping Kinds of records to keep How long to keep records Useful Items - You may want to see: Publication 51 (Circular A), Agricultural Employer's Tax Guide 463 Travel, Entertainment, Gift, and Car Expenses See chapter 16 for information about getting publications. Visit www irs gov freefile Benefits of Recordkeeping Everyone in business, including farmers, must keep appropriate records. Visit www irs gov freefile Recordkeeping will help you do the following. Visit www irs gov freefile Monitor the progress of your farming business. Visit www irs gov freefile   You need records to monitor the progress of your farming business. Visit www irs gov freefile Records can show whether your business is improving, which items are selling, or what changes you need to make. Visit www irs gov freefile Records can help you make better decisions that may increase the likelihood of business success. Visit www irs gov freefile Prepare your financial statements. Visit www irs gov freefile   You need records to prepare accurate financial statements. Visit www irs gov freefile These include income (profit and loss) statements and balance sheets. Visit www irs gov freefile These statements can help you in dealing with your bank or creditors and help you to manage your farm business. Visit www irs gov freefile Identify source of receipts. Visit www irs gov freefile   You will receive money or property from many sources. Visit www irs gov freefile Your records can identify the source of your receipts. Visit www irs gov freefile You need this information to separate farm from nonfarm receipts and taxable from nontaxable income. Visit www irs gov freefile Keep track of deductible expenses. Visit www irs gov freefile   You may forget expenses when you prepare your tax return unless you record them when they occur. Visit www irs gov freefile Prepare your tax returns. Visit www irs gov freefile   You need records to prepare your tax return. Visit www irs gov freefile For example, your records must support the income, expenses, and credits you report. Visit www irs gov freefile Generally, these are the same records you use to monitor your farming business and prepare your financial statements. Visit www irs gov freefile Support items reported on tax returns. Visit www irs gov freefile   You must keep your business records available at all times for inspection by the IRS. Visit www irs gov freefile If the IRS examines any of your tax returns, you may be asked to explain the items reported. Visit www irs gov freefile A complete set of records will speed up the examination. Visit www irs gov freefile Kinds of Records To Keep Except in a few cases, the law does not require any specific kind of records. Visit www irs gov freefile You can choose any recordkeeping system suited to your farming business that clearly shows, for example, your income and expenses. Visit www irs gov freefile You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. Visit www irs gov freefile See  chapter 2. Visit www irs gov freefile If you are in more than one business, you should keep a complete and separate set of records for each business. Visit www irs gov freefile A corporation should keep minutes of board of directors' meetings. Visit www irs gov freefile Your recordkeeping system should include a summary of your business transactions. Visit www irs gov freefile This summary is ordinarily made in accounting journals and ledgers. Visit www irs gov freefile For example, they must show your gross income, as well as your deductions and credits. Visit www irs gov freefile In addition, you must keep supporting documents. Visit www irs gov freefile Purchases, sales, payroll, and other transactions you have in your business generate supporting documents such as invoices and receipts. Visit www irs gov freefile These documents contain the information you need to record in your journals and ledgers. Visit www irs gov freefile It is important to keep these documents because they support the entries in your journals and ledgers and on your tax return. Visit www irs gov freefile Keep them in an orderly fashion and in a safe place. Visit www irs gov freefile For instance, organize them by year and type of income or expense. Visit www irs gov freefile Electronic records. Visit www irs gov freefile   All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. Visit www irs gov freefile When you replace hard copy books and records, you must maintain the electronic storage systems for as long as they are material to the administration of tax law. Visit www irs gov freefile An electronic storage system is any system for preparing or keeping your records either by electronic imaging or by transfer to an electronic storage media. Visit www irs gov freefile The electronic storage system must index, store, preserve, retrieve and reproduce the electronically stored books and records in legible format. Visit www irs gov freefile All electronic storage systems must provide a complete and accurate record of your data that is accessible to the IRS. Visit www irs gov freefile Electronic storage systems are also subject to the same controls and retention guidelines as those imposed on your original hard copy books and records. Visit www irs gov freefile The original hard copy books and records may be destroyed provided that the electronic storage system has been tested to establish that the hard copy books and records are being reproduced in compliance with IRS requirements for an electronic storage system and procedures are established to ensure continued compliance with all applicable rules and regulations. Visit www irs gov freefile You still have the responsibility of retaining any other books and records that are required to be retained. Visit www irs gov freefile The IRS may test your electronic storage system, including the equipment used, indexing methodology, software and retrieval capabilities. Visit www irs gov freefile This test is not considered an examination and the results must be shared with you. Visit www irs gov freefile If your electronic storage system meets the requirements mentioned earlier, you will be in compliance. Visit www irs gov freefile If not, you may be subject to penalties for non-compliance, unless you continue to maintain your original hard copybooks and records in a manner that allows you and the IRS to determine your correct tax. Visit www irs gov freefile For details on electronic storage system requirements, see Rev. Visit www irs gov freefile Proc. Visit www irs gov freefile 97-22. Visit www irs gov freefile You can find Rev. Visit www irs gov freefile Proc. Visit www irs gov freefile 97-22 on page 9 of Internal Revenue Bulletin 1997-13 at  www. Visit www irs gov freefile irs. Visit www irs gov freefile gov/pub/irs-irbs/irb97-13. Visit www irs gov freefile pdf. Visit www irs gov freefile Travel, transportation, entertainment, and gift expenses. Visit www irs gov freefile   Specific recordkeeping rules apply to these expenses. Visit www irs gov freefile For more information, see Publication 463. Visit www irs gov freefile Employment taxes. Visit www irs gov freefile   There are specific employment tax records you must keep. Visit www irs gov freefile For a list, see Publication 51 (Circular A). Visit www irs gov freefile Excise taxes. Visit www irs gov freefile   See How To Claim a Credit or Refund in chapter 14 for the specific records you must keep to verify your claim for credit or refund of excise taxes on certain fuels. Visit www irs gov freefile Assets. Visit www irs gov freefile   Assets are the property, such as machinery and equipment, you own and use in your business. Visit www irs gov freefile You must keep records to verify certain information about your business assets. Visit www irs gov freefile You need records to figure your annual depreciation deduction and the gain or (loss) when you sell the assets. Visit www irs gov freefile Your records should show all the following. Visit www irs gov freefile When and how you acquired the asset. Visit www irs gov freefile Purchase price. Visit www irs gov freefile Cost of any improvements. Visit www irs gov freefile Section 179 deduction taken. Visit www irs gov freefile Deductions taken for depreciation. Visit www irs gov freefile Deductions taken for casualty losses, such as losses resulting from fires or storms. Visit www irs gov freefile How you used the asset. Visit www irs gov freefile When and how you disposed of the asset. Visit www irs gov freefile Selling price. Visit www irs gov freefile Expenses of sale. Visit www irs gov freefile   The following are examples of records that may show this information. Visit www irs gov freefile Purchase and sales invoices. Visit www irs gov freefile Real estate closing statements. Visit www irs gov freefile Canceled checks. Visit www irs gov freefile Bank statements. Visit www irs gov freefile Financial account statements as proof of payment. Visit www irs gov freefile   If you do not have a canceled check, you may be able to prove payment with certain financial account statements prepared by financial institutions. Visit www irs gov freefile These include account statements prepared for the financial institution by a third party. Visit www irs gov freefile These account statements must be legible. Visit www irs gov freefile The following table lists acceptable account statements. Visit www irs gov freefile IF payment is by. Visit www irs gov freefile . Visit www irs gov freefile . Visit www irs gov freefile THEN the statement must show the. Visit www irs gov freefile . Visit www irs gov freefile . Visit www irs gov freefile Check Check number. Visit www irs gov freefile Amount. Visit www irs gov freefile Payee's name. Visit www irs gov freefile Date the check amount was posted to the account by the financial institution. Visit www irs gov freefile Electronic funds  transfer Amount transferred. Visit www irs gov freefile Payee's name. Visit www irs gov freefile Date the transfer was posted to the account by the financial institution. Visit www irs gov freefile Credit card Amount charged. Visit www irs gov freefile Payee's name. Visit www irs gov freefile Transaction date. Visit www irs gov freefile    Proof of payment of an amount, by itself, does not establish you are entitled to a tax deduction. Visit www irs gov freefile You should also keep other documents, such as credit card sales slips and invoices, to show that you also incurred the cost. Visit www irs gov freefile Tax returns. Visit www irs gov freefile   Keep copies of your filed tax returns. Visit www irs gov freefile They help in preparing future tax returns and making computations if you file an amended return. Visit www irs gov freefile Keep copies of your information returns such as Form 1099, Schedule K-1, and Form W-2. Visit www irs gov freefile How Long To Keep Records You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Visit www irs gov freefile Keep records that support an item of income or a deduction appearing on a return until the period of limitations for the return runs out. Visit www irs gov freefile A period of limitations is the period of time after which no legal action can be brought. Visit www irs gov freefile Generally, that means you must keep your records for at least 3 years from when your tax return was due or filed or within 2 years of the date the tax was paid, whichever is later. Visit www irs gov freefile However, certain records must be kept for a longer period of time, as discussed below. Visit www irs gov freefile Employment taxes. Visit www irs gov freefile   If you have employees, you must keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later. Visit www irs gov freefile Assets. Visit www irs gov freefile   Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. Visit www irs gov freefile You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure your basis for computing gain or (loss) when you sell or otherwise dispose of the property. Visit www irs gov freefile   You may need to keep records relating to the basis of property longer than the period of limitation. Visit www irs gov freefile Keep those records as long as they are important in figuring the basis of the original or replacement property. Visit www irs gov freefile Generally, this means as long as you own the property and, after you dispose of it, for the period of limitations that applies to you. Visit www irs gov freefile For example, if you received property in a nontaxable exchange, you must keep the records for the old property, as well as for the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition. Visit www irs gov freefile For more information on basis, see chapter 6. Visit www irs gov freefile Records for nontax purposes. Visit www irs gov freefile   When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. Visit www irs gov freefile For example, your insurance company or creditors may require you to keep them longer than the IRS does. Visit www irs gov freefile Prev  Up  Next   Home   More Online Publications
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Don't give up if you are not satisfied with the seller's response to your complaint. Once you have given the seller a reasonable amount of time to respond, consider filing a complaint with one or more of these outside organizations.

