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Whether you are a sole proprietor filing Schedule C, a partnership or LLC filing Form 1065, or a corporation filing Form 1120-S or 1120, your tax return will require you to report your accounting method to the IRS.
There are two basic accounting methods available to most small businesses, for tax purposes:
In some cases, you may be able to use a hybrid method that combines elements of both cash and accrual. Also, owners of certain types of businesses can use special accounting methods under the tax law. These include farmers, builders and contractors, and business owners receiving income under long-term contracts. If you're in one of these industries, your accountant can give you more information.
It pays to think through your options and talking with an accountant because the selection you make on your first tax return is difficult to change.
The major difference between cash and accrual accounting is that a cash-method taxpayer recognizes income and expenses at the point in time that the money is actually received or paid. In contrast, an accrual-method taxpayer generally reports income when they have a right to it (for example, at the time the sale is made, even if the customer does not pay at that time) and reports expenses as they become due, rather than by the date that the checks go out.
Most taxpayers use the cash method of accounting for their personal lives. It's very simple to use and requires little recordkeeping other than a checkbook register, bank statements and, perhaps, credit card statements.
You can continue to use the cash method for personal items even if you use the accrual method for your business. And if you have more than one business, you can use different methods for each business, as long as you maintain a separate set of accounting books and records for each one.
Other accounting methods. Certain kinds of businesses can use special accounting methods under the tax law. These include farmers, builders and contractors, and business owners receiving income under long-term contracts. If you 're in one of these industries, your accountant can give you more information about your options.