Accrual Basis

Today TaxMama hears from Nunya in the TaxQuips Forum who was advised by an EA “that typically she prefers accrual, but I can’t really recall for sure or why.  She was giving a small [business] seminar.”

Dear Nunya,

Ever since I read your note, I’ve been thinking about why anyone would prefer using accrual-based accounting as a general rule.

Then it became obvious to me. Of course! She’s talking about using accrual for book purposes. When you set up your accounting system on an accrual basis, that means you enter all your accounts payable into the system, as well as all your own billing. This can help you do budgeting, schedule payments, and better manage cash flow and debt.

That makes perfect sense – and is excellent advice.

However, for tax purposes, you are allowed to file your tax return on a cash basis.

Yes, you may use a different accounting method for books and taxes.That’s why corporate and partnership tax returns have an area on the balance sheet page called Schedule M-1 – to reconcile the books to the tax return. (typically on page 4 or 5)

For most businesses, especially service businesses, filing on a cash basis gives you the best tax advantage. Usually service businesses have higher accounts receivable (money due TO you) than accounts payable (money you owe) at the end of the year.

In fact, manufacturing, wholesaling and government contracting are in a similar position.
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Who wants to pay taxes on income you haven’t received yet at the end of the year?

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