 Income tax 2022, 2023, inventory, uniform capitalization rules and changes in accounting methods. 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 on line one income. Remember, in the first half of the income tax formula is in essence an income statement. However, just an outline, the scaffolding, other forms and schedules flowing into it. For example, the Schedule C, the business income, which has its own income statement in essence, income minus expenses or business deductions getting to the net income, flows into line one here of income of our income tax formula. This is the first page of the form 1040. The Schedule C would roll into the Schedule 1, which would roll into line eight of the 1040. This is a Schedule C, profit or loss from business in essence income statement with an income and expense part. All right, we're continuing on with our discussions of accounting methods in general, noting that the two major accounting methods that we may be able to pick are going to be the cash method, the accrual method. We might be able to do some combination or special method, but it's usually going to be a combination or have cash or accrual components within it, noting also that we might be restricted to some degree, forced possibly to do some more accrual method. One of them betrays the principles. If we have inventory, for example, and that we want to make sure we pick the proper method starting out, because although we have some flexibility to pick the accounting method, once we have picked the accounting method, we're somewhat locked into it and have to ask the IRS for a change if we want to change the method. Therefore, when doing the first Schedule C for the first small business reporting, you want to make sure you've thought about the method you're going to use and pick the right one because it could lock you into using that method. Continuing on then, we're looking at the Uniform Capitalization Rules now. So under the Uniform Capitalization Rules, you must capitalize the direct costs and part of the indirect cost of production or resale activities. Include these costs in the basis of property you produce or acquire for resale rather than claiming them as current deduction. So you recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of property. So note that when you buy something like equipment, for example, then even if you're on a cash-based system, you're going to have to put it on the books as an asset typically. And that makes sense, and that's basically an accrual thing that we have to do, right? Because if you were on a cash-based system, when you bought like a forklift or a building, you would just expense it at the point in time you paid for it even though you're going to consume it for a long period into the future. For like a building, it's quite extreme in that there would be a big difference between when you paid for the building, when you got the deduction, then if it was on a cash basis versus when you got the consumption or used the building in order to help generate revenue. And because that's so extreme, then even if you're on a cash-based method, we've got to kind of deviate from the cash-based method and do an accrual thing putting it on the books as an asset and then depreciating it in that case. In the case of inventory, we have a similar kind of situation because we want to try to match up the purchase of the inventory, not to the point in time that you paid for the inventory necessarily, but expense it at the point in time you consumed or used the inventory, matching up the cost of goods sold, the expense of consuming inventory to the point in time that you sold the inventory. So activities subject to the uniform capitalization rules, you may be subject to the uniform capitalization rules if you do any of the following unless the property is produced for your use other than in a business or an activity carried on for profit. So produce real or tangible personal property for this purpose. Tangential personal property includes a film, sound recording, videotape, book or similar property. Acquire property for resale. That would be an inventory situation acquiring for resale typically. You bought it to resell it. So exceptions, these rules do not apply to the following. So they don't apply to one small business tax payers defined earlier under inventories, and two property you produce in your indirect costs of producing the property are $200,000 or less. So once again, property you produce in your indirect costs of producing the property are $200,000 or less. So special methods, there are special methods of accounting for certain items of income or expense. These include the following amortization discussed in Chapter 8 of Publication 535. Then we've got the bad debts discussed in Chapter 10 of Publication 535. So amortization is kind of similar to depreciation. So except you're doing it for like intangible assets, for example, that you might have to amortize the value of the intangible assets over a certain time period. Bad debt is typically going to be an issue if you're dealing with accounts receivable, meaning if you have a type of business where you do the work first, you bill the client, and then you have to track the accounts receivable, then the question is, well, what if they don't pay you? Then if you already recorded the income in the past, then you've got this bad debt situation that you're not going to get paid. And the question is, when do you get to expense or deal with the bad debt? Because under accounting methods, there's an allowance method and a direct write-off method and so on, and you've got to tie it out to what the tax code wants as well. So depletion discussed in Chapter 9. So depletion is kind of similar to, again, like a depreciation type of situation, except you have a natural resource that you're actually consuming. So if you had like an oil well in the ground or something like that, you might have to try to value the amount that you're going to get out of that. And then as you start to use up the resource and pull it out, then you're depleting it and you'd have to record the depletion. Then depreciation discussed in publication 946, how to depreciate property. They just slowly depreciate. That's the one that most small businesses are probably going to be still subject to, right? Because that's what small businesses, when they will end up possibly likely needing to deviate if they buy equipment, large pieces of equipment, that should be going on the books as an asset as opposed to simply expensing them when purchased. Installment sales discussed in publication 537. So installment sales are going to be a special design of a sale when you have particular situations in place with regards to the sales. The sales happening in installments. So long-term contract methods of accounting. So that would be another industry specific type of thing. And that's in section 460. So that might be like for contractors that do long-term jobs because the revenue recognition principle will usually be that you have to record revenue when you complete the job. That would be when you give inventory, for example, if you're selling inventory or when you complete the service if you're doing service business. But what if you're in a long-term job and it's going to take you multiple years to make a building or something? Are you going to wait, you know, five years until the building is produced or should you use some other kind of revenue recognition principle recognizing revenue as you're building this long-term project which could include completed contract or percentage of completion, for example, those are kind of specialty areas. And be careful when if you're doing taxes for other people you might want to specialize in industry. So all of these items are kind of specialized to particular industries except depreciation which you'll probably deal with in most of the industries. But every industry could have its own particular, their particular little quirk that you might want to specialize in for that particular little quirk. So change in accounting method. Once you have set up your accounting method you must generally get IRS approval before you can change another method. So a change in accounting method includes a change in one, your overall method such as from cash to a cruel method and two, your treatment of any material item. So that's why you want to get the accounting method correct the first time. You might have to change it in the future. You would think that the IRS would want some kind of rationale for changing it. So for example, if you now have inventory being a more significant part of your business and you were changing from a cash to a cruel method you would think that that would be something that the IRS would approve of in that case. But if you're just saying I just want to change methods just because can I change methods? Why? Because I want to. Then the IRS you would think they would be a little bit more skeptical wanting to stay with consistency in that process. So to get approval you must file form 3115. You can get IRS approval to change an accounting method under either the automatic change procedure or the advanced consent request procedures. You may have to pay a user fee for more information. You could see the instructions for form 3115. So automatic change procedures. So how do we do this? Certain taxpayers can presume to have IRS approval to change their method of accounting. The approval is granted for the tax year for which the taxpayer requests a change, year of change if taxpayer complies with the provisions of the automatic change procedure. So no user fee is required for an application filed under an automatic change procedure generally covered in revenue procedure 2015-13, 2015-5 IRB 419 which is available at the IRS website. So generally you must use form 3551 to request an automatic change for more information. You can see the instructions for that form 3115. 3115 that is.