 Income tax 2022-2023. Accounting periods and methods introduction. Let's do some wealth preservation with some tax preparation. Support Accounting Instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again click the link below for a free month membership to our website and all the content on it. Most of this information comes from the tax guide for small business for individuals who use Schedule C Publication 334 Tax Year 2022. You can find on the IRS website irs.gov irs.gov. Looking at the income tax formula we're focused online. One income remember in the first half of the income tax formula is in essence an income statement although just an outline just a scaffolding other forms and schedules feeding into these line items such as the Schedule C which is the small business tax form basically an income statement in and of itself having income minus expenses or business deductions. The net income flowing into line one income of the income tax formula. Here's the first page of a form 1040 we're focused down here online. Number eight where the schedule C would flow into the schedule one which would flow in here to line eight page one of the form 1040. This is a schedule C. This is the profit or loss from business where we have income minus expenses or the business deductions to get to that net income in essence. All right let's talk about account accounting periods and methods. Introduction. So you must figure your taxable income and file an income tax return for an annual accounting period called a tax year. So when we're thinking about the accounting periods we're thinking about the time frame note that we're looking at income taxes. We typically need to be looking at a year's time frame. That's going to be a 12 month time frame when we get into the methods. Then we talk about the two major methods or the accrual method and a cash based method. But we also ask the question could there be a hybrid between the two methods because in reality those two methods are not mirror opposites of each other or anything like that. We could have accounting methods that have a bit of a cash based method and some of the accrual based method is that OK for taxes. We'll talk about that more as we go. Also you must consistently use an accounting method that clearly shows your income and expenses for the tax year. So we have to have our income reported for a year a year's time frame and we have to have an accounting method the two primary ones accrual and cash method that we are consistent. On why is that important because if we were to shift things like our tax year we can play with the edges the borders the cutoffs to try to manipulate the taxes. And if we were able to shift accounting methods from cash to accrual and back and forth for example we could once again quite easily adjust the cutoff dates by switching basically those methods and that would be not fair for taxes. Clearly we want to have consistency with taxes. So if you choose a tax year you need to stick with that tax year as a general rule unless you're going to switch it for specific circumstances. So that means you want to get everything set up properly at the start end so you don't have to change things. If you pick an accounting method then generally you want to stick with that accounting method. The IRS may be restrictive in letting you change that accounting method even though they're giving you some leeway to pick whatever method you want because the main thing they want to have here is consistency. Consistently and thoroughly. Because if there's not consistency then people could manipulate things by changing accounting methods and accounting periods. Okay so useful items. You may want to see publication 538 accounting periods and methods so if you want to dive into this in more detail you can jump into that publication on the IRS website iras.gov. So we have accounting periods. When preparing a statement of income and expenses generally your income tax return you must use your books and records for a specific interval of time called an accounting period. The annual accounting period for your income tax return is called a tax year. So we have to have a tax year here. You can use one of the following tax years. A calendar tax year. Obviously if you are a schedule C type of business most people are probably on a calendar tax year because they're going to be reporting it with their form 1040 and usually that's going to be on a normal tax year. Or you have a fiscal tax year. Now you might think these two terms they sound quite similar in nature and you might say for example my fiscal year is the calendar year. So they're basically the same in that case but you might have a situation where a fiscal year is different than the calendar year. So in that situation you would be saying the calendar year is obviously January through December if I have a different year for taxes then I could have a different basically fiscal year that I'm doing for my business. Why would you do that? Possibly if you have a natural year that is different than the calendar year. In other words sometimes you might want to end your tax year after the busiest time of the year and that would be like a natural a natural year for your business cycle even though it doesn't line up to a calendar year it also could be easier for just accounting and business purposes because if your busiest time of year for example is in December then that's not the time of the year that you want to do all this other stuff like tax preparation and all that kind of stuff you would rather be focusing in on generating revenue during that time of year and after that is over then do your end of year kind of stuff so that's why you might have like a natural year might make sense other than a calendar year and so there was that. So unless you have a required tax year you adopt a tax year by filing your first income tax return using that tax year so you want to make sure that you get this right from the start. Again a lot of small businesses that are sole proprietors will be a calendar year but if you're going to make a change you want to research it and try to get off the first step on the right track because it might be a little bit difficult to change it after you've already started adopting one particular calendar year. A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. Calendar year, calendar tax year. A calendar tax year is 12 consecutive months beginning January 1st and ending December 31st. Straightforward right just like it is on a calendar. So you must adopt the calendar tax year if any of the following apply. So what are my restrictions? Do I have to have a calendar tax year well possibly it depends on the situation. If these apply, you do not keep books so you have no annual accounting period. So your present tax year does not qualify as a fiscal year. So your use of the calendar tax year is required under the Internal Revenue Code or the Income Tax Regulations. If you filed your first income tax return using the calendar tax year and you later begin business as a sole proprietor you must continue to use the calendar tax year unless you get IRS approval to change it or are otherwise allowed to change it without IRS approval for more information see change in tax year. So again you want to get off to the first start the way you want to go forward you want to plan that out because it's more difficult to change it. Not impossible but you have to have rationale to change it and you've got to go through a process to change it because the IRS wants consistency so people aren't cheating by adjusting cutoff dates by changing years and methods. So if you adopt the calendar year you must maintain your books and records and report your income and expenses for the period from January 1st through December 31st of the year. Fiscal tax year what is it? A fiscal tax year is 12 consecutive months ending on the last day of any month except December. So clearly we still have to have 12 months you can't say well my fiscal year is only three months. No that's a quarter it has to be 12 months but it has a date an end period that's other than December. So a 52 or 53 week tax year is a fiscal tax year that varies from 52 or to 53 weeks but does not have to end on the last day of a month. So now we're drilling down to the weeks we can define a year by basically 12 months. 12 months are not exactly even because they have different days within them we could try to break it down into smaller increments of weeks. When you think about weeks in a year there's either 52 to 53 weeks in the year generally. So if you adopt a fiscal tax year you must maintain your books and records and report your income and expenses using the same tax year. For more information on a fiscal year including a 52 or 53 week tax year you can see publication 538 if you want to dive into that in more detail on the IRS website. Change in tax year and generally you must file form 1128 application to adopt change or retain a tax year to request IRS approval to change your tax year. So you could possibly change it but it's difficult that's why you want to get off right on the right foot when you start otherwise you could walk forward you could still move forward but you're going to fall on your face as you're moving forward which isn't the best mode of transportation. So see the instructions for form 1128 for exceptions. So if you qualify for an automatic approval request a user fee is not required. If you do not qualify for automatic approval a ruling must be requested. See the instructions for form 1128 for information about user fees if you are requesting a ruling.