  • State or local consumer protection offices – These government agencies mediate complaints, conduct investigations, and prosecute offenders of consumer laws.
  • Better Business Bureaus – This network of nonprofit organizations supported by local businesses tries to resolve buyer complaints against sellers. Records are kept on unresolved complaints as a source of information for the seller's future customers. The umbrella organization for the BBBs assists with complaints concerning the truthfulness of national advertising and helps settle disputes with automobile manufacturers through the BBB AUTO LINE program.
  • Trade associations – Companies selling similar products or services often belong to an industry association that will help resolve problems between their members and consumers.
  • National consumer organizations – Some of these organizations assist consumers with complaints. Others may be unable to help individuals but are interested in hearing about problems that may influence their education and advocacy efforts.
  • State regulatory agencies that have jurisdiction over the business – For example, banking, securities, insurance, and utilities are regulated at the state level. State Weights and Measures Offices are concerned with accurate measures and counts of packaged goods. They also check the accuracy of weighing and measuring devices such as supermarket scales, gasoline pumps, taxi meters and rental car odometers.
  • State and local licensing agencies – Doctors, lawyers, home improvement contractors, auto repair shops, debt collectors, and childcare providers are required to register or be licensed. The board or agency that oversees this process may handle complaints and have the authority to take disciplinary action. Your state or local consumer protection office can help you identify the appropriate agency.
  • Media programs – Local newspapers, radio stations, and television stations often have Action Lines or Hotline services that try to resolve consumer complaints they receive. To find these services, check with your local newspapers or broadcast stations.
  • Consumer Product Safety Commission (CPSC) – Report a safety concern or incident with a consumer product at CPSC's website, saferproducts.gov, even if you are able to contact the seller. Your report can help other consumers avoid unsafe products.

Dispute Resolution Programs

Some companies and industries offer programs to address disagreements between buyers and sellers. The auto industry has several of these programs. The National Association of Security Dealers offers a program designed to resolve investment-related disputes. Some small claims courts also offer a dispute resolution program as an alternative to a trial.

Mediation, arbitration, and conciliation are three common types of dispute resolution. During mediation, both sides involved in the dispute meet with a neutral third party and create their own agreement jointly. Arbitration uses a different approach, the third party decides how to settle the problem. Request a copy of the rules of any program before making a decision to participate. You will want to know beforehand if the decision is binding. Some programs do not require both parties to accept the decision. Also ask whether participation in the program place any restrictions on your ability to take other legal action? The American Bar Association publishes a directory of state and local dispute resolution programs.

Beware of Recovery Services

A scam artist has taken your money. Don't be scammed again by a "recovery service" offering to get your money back for you. The service is just trying to take your last dime. There is no charge for filing a complaint with a government agency.

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Visit www irs gov freefile Publication 538 - Main Content Table of Contents Accounting PeriodsCalendar Year Fiscal Year Short Tax Year Improper Tax Year Change in Tax Year Individuals Partnerships, S Corporations, and Personal Service Corporations (PSCs) Corporations (Other Than S Corporations and PSCs) Accounting MethodsSpecial methods. Visit www irs gov freefile Hybrid method. Visit www irs gov freefile Cash Method Accrual Method Inventories Change in Accounting Method How To Get Tax HelpLow Income Taxpayer Clinics (LITCs). Visit www irs gov freefile Accounting Periods You must use a tax year to figure your taxable income. Visit www irs gov freefile A tax year is an annual accounting period for keeping records and reporting income and expenses. Visit www irs gov freefile An annual accounting period does not include a short tax year (discussed later). Visit www irs gov freefile You can use the following tax years: A calendar year; or A fiscal year (including a 52-53-week tax year). Visit www irs gov freefile Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. Visit www irs gov freefile A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. Visit www irs gov freefile You cannot adopt a tax year by merely: Filing an application for an extension of time to file an income tax return; Filing an application for an employer identification number (Form SS-4); or Paying estimated taxes. Visit www irs gov freefile This section discusses: A calendar year. Visit www irs gov freefile A fiscal year (including a period of 52 or 53 weeks). Visit www irs gov freefile A short tax year. Visit www irs gov freefile An improper tax year. Visit www irs gov freefile A change in tax year. Visit www irs gov freefile Special situations that apply to individuals. Visit www irs gov freefile Restrictions that apply to the accounting period of a partnership, S corporation, or personal service corporation. Visit www irs gov freefile Special situations that apply to corporations. Visit www irs gov freefile Calendar Year A calendar year is 12 consecutive months beginning on January 1st and ending on December 31st. Visit www irs gov freefile If you adopt the calendar year, you must maintain your books and records and report your income and expenses from January 1st through December 31st of each year. Visit www irs gov freefile If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a partner in a partnership, or become a shareholder in an S corporation, you must continue to use the calendar year unless you obtain approval from the IRS to change it, or are otherwise allowed to change it without IRS approval. Visit www irs gov freefile See Change in Tax Year, later. Visit www irs gov freefile Generally, anyone can adopt the calendar year. Visit www irs gov freefile However, you must adopt the calendar year if: You keep no books or records; You have no annual accounting period; Your present tax year does not qualify as a fiscal year; or You are required to use a calendar year by a provision in the Internal Revenue Code or the Income Tax Regulations. Visit www irs gov freefile Fiscal Year A fiscal year is 12 consecutive months ending on the last day of any month except December 31st. Visit www irs gov freefile If you are allowed to adopt a fiscal year, you must consistently maintain your books and records and report your income and expenses using the time period adopted. Visit www irs gov freefile 52-53-Week Tax Year You can elect to use a 52-53-week tax year if you keep your books and records and report your income and expenses on that basis. Visit www irs gov freefile If you make this election, your 52-53-week tax year must always end on the same day of the week. Visit www irs gov freefile Your 52-53-week tax year must always end on: Whatever date this same day of the week last occurs in a calendar month, or Whatever date this same day of the week falls that is nearest to the last day of the calendar month. Visit www irs gov freefile For example, if you elect a tax year that always ends on the last Monday in March, your 2012 tax year will end on March 25, 2013. Visit www irs gov freefile Election. Visit www irs gov freefile   To make the election for the 52-53-week tax year, attach a statement with the following information to your tax return. Visit www irs gov freefile The month in which the new 52-53-week tax year ends. Visit www irs gov freefile The day of the week on which the tax year always ends. Visit www irs gov freefile The date the tax year ends. Visit www irs gov freefile It can be either of the following dates on which the chosen day: Last occurs in the month in (1), above, or Occurs nearest to the last day of the month in (1), above. Visit www irs gov freefile   When you figure depreciation or amortization, a 52-53-week tax year is generally considered a year of 12 calendar months. Visit www irs gov freefile   To determine an effective date (or apply provisions of any law) expressed in terms of tax years beginning, including, or ending on the first or last day of a specified calendar month, a 52-53-week tax year is considered to: Begin on the first day of the calendar month beginning nearest to the first day of the 52-53-week tax year, and End on the last day of the calendar month ending nearest to the last day of the 52-53-week tax year. Visit www irs gov freefile Example. Visit www irs gov freefile Assume a tax provision applies to tax years beginning on or after July 1, 2012, which happens to be a Sunday. Visit www irs gov freefile For this purpose, a 52-53-week tax year that begins on the last Tuesday of June, which falls on June 26, 2012, is treated as beginning on July 1, 2012. Visit www irs gov freefile Short Tax Year A short tax year is a tax year of less than 12 months. Visit www irs gov freefile A short period tax return may be required when you (as a taxable entity): Are not in existence for an entire tax year, or Change your accounting period. Visit www irs gov freefile Tax on a short period tax return is figured differently for each situation. Visit www irs gov freefile Not in Existence Entire Year Even if a taxable entity was not in existence for the entire year, a tax return is required for the time it was in existence. Visit www irs gov freefile Requirements for filing the return and figuring the tax are generally the same as the requirements for a return for a full tax year (12 months) ending on the last day of the short tax year. Visit www irs gov freefile Example 1. Visit www irs gov freefile XYZ Corporation was organized on July 1, 2012. Visit www irs gov freefile It elected the calendar year as its tax year. Visit www irs gov freefile Therefore, its first tax return was due March 15, 2013. Visit www irs gov freefile This short period return will cover the period from July 1, 2012, through December 31, 2012. Visit www irs gov freefile Example 2. Visit www irs gov freefile A calendar year corporation dissolved on July 23, 2012. Visit www irs gov freefile Its final return is due by October 15, 2012. Visit www irs gov freefile It will cover the short period from January 1, 2012, through July 23, 2012. Visit www irs gov freefile Death of individual. Visit www irs gov freefile   When an individual dies, a tax return must be filed for the decedent by the 15th day of the 4th month after the close of the individual's regular tax year. Visit www irs gov freefile The decedent's final return will be a short period tax return that begins on January 1st, and ends on the date of death. Visit www irs gov freefile In the case of a decedent who dies on December 31st, the last day of the regular tax year, a full calendar-year tax return is required. Visit www irs gov freefile Example. Visit www irs gov freefile   Agnes Green was a single, calendar year taxpayer. Visit www irs gov freefile She died on March 6, 2012. Visit www irs gov freefile Her final income tax return must be filed by April 15, 2013. Visit www irs gov freefile It will cover the short period from January 1, 2012, to March 6, 