Using the cash method of accounting.

• Author: O'Connor, Eileen J.

Taxpayers using the cash method of accounting, especially construction contractors, should be aware that some IRS districts are making it a high priority to identify potential changes to the accrual method of accounting. A 1992 Tax Court memorandum case gave the IRS a preliminary victory in this area. That victory became more significant this year when the taxpayer did not appeal the decision.

In J. P. Sheahan Associates, TC Memo 1992-239, the taxpayer was a roofing contractor. The company was 100% owned by its founder, and did just over $1 million in gross sales each year. Believing it was eligible to do so, the company used the cash receipts and disbursements method of accounting for Federal income tax purposes. The company ordered roofing materials only as it needed them, and returned excess materials to the supplier for credit. It had no year-end inventory and did not hold merchandise for sale. The company did, however, charge a 25% markup on the cost of materials used on a job.

On examination, the Service challenged Sheahan's use of the cash method. Because of the company's markup on the cost of the materials, the Tax Court agreed with the IRS and concluded the company was required to use the accrual method of accounting for purchases and sales of roofing materials.

In determining whether Sheahan had to use the accrual method of accounting overall, the court compared the taxable income resulting from the cash method with that resulting from the accrual method. As taxable income would have been higher had it been determined on the accrual method (the company did have receivables at year-end), the court sustained the Service in forcing the company's change to the accrual method of accounting.

Significantly, the Tax Court not only sustained the IRS's change of the taxpayer's overall...