Under IRC section 446, taxpayers generally can choose any method of accounting to compute taxable income as long as that method clearly reflects income. However, many small business taxpayers who wish to use the cash method are prevented from doing so because of Treasury regulations section 1.446-1(c)(2)(i), which states a taxpayer must use the accrual method for purchases and sales if he or she is required to account for inventories under IRC section 471. Regulations section 1.471-1 states that any time the production, purchase or sale of merchandise is an income-producing factor in a taxpayer's business, the taxpayer must consider the merchandise inventory. Numerous cases hold the sale of merchandise is an income-producing factor, and therefore, the accrual method of accounting is required even when the taxpayer does not keep inventories in the usual sense. In Thompson Electric (TC Memo 1995-292), for example, an electrical contractor was required to maintain inventories because he regularly kept on hand certain electrical parts used in his work.
Other taxpayers--otherwise eligible to use the cash method--may have elected to use the accrual method in a previous period and may want to change their overall accounting methods to the cash method.
For both types of taxpayers, revenue procedure 2000-22 may help. In it, the IRS outlines circumstances under which it will give certain small business taxpayers automatic consent to change their method of accounting from the accrual basis to cash. To be eligible for this, a taxpayer's average annual gross receipts for the three years preceding the year of change must be no more than $1 million.
Qualifying taxpayers will file form 3115 according to the automatic-change-in-accounting-method provisions of revenue procedure 99-49. The IRC section 481 adjustment for the accounting method change is recognized over the period specified under revenue procedure 99-49--four years for most taxpayers.
Other important aspects of revenue procedure 2000-22 are as follows:
* Even though the benefits of the revenue procedure are available to taxpayers that maintain inventories, they...