2012. Visit www irs gov freefile Figuring Tax for Short Year If the IRS approves a change in your tax year or you are required to change your tax year, you must figure the tax and file your return for the short tax period. Visit www irs gov freefile The short tax period begins on the first day after the close of your old tax year and ends on the day before the first day of your new tax year. Visit www irs gov freefile Figure tax for a short year under the general rule, explained below. Visit www irs gov freefile You may then be able to use a relief procedure, explained later, and claim a refund of part of the tax you paid. Visit www irs gov freefile General rule. Visit www irs gov freefile   Income tax for a short tax year must be annualized. Visit www irs gov freefile However, self-employment tax is figured on the actual self-employment income for the short period. Visit www irs gov freefile Individuals. Visit www irs gov freefile   An individual must figure income tax for the short tax year as follows. Visit www irs gov freefile Determine your adjusted gross income (AGI) for the short tax year and then subtract your actual itemized deductions for the short tax year. Visit www irs gov freefile You must itemize deductions when you file a short period tax return. Visit www irs gov freefile Multiply the dollar amount of your exemptions by the number of months in the short tax year and divide the result by 12. Visit www irs gov freefile Subtract the amount in (2) from the amount in (1). Visit www irs gov freefile The result is your modified taxable income. Visit www irs gov freefile Multiply the modified taxable income in (3) by 12, then divide the result by the number of months in the short tax year. Visit www irs gov freefile The result is your annualized income. Visit www irs gov freefile Figure the total tax on your annualized income using the appropriate tax rate schedule. Visit www irs gov freefile Multiply the total tax by the number of months in the short tax year and divide the result by 12. Visit www irs gov freefile The result is your tax for the short tax year. Visit www irs gov freefile Relief procedure. Visit www irs gov freefile   Individuals and corporations can use a relief procedure to figure the tax for the short tax year. Visit www irs gov freefile It may result in less tax. Visit www irs gov freefile Under this procedure, the tax is figured by two separate methods. Visit www irs gov freefile If the tax figured under both methods is less than the tax figured under the general rule, you can file a claim for a refund of part of the tax you paid. Visit www irs gov freefile For more information, see section 443(b)(2) of the Internal Revenue Code. Visit www irs gov freefile Alternative minimum tax. Visit www irs gov freefile   To figure the alternative minimum tax (AMT) due for a short tax year: Figure the annualized alternative minimum taxable income (AMTI) for the short tax period by completing the following steps. Visit www irs gov freefile Multiply the AMTI by 12. Visit www irs gov freefile Divide the result by the number of months in the short tax year. Visit www irs gov freefile Multiply the annualized AMTI by the appropriate rate of tax under section 55(b)(1) of the Internal Revenue Code. Visit www irs gov freefile The result is the annualized AMT. Visit www irs gov freefile Multiply the annualized AMT by the number of months in the short tax year and divide the result by 12. Visit www irs gov freefile   For information on the AMT for individuals, see the Instructions for Form 6251, Alternative Minimum Tax–Individuals. Visit www irs gov freefile For information on the AMT for corporations, see the Instructions to Form 4626, Alternative Minimum Tax–Corporations. Visit www irs gov freefile Tax withheld from wages. Visit www irs gov freefile   You can claim a credit against your income tax liability for federal income tax withheld from your wages. Visit www irs gov freefile Federal income tax is withheld on a calendar year basis. Visit www irs gov freefile The amount withheld in any calendar year is allowed as a credit for the tax year beginning in the calendar year. Visit www irs gov freefile Improper Tax Year Taxpayers that have adopted an improper tax year must change to a proper tax year. Visit www irs gov freefile For example, if a taxpayer began business on March 15 and adopted a tax year ending on March 14 (a period of exactly 12 months), this would be an improper tax year. Visit www irs gov freefile See Accounting Periods, earlier, for a description of permissible tax years. Visit www irs gov freefile To change to a proper tax year, you must do one of the following. Visit www irs gov freefile If you are requesting a change to a calendar tax year, file an amended income tax return based on a calendar tax year that corrects the most recently filed tax return that was filed on the basis of an improper tax year. Visit www irs gov freefile Attach a completed Form 1128 to the amended tax return. Visit www irs gov freefile Write “FILED UNDER REV. Visit www irs gov freefile PROC. Visit www irs gov freefile 85-15” at the top of Form 1128 and file the forms with the Internal Revenue Service Center where you filed your original return. Visit www irs gov freefile If you are requesting a change to a fiscal tax year, file Form 1128 in accordance with the form instructions to request IRS approval for the change. Visit www irs gov freefile Change in Tax Year Generally, you must file Form 1128 to request IRS approval to change your tax year. Visit www irs gov freefile See the Instructions for Form 1128 for exceptions. Visit www irs gov freefile If you qualify for an automatic approval request, a user fee is not required. Visit www irs gov freefile Individuals Generally, individuals must adopt the calendar year as their tax year. Visit www irs gov freefile An individual can adopt a fiscal year provided that the individual maintains his or her books and records on the basis of the adopted fiscal year. Visit www irs gov freefile Partnerships, S Corporations, and Personal Service Corporations (PSCs) Generally, partnerships, S corporations (including electing S corporations), and PSCs must use a required tax year. Visit www irs gov freefile A required tax year is a tax year that is required under the Internal Revenue Code and Income Tax Regulations. Visit www irs gov freefile The entity does not have to use the required tax year if it receives IRS approval to use another permitted tax year or makes an election under section 444 of the Internal Revenue Code (discussed later). Visit www irs gov freefile The following discussions provide the rules for partnerships, S corporations, and PSCs. Visit www irs gov freefile Partnership A partnership must conform its tax year to its partners' tax years unless any of the following apply. Visit www irs gov freefile The partnership makes an election under section 444 of the Internal Revenue Code to have a tax year other than a required tax year by filing Form 8716. Visit www irs gov freefile The partnership elects to use a 52-53-week tax year that ends with reference to either its required tax year or a tax year elected under section 444. Visit www irs gov freefile The partnership can establish a business purpose for a different tax year. Visit www irs gov freefile The rules for the required tax year for partnerships are as follows. Visit www irs gov freefile If one or more partners having the same tax year own a majority interest (more than 50%) in partnership profits and capital, the partnership must use the tax year of those partners. Visit www irs gov freefile If there is no majority interest tax year, the partnership must use the tax year of all its principal partners. Visit www irs gov freefile A principal partner is one who has a 5% or more interest in the profits or capital of the partnership. Visit www irs gov freefile If there is no majority interest tax year and the principal partners do not have the same tax year, the partnership generally must use a tax year that results in the least aggregate deferral of income to the partners. Visit www irs gov freefile If a partnership changes to a required tax year because of these rules, it can get automatic approval by filing Form 1128. Visit www irs gov freefile Least aggregate deferral of income. Visit www irs gov freefile   The tax year that results in the least aggregate deferral of income is determined as follows. Visit www irs gov freefile Figure the number of months of deferral for each partner using one partner's tax year. Visit www irs gov freefile Find the months of deferral by counting the months from the end of that tax year forward to the end of each other partner's tax year. Visit www irs gov freefile Multiply each partner's months of deferral figured in step (1) by that partner's share of interest in the partnership profits for the year used in step (1). Visit www irs gov freefile Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1). Visit www irs gov freefile Repeat steps (1) through (3) for each partner's tax year that is different from the other partners' years. Visit www irs gov freefile   The partner's tax year that results in the lowest aggregate (total) number is the tax year that must be used by the partnership. Visit www irs gov freefile If the calculation results in more than one tax year qualifying as the tax year with the least aggregate deferral, the partnership can choose any one of those tax years as its tax year. Visit www irs gov freefile However, if one of the tax years that qualifies is the partnership's existing tax year, the partnership must retain that tax year. Visit www irs gov freefile Example. Visit www irs gov freefile A and B each have a 50% interest in partnership P, which uses a fiscal year ending June 30. Visit www irs gov freefile A uses the calendar year and B uses a fiscal year ending November 30. Visit www irs gov freefile P must change its tax year to a fiscal year ending November 30 because this results in the least aggregate deferral of income to the partners, as shown in the following table. Visit www irs gov freefile Year End 12/31: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Visit www irs gov freefile 5 -0- -0- B 11/30 0. Visit www irs gov freefile 5 11 5. Visit www irs gov freefile 5 Total Deferral 5. Visit www irs gov freefile 5 Year End 11/30: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Visit www irs gov freefile 5 1 0. Visit www irs gov freefile 5 B 11/30 0. Visit www irs gov freefile 5 -0- -0- Total Deferral 0. Visit www irs gov freefile 5 When determination is made. Visit www irs gov freefile   The determination of the tax year under the least aggregate deferral rules must generally be made at the beginning of the partnership's current tax year. Visit www irs gov freefile However, the IRS can require the partnership to use another day or period that will more accurately reflect the ownership of the partnership. Visit www irs gov freefile This could occur, for example, if a partnership interest was transferred for the purpose of qualifying for a particular tax year. Visit www irs gov freefile Short period return. Visit www irs gov freefile   When a partnership changes its tax year, a short period return must be filed. Visit www irs gov freefile The short period return covers the months between the end of the partnership's prior tax year and the beginning of its new tax year. Visit www irs gov freefile   If a partnership changes to the tax year resulting in the least aggregate deferral, it must file a Form 1128 with the short period return showing the computations used to determine that tax year. Visit www irs gov freefile The short period return must indicate at the top of page 1, “FILED UNDER SECTION 1. Visit www irs gov freefile 706-1. Visit