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As a new business, you need to determine which annual accounting period you will use to file your returns. You can file your returns using a calendar tax year or a fiscal tax year. When you file your first return, you establish the tax year you will use for future returns. Once established you cannot change your tax year without getting permission from the Internal Revenue Service. You also need to notify the Tax Commission when you change your accounting period.
It is usually more convenient to file on a calendar year tax basis. If your business has employees, the tax returns for these taxes are on a calendar year basis. Generally it is more convenient to file all of your returns on the same tax year basis so the due dates are the same. You don't have to remember to different due dates and risk the chance of forgetting to file a return on time.
You need to determine the accounting method you will use in your business. No single accounting method is required of all taxpayers. However, the method you choose to use must clearly show the businesses income and expenses. Essentially there are two methods of accounting:
You also have special accounting methods for amortization, bad debts, depletion, depreciation, and installment sales. For these items you need to refer to these Internal Revenue Service publications:
You may also use a method of accounting that uses a combination of methods.
If you have more that one business and keep a separate set of books for each, you may use a different accounting method for each business. Once you have established an accounting method, you generally cannot change methods unless you get advanced approval from the IRS. If you want to request a change in your accounting method file IRS Form 3115.
There are some accounting method changes that do not require advance approval from the IRS. Revenue Procedure 99-49 describes them.
Be careful, changing accounting method not only means your overall system of accounting, it can be how you treat a material item in your accounting. A material item is one that affects the proper timing of when you include income or an allowance for a deduction.
For example, you start depreciating an item using the wrong depreciation method and two years later realize that you were using the method and switch to the correct method. This is a change in accounting method.
Remember that you must keep records that will enable you to file a correct return. Also, in addition to your permanent books of account, you must keep any other records necessary to support entries on your return.
Many individuals and sole proprietors use the cash method of accounting. The records for the cash method are simpler to maintain. However, if you maintain an inventory, you generally need to use the accrual method to account for your sales and purchases.
Even though you may use the cash method for your business books, sales and use tax must be reported and paid on an accrual basis. This will be explained in the accrual method discussion later in this section.
When using the cash method, you include in your gross income all income actually or indirectly received during the tax year. This includes the fair market value of any property or services you receive.
If you or your agent receives a check dated December 24, 2007 and you do not cash or deposit it until January 2008, you must still account for the income in 2007. You must claim the income when it is received or made available to you without restrictions. This applies if you receive a check on December 31 and are not able to cash it until January 2. The date of the check controls and the income must be claimed when it became available.
If your debts are paid by another individual or canceled by a creditor or you have to repay income you received and claimed in a prior year, refer to IRS Publication 535.
Generally you deduct expenses in the tax year they are actually paid. A couple of exceptions are when you pay an expense in advance or are required to capitalize certain costs.
With this method of accounting, you generally report income in the year it is earned and deduct or capitalize expenses in the year they are incurred.
Sales and purchases subject to Utah sales and use tax must be reported on an accrual basis. This means that these transactions must be reported and the taxes paid when the item is invoiced regardles of when you acutally recieve or make the payment.
Under the accrual method of accounting, you generally include income in your gross income for the tax year that you invoice your customer regardless of when payment is received.
For example: On December 13, 2007 a customer submits an order for $800 of merchandize through your internet web page. You ship the goods on December 17 and invoice the customer. You do not receive the payment until February 12, 2008. The income is included in your 2007 income.
There are special rules that may apply if you:
If you have any of these transactions refer to IRS Publication 538.
Generally, when using the accrual method, expenses are deducted or capitalized when two events apply:
Generally, if you produce, purchase, or sell merchandise in your business, you must keep an inventory and use the accrual method for purchases and sales of merchandise. There are some exceptions that allow taxpayers to use the cash method even if they produce, purchase, or sell merchandise. Also, these taxpayer may elect not to keep an inventory even if they do not change to the cash method.
To be a qualifying taxpayer or business you must meet the gross receipts test explained in IRS Publication 334, Tax Guide for Small Business.
You cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until you make the payment and the amount is included in the related person's gross income. A related person is more than a husband and wife, a member of a family, or an ancestor. If your business is a personal service corporation and any employee-owner, regardless of the amount of stock owned by the employee-owner you are a related person. There are other entities that are considered related such as a corporation that owns more than 50% of the outstanding stock. A complete list of related persons can be found in IRS Publication 538.
With a basic understanding of the accounting methods, we need to know what is considered to be income and expenses.