Erin is considering switching her business from the cash method to the accrual m

Question

Erin is considering switching her business from the cash method to the accrual method at the beginning of next year (year 1).

Determine the amount and timing of her §481 adjustment assuming the IRS grants Erin's request in the following alternative scenarios.

a. At the end of year 0/beginning of year 1, Erin's business has $20,900 of accounts receivable and $26,600 of accounts payable that have not been recorded for tax purposes.

b. At the end of year 0/beginning of year 1, Erin's business reports $37,200 of accounts receivable and $15,800 of accounts payable that have not been recorded for tax purposes.

Explanation / Answer

SOLUTION

(A)

Erin would be required to make a IRC under section 481 adjustment to ensure that she does not omit receivables and payables from taxable income under the accrual method of accounting that she is switching to. Her net IRC under section 481 adjustment is to decrease net income by $5,700 ($20,900 receivables minus the $26,600 payables). Because this is an income decreasing adjustment, Erin would deduct the full adjustment amount in year1.

(B)

Erin's net IRC under section 481 adjustment is to increase net income by $21,400 ($37,200 receivables minus the$15,800 payables). Because this is a income increasing adjustment, Erin would include 25 percent of the net adjustment ($5,350) in taxable income in each of the next four years beginning with year 1.

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