www irs gov freefile ” More information. Visit www irs gov freefile   For more information about changing a partnership's tax year, and information about ruling requests, see the Instructions for Form 1128. Visit www irs gov freefile S Corporation All S corporations, regardless of when they became an S corporation, must use a permitted tax year. Visit www irs gov freefile A permitted tax year is any of the following. Visit www irs gov freefile The calendar year. Visit www irs gov freefile A tax year elected under section 444 of the Internal Revenue Code. Visit www irs gov freefile See Section 444 Election, below for details. Visit www irs gov freefile A 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Visit www irs gov freefile Any other tax year for which the corporation establishes a business purpose. Visit www irs gov freefile If an electing S corporation wishes to adopt a tax year other than a calendar year, it must request IRS approval using Form 2553, instead of filing Form 1128. Visit www irs gov freefile For information about changing an S corporation's tax year and information about ruling requests, see the Instructions for Form 1128. Visit www irs gov freefile Personal Service Corporation (PSC) A PSC must use a calendar tax year unless any of the following apply. Visit www irs gov freefile The corporation makes an election under section 444 of the Internal Revenue Code. Visit www irs gov freefile See Section 444 Election, below for details. Visit www irs gov freefile The corporation elects to use a 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Visit www irs gov freefile The corporation establishes a business purpose for a fiscal year. Visit www irs gov freefile See the Instructions for Form 1120 for general information about PSCs. Visit www irs gov freefile For information on adopting or changing tax years for PSCs and information about ruling requests, see the Instructions for Form 1128. Visit www irs gov freefile Section 444 Election A partnership, S corporation, electing S corporation, or PSC can elect under section 444 of the Internal Revenue Code to use a tax year other than its required tax year. Visit www irs gov freefile Certain restrictions apply to the election. Visit www irs gov freefile A partnership or an S corporation that makes a section 444 election must make certain required payments and a PSC must make certain distributions (discussed later). Visit www irs gov freefile The section 444 election does not apply to any partnership, S corporation, or PSC that establishes a business purpose for a different period, explained later. Visit www irs gov freefile A partnership, S corporation, or PSC can make a section 444 election if it meets all the following requirements. Visit www irs gov freefile It is not a member of a tiered structure (defined in section 1. Visit www irs gov freefile 444-2T of the regulations). Visit www irs gov freefile It has not previously had a section 444 election in effect. Visit www irs gov freefile It elects a year that meets the deferral period requirement. Visit www irs gov freefile Deferral period. Visit www irs gov freefile   The determination of the deferral period depends on whether the partnership, S corporation, or PSC is retaining its tax year or adopting or changing its tax year with a section 444 election. Visit www irs gov freefile Retaining tax year. Visit www irs gov freefile   Generally, a partnership, S corporation, or PSC can make a section 444 election to retain its tax year only if the deferral period of the new tax year is 3 months or less. Visit www irs gov freefile This deferral period is the number of months between the beginning of the retained year and the close of the first required tax year. Visit www irs gov freefile Adopting or changing tax year. Visit www irs gov freefile   If the partnership, S corporation, or PSC is adopting or changing to a tax year other than its required year, the deferral period is the number of months from the end of the new tax year to the end of the required tax year. Visit www irs gov freefile The IRS will allow a section 444 election only if the deferral period of the new tax year is less than the shorter of: Three months, or The deferral period of the tax year being changed. Visit www irs gov freefile This is the tax year immediately preceding the year for which the partnership, S corporation, or PSC wishes to make the section 444 election. Visit www irs gov freefile If the partnership, S corporation, or PSC's tax year is the same as its required tax year, the deferral period is zero. Visit www irs gov freefile Example 1. Visit www irs gov freefile BD Partnership uses a calendar year, which is also its required tax year. Visit www irs gov freefile BD cannot make a section 444 election because the deferral period is zero. Visit www irs gov freefile Example 2. Visit www irs gov freefile E, a newly formed partnership, began operations on December 1. Visit www irs gov freefile E is owned by calendar year partners. Visit www irs gov freefile E wants to make a section 444 election to adopt a September 30 tax year. Visit www irs gov freefile E's deferral period for the tax year beginning December 1 is 3 months, the number of months between September 30 and December 31. Visit www irs gov freefile Making the election. Visit www irs gov freefile   Make a section 444 election by filing Form 8716 with the Internal Revenue Service Center where the entity will file its tax return. Visit www irs gov freefile Form 8716 must be filed by the earlier of: The due date (not including extensions) of the income tax return for the tax year resulting from the section 444 election, or The 15th day of the 6th month of the tax year for which the election will be effective. Visit www irs gov freefile For this purpose, count the month in which the tax year begins, even if it begins after the first day of that month. Visit www irs gov freefile Note. Visit www irs gov freefile If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day. Visit www irs gov freefile   Attach a copy of Form 8716 to Form 1065, Form 1120S, or Form 1120 for the first tax year for which the election is made. Visit www irs gov freefile Example 1. Visit www irs gov freefile AB, a partnership, begins operations on September 13, 2012, and is qualified to make a section 444 election to use a September 30 tax year for its tax year beginning September 13, 2012. Visit www irs gov freefile AB must file Form 8716 by January 15, 2013, which is the due date of the partnership's tax return for the period from September 13, 2012, to September 30, 2012. Visit www irs gov freefile Example 2. Visit www irs gov freefile The facts are the same as in Example 1 except that AB begins operations on October 21, 2012. Visit www irs gov freefile AB must file Form 8716 by March 17, 2013. Visit www irs gov freefile Example 3. Visit www irs gov freefile B is a corporation that first becomes a PSC for its tax year beginning September 1, 2012. Visit www irs gov freefile B qualifies to make a section 444 election to use a September 30 tax year for its tax year beginning September 1, 2012. Visit www irs gov freefile B must file Form 8716 by December 17, 2012, the due date of the income tax return for the short period from September 1, 2012, to September 30, 2012. Visit www irs gov freefile Note. Visit www irs gov freefile The due dates in Examples 2 and 3 are adjusted because the dates fall on a Saturday, Sunday or legal holiday. Visit www irs gov freefile Extension of time for filing. Visit www irs gov freefile   There is an automatic extension of 12 months to make this election. Visit www irs gov freefile See the Form 8716 instructions for more information. Visit www irs gov freefile Terminating the election. Visit www irs gov freefile   The section 444 election remains in effect until it is terminated. Visit www irs gov freefile If the election is terminated, another section 444 election cannot be made for any tax year. Visit www irs gov freefile   The election ends when any of the following applies to the partnership, S corporation, or PSC. Visit www irs gov freefile The entity changes to its required tax year. Visit www irs gov freefile The entity liquidates. Visit www irs gov freefile The entity becomes a member of a tiered structure. Visit www irs gov freefile The IRS determines that the entity willfully failed to comply with the required payments or distributions. Visit www irs gov freefile   The election will also end if either of the following events occur. Visit www irs gov freefile An S corporation's S election is terminated. Visit www irs gov freefile However, if the S corporation immediately becomes a PSC, the PSC can continue the section 444 election of the S corporation. Visit www irs gov freefile A PSC ceases to be a PSC. Visit www irs gov freefile If the PSC elects to be an S corporation, the S corporation can continue the election of the PSC. Visit www irs gov freefile Required payment for partnership or S corporation. Visit www irs gov freefile   A partnership or an S corporation must make a required payment for any tax year: The section 444 election is in effect. Visit www irs gov freefile The required payment for that year (or any preceding tax year) is more than $500. Visit www irs gov freefile    This payment represents the value of the tax deferral the owners receive by using a tax year different from the required tax year. Visit www irs gov freefile   Form 8752, Required Payment or Refund Under Section 7519, must be filed each year the section 444 election is in effect, even if no payment is due. Visit www irs gov freefile If the required payment is more than $500 (or the required payment for any prior year was more than $500), the payment must be made when Form 8752 is filed. Visit www irs gov freefile If the required payment is $500 or less and no payment was required in a prior year, Form 8752 must be filed showing a zero amount. Visit www irs gov freefile Applicable election year. Visit www irs gov freefile   Any tax year a section 444 election is in effect, including the first year, is called an applicable election year. Visit www irs gov freefile Form 8752 must be filed and the required payment made (or zero amount reported) by May 15th of the calendar year following the calendar year in which the applicable election year begins. Visit www irs gov freefile Required distribution for PSC. Visit www irs gov freefile   A PSC with a section 444 election in effect must distribute certain amounts to employee-owners by December 31 of each applicable year. Visit www irs gov freefile If it fails to make these distributions, it may be required to defer certain deductions for amounts paid to owner-employees. Visit www irs gov freefile The amount deferred is treated as paid or incurred in the following tax year. Visit www irs gov freefile   For information on the minimum distribution, see the instructions for Part I of Schedule H (Form 1120), Section 280H Limitations for a Personal Service Corporation (PSC). Visit www irs gov freefile Back-up election. Visit www irs gov freefile   A partnership, S corporation, or PSC can file a back-up section 444 election if it requests (or plans to request) permission to use a business purpose tax year, discussed later. Visit www irs gov freefile If the request is denied, the back-up section 444 election must be activated (if the partnership, S corporation, or PSC otherwise qualifies). Visit www irs gov freefile Making back-up election. Visit www irs gov freefile   The general rules for making a section 444 election, as discussed earlier, apply. Visit www irs gov freefile When filing Form 8716, type or print “BACK-UP ELECTION” at the top of the form. Visit www irs gov freefile However, if Form 8716 is filed on or after the