Dear Tax Talk,
Can an S corp with revenues in excess of $5 million elect to use a cash accounting method if it is not a service
company and maintains a significant inventory?
There are generally two types of accounting methods available to taxpayers: cash or accrual. Under the cash method,
income is not taxed until cash is received and expenses are not deducted until paid.
The accrual method differs, as income is recognized when invoiced and expenses are deducted when
incurred. Most individuals and many small businesses use the cash method of accounting, unless otherwise precluded.
Generally, if you produce, purchase or sell merchandise, you must keep an inventory and use an accrual method for sales
and purchases of merchandise.
For example, wholesalers, retailers and manufacturers are required to use the accrual method. Doctors
and dentists can use the cash method even though they may have inventory, as these items are considered supplies.
An S corporation can use the cash
basis method of accounting if it does not have
inventory, regardless of its sales. A conventional
corporation that is neither an S corporation nor
a qualified personal service corporation is disqualified
from using the cash basis method of accounting
if its sales exceed $5 million.
IRS Publication 538 discusses
accounting methods, including limitations on the cash basis method of accounting. However, the discussion on the limitations
of the cash basis method can be confusing. Actually, I found Code
448 to be more straightforward than the publication.