 Income tax 2021-2022. Accounting methods. Get ready to get refunds to the max. Diving into income tax 2021-2022. Most of this information can be found in publication 334, Tax Guide for Small Business 2021. Income tax formula, top line income. Noting we'd have another schedule, basically an income statement, which has income and expenses. Expenses basically being deductions, bottom line flowing into line one of the income tax formula income and page one of the form 1040, which would be then on line number eight. So that would mean that the schedule C would flow into the schedule one, which would then flow into line eight on page one of form 1040, which we see here. Here is the schedule C, profit or loss from business, basically an income statement. So now we're thinking about the accounting methods, more specifically, from an accounting standpoint, the two methods that kind of come into people's minds is gonna be the cash method and an accrual method. Now, most people have those two concepts in their minds as if they're kind of completely distinct methods, but it's more likely that there's basically kind of a continuum or a line that those two methods kind of fall upon. So you might be a hybrid in essence between a cash and an accrual method. It's possible to be on more of a cash method for say the expense side of things or the purchases side of things and more on an accrual method, possibly on the revenue side of things, for example. And oftentimes that will just simply depend on the business that you are in, the type of industry that you are in and the size and so on, best practices within that industry. From a tax standpoint, then we need to determine what the accounting method we're going to use for taxes is, it's gonna be very important once again to get that right on the start when you first start out, because if there's a problem later on, you're gonna have complexities with changing the accounting method because the IRS wants consistency with the accounting method. So if you reported incorrectly on the first one, that could be a problem and or if you want to change the accounting method, that can be a problem. Now, note that larger businesses often are kind of required, they kind of have to end up going towards an accrual method to be kind of more accurate and businesses that have a lot of inventory are typically more on a cruel basis, just from a natural accounting perspective, because tracking inventory in and of itself, it is basically an accrual kind of activity generally. So those are a couple of things to keep in mind. Again, it's possible if you're a smaller business and like say, like if you have inventory, you might be saying, well, cash method might still be easier to do, but you still want to kind of think about, what if the law changes and the inventory, that require businesses with inventory to be on a cruel basis method, or what if I grow, is that going to cause me a problem with my bookkeeping and my tax reporting, which I'd like to make as easy as possible. So an accounting method is a set of rules used to determine when and how income and expenses are reported. Your accounting method includes not only their overall method of accounting you use, but also the accounting treatment you use for any material item. You choose an accounting method for your business when you file your first income tax return, that includes a schedule C for the business. So the first tax return is going to set the standard for what your accounting method is. You want to get it right. You want to think it through. You want to make sure you got the right checkbox checked off because if it's not, it causes problems down the line. Big headaches could be caused and headaches are bad. So like avoid them if you can. After that, if you want to change your accounting method, you must generally get IRS approval. You got to ask for approval. Please, I messed, I checked off the wrong box IRS. Well, it's passed the statute of liberty. Come on. So see change in accounting method later so you can take a look at that. So kinds of methods, generally you can use any of the following accounting methods. So we got the cash method. We've got an accrual method. We've got special methods of accounting for certain items of income and expense. We might have special methods for like long-term contracts and stuff like that. So those would be in specialty industries, completed contract possibly when you're thinking about accounting methods from an accounting standpoint and percentage of completions and stuff like that. So combine methods using elements of two or more methods above. So the two methods that most people think of is going to be a cash method and an accrual method. Again, most people think of them as completely distinct, but basically most people are actually doing some kind of hybrid between the two because even if you're on a cash method, there's certain things that you kind of have to deviate from a cash method to report on. So even if you're checking off cash method, your for example might have to then report equipment as depreciable, which is an accrual kind of thing putting on the books as an asset then depreciating it as opposed to expensing it when you pay for it, possibly paying cash when you purchase it. Even then, you oftentimes might have to put it on the books as an asset. When you look at the accrual method, we often have to do kind of adjusting entries to kind of shore things up to make them from more of a cash to kind of like an accrual method. So like I said, it's possible to have a cash method, say for the purchasing side of things or the expenses and the accrual method for the income side of things. In that case, you'd be using elements of both methods involved in it and you could have specific methods of accounting for certain things like revenue recognition kind of items that are a little bit more unusual because for example, you have long contracts which kind of violates the normal revenue recognition principle. And so then the question is, well, when should you be recognizing revenue if I've got like a five year long contract and I haven't completed the job for five years because it takes five years to complete and usually I don't recognize revenue until it's completed, but is there any kind of deviation from that in that instance? So you must use the same accounting method to figure your taxable income and to keep your books. So there's basically saying in general, you want obviously the same method for taxes and the books. So also you must use an accounting method that clearly shows your income. And notice when you think about this kind of thing, the same method with regards to your books because you can think about a situation where people might say, well, I do my books on an accrual method because the accrual method is usually more accurate for internal reporting needs, but I wanna use a cash method for possibly taxes because they think that they may be able to manipulate the cash method to get a better tax result. And so the IRS, it looks, my interpretation of this would be, they're trying to kind of stop that, they're kind of trying to stop people from doing things on the taxes just purely for tax reasons. They're trying to say, if you use it for your bookkeeping, you should be using it for basically the taxes. In essence, you should have a bookkeeping reason not for deviation from the standard kind of methods that you would be using would be that would be my interpretation of that general idea. Also, you must use an accounting method that clearly shows your income. So obviously it needs to accurately show the income. And so business and personal items, you can account for business and personal items under different accounting methods. For example, you can figure your business income under an accrual method, even if you use the cash method to figure personal items. So in other words, when you file the form 1040 usually and you have deductions like the schedule aid deductions for example, we're giving to charity, for example, then you do those things on a cash basis, those deductions. So what if your business is on an accrual basis? Well, that's okay because basically the business is its own kind of entity that you're gonna choose an accounting method which can be different and distinct than the method that you're gonna be on the personal side which is normally gonna be a cash method. And also if you're on a cash method for the personal side that of course doesn't mean that you have to choose a cash method for the business side. The business is in essence distinct and you determine the method based on other factors such as your bookkeeping method, the industry, your end and so on. So two or more businesses. If you have two or more separate and distinct businesses, you can use a different accounting method each if the method clearly reflects the income of each. They are separate and distinct only if you maintain complete and separate books and records for each business. So if you have completely two different, completely different businesses, possibly if you're married filing joint, maybe you have a husband and a wife that have two different businesses for example, then obviously just because they're on the same form 1040 it doesn't mean that you have to use a cash method on both of them or out of the cruel method on both of them because if they're distinct businesses you should be choosing the type of method that comports to that particular business. Now if you're doing the books for the two businesses in one set of books, then you would think they would have the same method because you would think that would be reported on one schedule C as opposed to two schedule Cs but if they're two distinct businesses and then you would think whatever the method that would be applicable to that business which might be in part aligned to the reporting or method that you're using for your bookkeeping would be the one that you would use and that could differ.