date Form 1128 (or Form 2553) is filed, type or print “FORM 1128 (or FORM 2553) BACK-UP ELECTION” at the top of Form 8716. Visit www irs gov freefile Activating election. Visit www irs gov freefile   A partnership or S corporation activates its back-up election by filing the return required and making the required payment with Form 8752. Visit www irs gov freefile The due date for filing Form 8752 and making the payment is the later of the following dates. Visit www irs gov freefile May 15 of the calendar year following the calendar year in which the applicable election year begins. Visit www irs gov freefile 60 days after the partnership or S corporation has been notified by the IRS that the business year request has been denied. Visit www irs gov freefile   A PSC activates its back-up election by filing Form 8716 with its original or amended income tax return for the tax year in which the election is first effective and printing on the top of the income tax return, “ACTIVATING BACK-UP ELECTION. Visit www irs gov freefile ” 52-53-Week Tax Year A partnership, S corporation, or PSC can use a tax year other than its required tax year if it elects a 52-53-week tax year (discussed earlier) that ends with reference to either its required tax year or a tax year elected under section 444 (discussed earlier). Visit www irs gov freefile A newly formed partnership, S corporation, or PSC can adopt a 52-53-week tax year ending with reference to either its required tax year or a tax year elected under section 444 without IRS approval. Visit www irs gov freefile However, if the entity wishes to change to a 52-53-week tax year or change from a 52-53-week tax year that references a particular month to a non-52-53-week tax year that ends on the last day of that month, it must request IRS approval by filing Form 1128. Visit www irs gov freefile Business Purpose Tax Year A partnership, S corporation, or PSC establishes the business purpose for a tax year by filing Form 1128. Visit www irs gov freefile See the Instructions for Form 1128 for details. Visit www irs gov freefile Corporations (Other Than S Corporations and PSCs) A new corporation establishes its tax year when it files its first tax return. Visit www irs gov freefile A newly reactivated corporation that has been inactive for a number of years is treated as a new taxpayer for the purpose of adopting a tax year. Visit www irs gov freefile An S corporation or a PSC must use the required tax year rules, discussed earlier, to establish a tax year. Visit www irs gov freefile Generally, a corporation that wants to change its tax year must obtain approval from the IRS under either the: (a) automatic approval procedures; or (b) ruling request procedures. Visit www irs gov freefile See the Instructions for Form 1128 for details. Visit www irs gov freefile Accounting Methods An accounting method is a set of rules used to determine when income and expenses are reported on your tax return. Visit www irs gov freefile Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item. Visit www irs gov freefile You choose an accounting method when you file your first tax return. Visit www irs gov freefile If you later want to change your accounting method, you must get IRS approval. Visit www irs gov freefile See Change in Accounting Method, later. Visit www irs gov freefile No single accounting method is required of all taxpayers. Visit www irs gov freefile You must use a system that clearly reflects your income and expenses and you must maintain records that will enable you to file a correct return. Visit www irs gov freefile In addition to your permanent accounting books, you must keep any other records necessary to support the entries on your books and tax returns. Visit www irs gov freefile You must use the same accounting method from year to year. Visit www irs gov freefile An accounting method clearly reflects income only if all items of gross income and expenses are treated the same from year to year. Visit www irs gov freefile If you do not regularly use an accounting method that clearly reflects your income, your income will be refigured under the method that, in the opinion of the IRS, does clearly reflect income. Visit www irs gov freefile Methods you can use. Visit www irs gov freefile   In general, you can compute your taxable income under any of the following accounting methods. Visit www irs gov freefile Cash method. Visit www irs gov freefile Accrual method. Visit www irs gov freefile Special methods of accounting for certain items of income and expenses. Visit www irs gov freefile A hybrid method which combines elements of two or more of the above accounting methods. Visit www irs gov freefile The cash and accrual methods of accounting are explained later. Visit www irs gov freefile Special methods. Visit www irs gov freefile   This publication does not discuss special methods of accounting for certain items of income or expenses. Visit www irs gov freefile For information on reporting income using one of the long-term contract methods, see section 460 of the Internal Revenue Code and the related regulations. Visit www irs gov freefile The following publications also discuss special methods of reporting income or expenses. Visit www irs gov freefile Publication 225, Farmer's Tax Guide. Visit www irs gov freefile Publication 535, Business Expenses. Visit www irs gov freefile Publication 537, Installment Sales. Visit www irs gov freefile Publication 946, How To Depreciate Property. Visit www irs gov freefile Hybrid method. Visit www irs gov freefile   Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently. Visit www irs gov freefile However, the following restrictions apply. Visit www irs gov freefile If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. Visit www irs gov freefile See Exceptions under Inventories, later. Visit www irs gov freefile Generally, you can use the cash method for all other items of income and expenses. Visit www irs gov freefile See Inventories, later. Visit www irs gov freefile If you use the cash method for reporting your income, you must use the cash method for reporting your expenses. Visit www irs gov freefile If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Visit www irs gov freefile Any combination that includes the cash method is treated as the cash method for purposes of section 448 of the Internal Revenue Code. Visit www irs gov freefile Business and personal items. Visit www irs gov freefile   You can account for business and personal items using different accounting methods. Visit www irs gov freefile For example, you can determine your business income and expenses under an accrual method, even if you use the cash method to figure personal items. Visit www irs gov freefile Two or more businesses. Visit www irs gov freefile   If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. Visit www irs gov freefile No business is separate and distinct, unless a complete and separate set of books and records is maintained for each business. Visit www irs gov freefile Note. Visit www irs gov freefile If you use different accounting methods to create or shift profits or losses between businesses (for example, through inventory adjustments, sales, purchases, or expenses) so that income is not clearly reflected, the businesses will not be considered separate and distinct. Visit www irs gov freefile Cash Method Most individuals and many small businesses use the cash method of accounting. Visit www irs gov freefile Generally, if you produce, purchase, or sell merchandise, you must keep an inventory and use an accrual method for sales and purchases of merchandise. Visit www irs gov freefile See Inventories, later, for exceptions to this rule. Visit www irs gov freefile Income Under the cash method, you include in your gross income all items of income you actually or constructively receive during the tax year. Visit www irs gov freefile If you receive property and services, you must include their fair market value (FMV) in income. Visit www irs gov freefile Constructive receipt. Visit www irs gov freefile   Income is constructively received when an amount is credited to your account or made available to you without restriction. Visit www irs gov freefile You need not have possession of it. Visit www irs gov freefile If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. Visit www irs gov freefile Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. Visit www irs gov freefile Example. Visit www irs gov freefile You are a calendar year taxpayer. Visit www irs gov freefile Your bank credited, and made available, interest to your bank account in December 2012. Visit www irs gov freefile You did not withdraw it or enter it into your books until 2013. Visit www irs gov freefile You must include the amount in gross income for 2012, the year you constructively received it. Visit www irs gov freefile You cannot hold checks or postpone taking possession of similar property from one tax year to another to postpone paying tax on the income. Visit www irs gov freefile You must report the income in the year the property is received or made available to you without restriction. Visit www irs gov freefile Expenses Under the cash method, generally, you deduct expenses in the tax year in which you actually pay them. Visit www irs gov freefile This includes business expenses for which you contest liability. Visit www irs gov freefile However, you may not be able to deduct an expense paid in advance. Visit www irs gov freefile Instead, you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules. Visit www irs gov freefile Expense paid in advance. Visit www irs gov freefile   An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Visit www irs gov freefile   Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Visit www irs gov freefile 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Visit www irs gov freefile   If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must obtain approval from the IRS before using the general rule and/or the 12-month rule. Visit www irs gov freefile See Change in Accounting Method, later. Visit www irs gov freefile Example 1. Visit www irs gov freefile You are a calendar year taxpayer and pay $3,000 in 2012 for a business insurance policy that is effective for three years (36 months), beginning on July 1, 2012. Visit www irs gov freefile The general rule that an expense paid in advance is deductible only in the year to which it applies is applicable to this payment because the payment does not qualify for the 12-month rule. Visit www irs gov freefile Therefore, only $500 (6/36 x $3,000) is deductible in 2012, $1,000 (12/36 x $3,000) is deductible in 2013, $1,000 (12/36 x $3,000) is deductible in 2014, and the remaining $500 is deductible in 2015. Visit www irs gov freefile Example 2. Visit www irs gov freefile You are a calendar year taxpayer and pay $10,000 on July 1, 2012, for a business insurance policy that is effective for only one year beginning on July 1, 2012. Visit www irs gov freefile The 12-month rule applies. Visit www irs gov freefile Therefore, the full $10,000 is deductible in 2012. Visit www irs gov freefile Excluded Entities The following entities cannot use the cash method, including any combination of methods that includes the cash method. Visit www irs gov freefile (See Special rules for farming businesses, later. Visit www irs gov freefile ) A corporation (other than an S corporation) with average annual gross receipts exceeding $5 million. Visit www irs gov freefile See Gross receipts test, below. Visit www irs gov freefile A partnership with a corporation (other than an S corporation) as a partner, and with the partnership having average annual gross receipts exceeding $5 million. Visit www irs