40.3 Accounting Methods for Reporting Business Income

Business income is reported on either the accrual or cash basis. If you have more than one business, you may have a different accounting method for each business.


Unless a cash method safe harbor (discussed below) applies, the IRS requires inventories at the beginning and end of every taxable year in which the production, purchase, or sale of merchandise is an income-producing factor. If you must keep inventories, you must use the accrual basis.

Cash method.

You report income items in the taxable year in which they are received; you deduct all expenses in the taxable year in which they are paid. Under the cash method, income is also reported if it is “constructively” received. You have “constructively” received income when an amount is credited to your account, subject to your control, or set apart for you and may be drawn by you at any time. For example, in 2012 you receive a check in payment of services, but you do not cash it until 2013. You have constructively received the income in 2012, and it is taxable in 2012.

On the cash basis, you deduct expenses in the year of payment. Expenses paid by a general credit card (e.g., MasterCard or Visa) are deducted in the year they are charged. Expenses paid through a “pay by phone” account with a bank are deducted in the year the bank sends the check. This date is reported by the bank on its monthly statement.

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