gov freefile See Gross receipts test, below. Visit www irs gov freefile A tax shelter. Visit www irs gov freefile Exceptions The following entities are not prohibited from using the cash method of accounting. Visit www irs gov freefile Any corporation or partnership, other than a tax shelter, that meets the gross receipts test for all tax years after 1985. Visit www irs gov freefile A qualified personal service corporation (PSC). Visit www irs gov freefile Gross receipts test. Visit www irs gov freefile   A corporation or partnership, other than a tax shelter, that meets the gross receipts test can generally use the cash method. Visit www irs gov freefile A corporation or a partnership meets the test if, for each prior tax year beginning after 1985, its average annual gross receipts are $5 million or less. Visit www irs gov freefile    An entity's average annual gross receipts for a prior tax year is determined by: Adding the gross receipts for that tax year and the 2 preceding tax years; and Dividing the total by 3. Visit www irs gov freefile See Gross receipts test for qualifying taxpayers, for more information. Visit www irs gov freefile Generally, a partnership applies the test at the partnership level. Visit www irs gov freefile Gross receipts for a short tax year are annualized. Visit www irs gov freefile Aggregation rules. Visit www irs gov freefile   Organizations that are members of an affiliated service group or a controlled group of corporations treated as a single employer for tax purposes are required to aggregate their gross receipts to determine whether the gross receipts test is met. Visit www irs gov freefile Change to accrual method. Visit www irs gov freefile   A corporation or partnership that fails to meet the gross receipts test for any tax year is prohibited from using the cash method and must change to an accrual method of accounting, effective for the tax year in which the entity fails to meet this test. Visit www irs gov freefile Special rules for farming businesses. Visit www irs gov freefile   Generally, a taxpayer engaged in the trade or business of farming is allowed to use the cash method for its farming business. Visit www irs gov freefile However, certain corporations (other than S corporations) and partnerships that have a partner that is a corporation must use an accrual method for their farming business. Visit www irs gov freefile For this purpose, farming does not include the operation of a nursery or sod farm or the raising or harvesting of trees (other than fruit and nut trees). Visit www irs gov freefile   There is an exception to the requirement to use an accrual method for corporations with gross receipts of $1 million or less for each prior tax year after 1975. Visit www irs gov freefile For family corporations engaged in farming, the exception applies if gross receipts were $25 million or less for each prior tax year after 1985. Visit www irs gov freefile See chapter 2 of Publication 225, Farmer's Tax Guide, for more information. Visit www irs gov freefile Qualified PSC. Visit www irs gov freefile   A PSC that meets the following function and ownership tests can use the cash method. Visit www irs gov freefile Function test. Visit www irs gov freefile   A corporation meets the function test if at least 95% of its activities are in the performance of services in the fields of health, veterinary services, law, engineering (including surveying and mapping), architecture, accounting, actuarial science, performing arts, or consulting. Visit www irs gov freefile Ownership test. Visit www irs gov freefile   A corporation meets the ownership test if at least 95% of its stock is owned, directly or indirectly, at all times during the year by one or more of the following. Visit www irs gov freefile Employees performing services for the corporation in a field qualifying under the function test. Visit www irs gov freefile Retired employees who had performed services in those fields. Visit www irs gov freefile The estate of an employee described in (1) or (2). Visit www irs gov freefile Any other person who acquired the stock by reason of the death of an employee referred to in (1) or (2), but only for the 2-year period beginning on the date of death. Visit www irs gov freefile   Indirect ownership is generally taken into account if the stock is owned indirectly through one or more partnerships, S corporations, or qualified PSCs. Visit www irs gov freefile Stock owned by one of these entities is considered owned by the entity's owners in proportion to their ownership interest in that entity. Visit www irs gov freefile Other forms of indirect stock ownership, such as stock owned by family members, are generally not considered when determining if the ownership test is met. Visit www irs gov freefile   For purposes of the ownership test, a person is not considered an employee of a corporation unless that person performs more than minimal services for the corporation. Visit www irs gov freefile Change to accrual method. Visit www irs gov freefile   A corporation that fails to meet the function test for any tax year; or fails to meet the ownership test at any time during any tax year must change to an accrual method of accounting, effective for the year in which the corporation fails to meet either test. Visit www irs gov freefile A corporation that fails to meet the function test or the ownership test is not treated as a qualified PSC for any part of that tax year. Visit www irs gov freefile Accrual Method Under the accrual method of accounting, generally you report income in the year it is earned and deduct or capitalize expenses in the year incurred. Visit www irs gov freefile The purpose of an accrual method of accounting is to match income and expenses in the correct year. Visit www irs gov freefile Income Generally, you include an amount in gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. Visit www irs gov freefile Under this rule, you report an amount in your gross income on the earliest of the following dates. Visit www irs gov freefile When you receive payment. Visit www irs gov freefile When the income amount is due to you. Visit www irs gov freefile When you earn the income. Visit www irs gov freefile When title has passed. Visit www irs gov freefile Estimated income. Visit www irs gov freefile   If you include a reasonably estimated amount in gross income and later determine the exact amount is different, take the difference into account in the tax year you make that determination. Visit www irs gov freefile Change in payment schedule. Visit www irs gov freefile   If you perform services for a basic rate specified in a contract, you must accrue the income at the basic rate, even if you agree to receive payments at a reduced rate. Visit www irs gov freefile Continue this procedure until you complete the services, then account for the difference. Visit www irs gov freefile Advance Payment for Services Generally, you report an advance payment for services to be performed in a later tax year as income in the year you receive the payment. Visit www irs gov freefile However, if you receive an advance payment for services you agree to perform by the end of the next tax year, you can elect to postpone including the advance payment in income until the next tax year. Visit www irs gov freefile However, you cannot postpone including any payment beyond that tax year. Visit www irs gov freefile Service agreement. Visit www irs gov freefile   You can postpone reporting income from an advance payment you receive for a service agreement on property you sell, lease, build, install, or construct. Visit www irs gov freefile This includes an agreement providing for incidental replacement of parts or materials. Visit www irs gov freefile However, this applies only if you offer the property without a service agreement in the normal course of business. Visit www irs gov freefile Postponement not allowed. Visit www irs gov freefile   Generally, one cannot postpone including an advance payment in income for services if either of the following applies. Visit www irs gov freefile You are to perform any part of the service after the end of the tax year immediately following the year you receive the advance payment. Visit www irs gov freefile You are to perform any part of the service at any unspecified future date that may be after the end of the tax year immediately following the year you receive the advance payment. Visit www irs gov freefile Examples. Visit www irs gov freefile   In each of the following examples, assume the tax year is a calendar year and that the accrual method of accounting is used. Visit www irs gov freefile Example 1. Visit www irs gov freefile You manufacture, sell, and service computers. Visit www irs gov freefile You received payment in 2012 for a one-year contingent service contract on a computer you sold. Visit www irs gov freefile You can postpone including in income the part of the payment you did not earn in 2012 if, in the normal course of your business, you offer computers for sale without a contingent service contract. Visit www irs gov freefile Example 2. Visit www irs gov freefile You are in the television repair business. Visit www irs gov freefile You received payments in 2012 for one-year contracts under which you agree to repair or replace certain parts that fail to function properly in television sets manufactured and sold by unrelated parties. Visit www irs gov freefile You include the payments in gross income as you earn them. Visit www irs gov freefile Example 3. Visit www irs gov freefile You own a dance studio. Visit www irs gov freefile On October 1, 2012, you receive payment for a one-year contract for 48 one-hour lessons beginning on that date. Visit www irs gov freefile You give eight lessons in 2012. Visit www irs gov freefile Under this method of including advance payments, you must include one-sixth (8/48) of the payment in income for 2012, and five-sixths (40/48) of the payment in 2013, even if you do not give all the lessons by the end of 2013. Visit www irs gov freefile Example 4. Visit www irs gov freefile Assume the same facts as in Example 3, except the payment is for a two-year contract for 96 lessons. Visit www irs gov freefile You must include the entire payment in income in 2012 since part of the services may be performed after the following year. Visit www irs gov freefile Guarantee or warranty. Visit www irs gov freefile   Generally, you cannot postpone reporting income you receive under a guarantee or warranty contract. Visit www irs gov freefile Prepaid rent. Visit www irs gov freefile   You cannot postpone reporting income from prepaid rent. Visit www irs gov freefile Prepaid rent does not include payment for the use of a room or other space when significant service is also provided for the occupant. Visit www irs gov freefile You provide significant service when you supply space in a hotel, boarding house, tourist home, motor court, motel, or apartment house that furnishes hotel services. Visit www irs gov freefile Books and records. Visit www irs gov freefile   Any advance payment you include in gross receipts on your tax return for the year you receive payment must not be less than the payment you include in income for financial reports under the method of accounting used for those reports. Visit www irs gov freefile Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Visit www irs gov freefile IRS approval. Visit www irs gov freefile   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payment for services. Visit www irs gov freefile Advance Payment for Sales Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods held primarily for sale to customers in the ordinary course of your trade or business. Visit www irs gov freefile However, the rules do not apply to a payment (or part of a payment) for services that are not an integral part of the main activities covered under the agreement. Visit www irs gov freefile An agreement includes a gift certificate that can be redeemed for goods. Visit www irs gov freefile Amounts due and payable are considered received. Visit www irs gov freefile How to report payments. Visit www irs gov freefile   Generally, include an advance payment in income in the year in which you receive it. Visit www irs gov freefile However, you can use the alternative method, discussed next. Visit www irs gov freefile Alternative method of reporting. Visit www irs gov freefile   Under the alternative method, generally include an advance payment in income in the earlier tax year in which you: Include advance payments in gross receipts under the method of accounting you use for tax purposes, or Include any part of advance payments in income for financial reports under the method of accounting used for those reports. Visit www irs gov freefile Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Visit www irs gov freefile Example 1. Visit www irs gov freefile You are a retailer. Visit www irs gov freefile You use an accrual method of accounting and account for the sale of goods when you ship the goods. Visit www irs gov freefile You use this method for both tax and financial reporting purposes. Visit www irs gov freefile You can include advance payments in gross receipts for tax purposes in either: (a) the tax year in which you receive the payments; or (b) the tax year in which you ship the goods. Visit www irs gov freefile However, see Exception for inventory goods, later. Visit www irs gov freefile Example 2. Visit www irs gov freefile You are a calendar year taxpayer. Visit www irs gov freefile You manufacture household furniture and use an accrual method of accounting. Visit www irs gov freefile Under this method, you accrue income for your financial reports when you ship the furniture. Visit www irs gov freefile For tax purposes, you do not accrue income until the furniture has been delivered and accepted. Visit www irs gov freefile In 2012, you received an advance payment of $8,000 for an order of furniture to be manufactured for a total price of $20,000. Visit www irs gov freefile You shipped the furniture to the customer in December 2012, but it was not delivered and accepted until January 2013. Visit www irs gov freefile For tax purposes, you include the $8,000 advance payment in gross income for 2012; and include the remaining $12,000 of the contract price in gross income for 2013. Visit www irs gov freefile Information schedule. Visit www irs gov freefile   If you use the alternative method of reporting advance payments, you must attach a statement with the following information to your tax return each year. Visit www irs gov freefile Total advance payments received in the current tax year. Visit www irs gov freefile Total advance payments received in earlier tax years and not included in income before the current tax year. Visit www irs gov freefile Total payments received in earlier tax years included in income for the current tax year. Visit www irs gov freefile Exception for inventory goods. Visit www irs gov freefile   If you have an agreement to sell goods properly included in inventory, you can postpone including the advance payment in income until the end of the second tax year following the year you receive an advance payment if, on the last day of the tax year, you meet the following requirements. Visit www irs gov freefile You account for the advance payment under the alternative method (discussed earlier). Visit www irs gov freefile You have received a substantial advance payment on the agreement (discussed next). Visit www irs gov freefile You have enough substantially similar goods on hand, or available through your normal source of supply, to satisfy the agreement. Visit www irs gov freefile These rules also apply to an agreement, such as a gift certificate, that can be satisfied with goods that cannot be identified in the tax year you receive an advance payment. Visit www irs gov freefile   If you meet these conditions, all advance payments you receive by the end of the second tax year, including payments received in prior years but not reported, must be included in income by the second tax year following the tax year of receipt of substantial advance payments. Visit www irs gov freefile You must also deduct in that second year all actual or estimated costs for the goods required to satisfy the agreement. Visit www irs gov freefile If you estimated the cost, you must take into account any difference between the estimate and the actual cost when the goods are delivered. Visit www irs gov freefile Note. Visit www irs gov freefile You must report any advance payments you receive after the second year in the year received. Visit www irs gov freefile No further deferral is allowed. Visit www irs gov freefile Substantial advance payments. Visit www irs gov freefile   Under an agreement for a future sale, you have substantial advance payments if, by the end of the tax year, the total advance payments received during that year and preceding tax years are equal to or more than the total costs reasonably estimated to be includible in inventory because of the agreement. Visit www irs gov freefile Example. Visit www irs gov freefile You are a calendar year, accrual method taxpayer who accounts for advance payments under the alternative method. Visit www irs gov freefile In 2008, you entered into a contract for the sale of goods properly includible in your inventory. Visit www irs gov freefile The total contract price is $50,000 and you estimate that your total inventoriable costs for the goods will be $25,000. Visit www irs gov freefile You receive the following advance payments under the contract. Visit www irs gov freefile 2009 $17,500 2010 10,000 2011 7,500 2012 5,000 2013 5,000 2014 5,000 Total contract price $50,000   Your customer asked you to deliver the goods in 2015. Visit www irs gov freefile In your 2010 closing inventory, you had on hand enough of the type of goods specified in the contract to satisfy the contract. Visit www irs gov freefile Since the advance payments you had received by the end of 2010 were more than the costs you estimated, the payments are substantial advance payments. Visit www irs gov freefile   For 2012, include in income all payments you received by the end of 2012, the second tax year following the tax year in which you received substantial advance payments. Visit www irs gov freefile You must include $40,000 in sales for 2012 (the total amounts received from 2009 through 2012) and include in inventory the cost of the goods (or similar goods) on hand. Visit www irs gov freefile If no such goods are on hand, then estimate the cost necessary to satisfy the contract. Visit www irs gov freefile   No further deferral is allowed. Visit www irs gov freefile You must include in gross income the advance payment you receive each remaining year of the contract. Visit www irs gov freefile Take into account the difference between any estimated cost of goods sold and the actual cost when you deliver the goods in 2015. Visit www irs gov freefile IRS approval. Visit www irs gov freefile   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payments for sales. Visit www irs gov freefile Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply. Visit www irs gov freefile The all-events test has been met. Visit www irs gov freefile The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Visit www irs gov freefile Economic performance has occurred. Visit www irs gov freefile Economic Performance Generally, you cannot deduct or capitalize a business expense until economic performance occurs. Visit www irs gov freefile If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used. Visit www irs gov freefile If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Visit www irs gov freefile Example. Visit www irs gov freefile You are a calendar year taxpayer. Visit www irs gov freefile You buy office supplies in December 2012. Visit www irs gov freefile You receive the supplies and the bill in December, but you pay the bill in January 2013. Visit www irs gov freefile You can deduct the expense in 2012 because all events have occurred to fix the liability, the amount of the liability can be determined, and economic performance occurred in 2012. Visit www irs gov freefile Your office supplies may qualify as a recurring item, discussed later. Visit www irs gov freefile If so, you can deduct them in 2012, even if the supplies are not delivered until 2013 (when economic performance occurs). Visit www irs gov freefile Workers' compensation and tort liability. Visit www irs gov freefile   If you are required to make payments under workers' compensation laws or in satisfaction of any tort liability, economic performance occurs as you make the payments. Visit www irs gov freefile If you are required to make payments to a special designated settlement fund established by court order for a tort liability, economic performance occurs as you make the payments. Visit www irs gov freefile Taxes. Visit www irs gov freefile   Economic performance generally occurs as estimated income tax, property taxes, employment taxes, etc. Visit www irs gov freefile are paid. Visit www irs gov freefile However, you can elect to treat taxes as a recurring item, discussed later. Visit www irs gov freefile You can also elect to ratably accrue real estate taxes. Visit www irs gov freefile See chapter 5 of Publication 535 for information about real estate taxes. Visit www irs gov freefile Other liabilities. Visit www irs gov freefile   Other liabilities for which economic performance occurs as you make payments include liabilities for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, and warranty and service contracts. Visit www irs gov freefile Interest. Visit www irs gov freefile   Economic performance occurs with the passage of time (as the borrower uses, and the lender forgoes use of, the lender's money) rather than as payments are made. Visit www irs gov freefile Compensation for services. Visit www irs gov freefile   Generally, economic performance occurs as an employee renders service to the employer. Visit www irs gov freefile However, deductions for compensation or other benefits paid to an employee in a year subsequent to economic performance are subject to the rules governing deferred compensation, deferred benefits, and funded welfare benefit plans. Visit www irs gov freefile For information on employee benefit programs, see Publication 15-B, Employer's Tax Guide to Fringe Benefits. Visit www irs gov freefile Vacation pay. Visit www irs gov freefile   You can take a current deduction for vacation pay earned by your employees if you pay it during the year or, if the amount is vested, within 2½ months after the end of the year. Visit www irs gov freefile If you pay it later than this, you must deduct it in the year actually paid. Visit www irs gov freefile An amount is vested if your right to it cannot be nullified or cancelled. Visit www irs gov freefile Exception for recurring items. Visit www irs gov freefile   An exception to the economic performance rule allows certain recurring items to be treated as incurred during the tax year even though economic performance has not occurred. Visit www irs gov freefile The exception applies if all the following requirements are met. Visit www irs gov freefile The all-events test, discussed earlier, is met. Visit www irs gov freefile Economic performance occurs by the earlier of the following dates. Visit www irs gov freefile 8½ months after the close of the year. Visit www irs gov freefile The date you file a timely return (including extensions) for the year. Visit www irs gov freefile The item is recurring in nature and you consistently treat similar items as incurred in the tax year in which the all-events test is met. Visit www irs gov freefile Either: The item is not material, or Accruing the item in the year in which the all-events test is met results in a better match against income than accruing the item in the year of economic performance. Visit www irs gov freefile This exception does not apply to workers' compensation or tort liabilities. Visit www irs gov freefile Amended return. Visit www irs gov freefile   You may be able to file an amended return and treat a liability as incurred under the recurring item exception. Visit www irs gov freefile You can do so if economic performance for the liability occurs after you file your tax return for the year, but within 8½ months after the close of the tax year. Visit www irs gov freefile Recurrence and consistency. Visit www irs gov freefile   To determine whether an item is recurring and consistently reported, consider the frequency with which the item and similar items are incurred (or expected to be incurred) and how you report these items for tax purposes. Visit www irs gov freefile A new expense or an expense not incurred every year can be treated as recurring if it is reasonable to expect that it will be incurred regularly in the future. Visit www irs gov freefile Materiality. Visit www irs gov freefile   Factors to consider in determining the materiality of a recurring item include the size of the item (both in absolute terms and in relation to your income and other expenses) and the treatment of the item on your financial statements. Visit www irs gov freefile   An item considered material for financial statement purposes is also considered material for tax purposes. Visit www irs gov freefile However, in certain situations an immaterial item for financial accounting purposes is treated as material for purposes of economic performance. Visit www irs gov freefile Matching expenses with income. Visit www irs gov freefile   Costs directly associated with the revenue of a period are properly allocable to that period. Visit www irs gov freefile To determine whether the accrual of an expense in a particular year results in a better match with the income to which it relates, generally accepted accounting principles (GAAP; visit www. Visit www irs gov freefile fasab. Visit www irs gov freefile gov/accepted. Visit www irs gov freefile html) are an important factor. Visit www irs gov freefile   For example, if you report sales income in the year of sale, but you do not ship the goods until the following year, the shipping costs are more properly matched to income in the year of sale than the year the goods are shipped. Visit www irs gov freefile Expenses that cannot be practically associated with income of a particular period, such as advertising costs, should be assigned to the period the costs are incurred. Visit www irs gov freefile However, the matching requirement is considered met for certain types of expenses. Visit www irs gov freefile These expenses include taxes, payments under insurance, warranty, and service contracts, rebates, refunds, awards, prizes, and jackpots. Visit www irs gov freefile Expenses Paid in Advance An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Visit www irs gov freefile Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Visit www irs gov freefile 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Visit www irs gov freefile If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must get IRS approval before using the general rule and/or the 12-month rule. Visit www irs gov freefile See Change in Accounting Method, later, for information on how to get IRS approval. Visit www irs gov freefile See Expense paid in advance under Cash Method, earlier, for examples illustrating the application of the general and 12-month rules. Visit www irs gov freefile Related Persons Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Visit www irs gov freefile Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. Visit www irs gov freefile See section 267 of the Internal Revenue Code and Publication 542, Corporations, for the definition of related person. Visit www irs gov freefile Inventories An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Visit www irs gov freefile If you must account for an inventory in your business, you must use an accrual method of accounting for your purchases and sales. Visit www irs gov freefile However, see Exceptions, next. Visit www irs gov freefile See also Accrual Method, earlier. Visit www irs gov freefile To figure taxable income, you must value your inventory at the beginning and end of each tax year. Visit www irs gov freefile To determine the value, you need a method for identifying the items in your inventory and a method for valuing these items. Visit www irs gov freefile See Identifying Cost and Valuing Inventory, later. Visit www irs gov freefile The rules for valuing inventory are not the same for all businesses. Visit www irs gov freefile The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Visit www irs gov freefile Your inventory practices must be consistent from year to year. Visit www irs gov freefile The rules discussed here apply only if they do not conflict with the uniform capitalization rules of section 263A and the mark-to-market rules of section 475. Visit www irs gov freefile Exceptions The following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. Visit www irs gov freefile These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later). Visit www irs gov freefile A qualifying taxpayer under Revenue Procedure 2001-10 on page 272 of Internal Revenue Bulletin 2001-2, available at www. Visit www irs gov freefile irs. Visit www irs gov freefile gov/pub/irs-irbs/irb01–02. Visit www irs gov freefile pdf. Visit www irs gov freefile A qualifying small business taxpayer under Revenue Procedure 2002-28, on page 815 of Internal Revenue Bulletin 2002-18, available at www. Visit www irs gov freefile irs. Visit www irs gov freefile gov/pub/irs-irbs/irb02–18. Visit www irs gov freefile pdf. Visit www irs gov freefile In addition to the information provided in this publication, you should see the revenue procedures referenced in the list, above, and the instructions for Form 3115 for information you will need to adopt or change to these accounting methods (see Changing methods, later). Visit www irs gov freefile Qualifying taxpayer. Visit www irs gov freefile   You are a qualifying taxpayer under Revenue Procedure 2001-10 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 17, 1998 (see Gross receipts test for qualifying taxpayers, next). Visit www irs gov freefile Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $1 million or less. Visit www irs gov freefile You are not a tax shelter as defined under section 448(d)(3) of the Internal Revenue Code. Visit www irs gov freefile Gross receipts test for qualifying taxpayers. Visit www irs gov freefile   To determine if you meet the gross receipts test for qualifying taxpayers, use the following steps: Step 1. Visit www irs gov freefile List each of the test years. Visit www irs gov freefile For qualifying taxpayers under Revenue Procedure 2001-10, the test years are each prior tax year ending on or after December 17, 1998. Visit www irs gov freefile Step 2. Visit www irs gov freefile Determine your average annual gross receipts for each test year listed in Step 1. Visit www irs gov freefile Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Visit www irs gov freefile Step 3. Visit www irs gov freefile You meet the gross receipts test for qualifying taxpayers if your average annual gross receipts for each test year listed in Step 1 is $1 million or less. Visit www irs gov freefile Qualifying small business taxpayer. Visit www irs gov freefile   You are a qualifying small business taxpayer under Revenue Procedure 2002-28 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 31, 2000 (see Gross receipts test for qualifying small business taxpayers, next). Visit www irs gov freefile Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $10 million or less. Visit www irs gov freefile You are not prohibited from using the cash method under section 448 of the Internal Revenue Code. Visit www irs gov freefile Your principle business activity is an eligible business. Visit www irs gov freefile See Eligible business, later. Visit www irs gov freefile You have not changed (or have not been required to change) from the cash method because you became ineligible to use the cash method under Revenue Procedure 2002-28. Visit www irs gov freefile Note. Visit www irs gov freefile Revenue Procedure 2002-28 does not apply to a farming business of a qualifying small business taxpayer. Visit www irs gov freefile A taxpayer engaged in the trade or business of farming generally is allowed to use the cash method for any farming business. Visit www irs gov freefile See Special rules for farming businesses under Cash Method, earlier. Visit www irs gov freefile Gross receipts test for qualifying small business taxpayers. Visit www irs gov freefile   To determine if you meet the gross receipts test for qualifying small business taxpayers, use the following steps: Step 1. Visit www irs gov freefile List each of the test years. Visit www irs gov freefile For qualifying small business taxpayers under Revenue Procedure 2002-28, the test years are each prior tax year ending on or after December 31, 2000. Visit www irs gov freefile Step 2. Visit www irs gov freefile Determine your average annual gross receipts for each test year listed in Step 1. Visit www irs gov freefile Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Visit www irs gov freefile Step 3. Visit www irs gov freefile You meet the gross receipts test for qualifying small business taxpayers if your average annual gross receipts for each test year listed in Step 1 is $10 million or less. Visit www irs gov freefile Eligible business. Visit www irs gov freefile   An eligible business is any business for which a qualified small business taxpayer can use the cash method and choose to not keep an inventory. Visit www irs gov freefile You have an eligible business if you meet any of the following requirements. Visit www irs gov freefile Your principal business activity is described in a North American Industry Classification System (NAICS) code other than any of the following NAICS subsector codes: NAICS codes 211 and 212 (mining activities). Visit www irs gov freefile NAICS codes 31-33 (manufacturing). Visit www irs gov freefile NAICS code 42 (wholesale trade). Visit www irs gov freefile NAICS codes 44-45 (retail trade). Visit www irs gov freefile NAICS codes 5111 and 5122 (information industries). Visit www irs gov freefile Your principal business activity is the provision of services, including the provision of property incident to those services. Visit www irs gov freefile Your principal business activity is the fabrication or modification of tangible personal property upon demand in accordance with customer design or specifications. Visit www irs gov freefile   Information about the NAICS codes can be found at http://www. Visit www irs gov freefile census. Visit www irs gov freefile gov/naics or in the instructions for your federal income tax return. Visit www irs gov freefile Gross receipts. Visit www irs gov freefile   In general, gross receipts must include all receipts from all your trades or businesses that must be recognized under the method of accounting you used for that tax year for federal income tax purposes. Visit www irs gov freefile See the definit