IRS Publication 583: Starting a Business and Keeping Records

If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a partner in a partnership, or become a shareholder in an S corporation, you must continue to use the calendar year unless you get IRS approval to change it or are otherwise allowed to change it without IRS approval. You must use a calendar tax year if: You keep no books or records. You have no annual accounting period. Your present tax year does not qualify as a fiscal year. You are required to use a calendar year by a provision of the Internal Revenue Code or the Income Tax Regulations. For more information, see Pub. 538. First-time filer. If you have never filed an income tax return for your business, you can adopt either a calendar tax year or a fiscal tax year. Although, some partnerships and S corporations must use a particular tax year. See Pub. 538 for more information. You adopt a tax year by filing your first income tax return using that tax year. You have not adopted a tax year if all you did was one or more of the following. Filed an application for an extension of time to file an income tax return. Filed an application for an EIN. Paid estimated taxes for that tax year. Changing your tax year. Once you have adopted your tax year, you may have to get IRS approval to change it. To get approval, you must file Form 1128, Application To Adopt, Change, or Retain a Tax Year. You may have to pay a fee. For more information, see Pub. 538. Choosing an Accounting Method An accounting method is a set of rules used to determine when and how income and expenses are reported. You choose an accounting method for your business when you file your first income tax return. There are two basic accounting methods. Cash method. Under the cash method, you report income in the tax year you receive it. You usually deduct or capitalize expenses in the tax year you pay them. Accrual method. Under an accrual method, you generally report income in the tax year you earn it, even though you may receive payment in a later year. You deduct or capitalize expenses in the tax year you incur them, whether or not you pay them that year. For other methods, see Pub. 538. If an inventory is necessary to account for your income, you must generally use an accrual method of accounting for purchases and sales. Inventories include goods held for sale in the normal course of business. They also include raw materials and supplies that will physically become a part of merchandise intended for sale. Inventories are explained in Pub. 538. . Certain small business taxpayers can use the cash method of accounting and can also account for inventoriable items as materials and supplies that are not incidental. For more information, see Pub. 538. . You must use the same accounting method to figure your taxable income and to keep your books. Also, you must use an accounting method that clearly shows your income. In general, any accounting method that consistently uses accounting principles suitable for your trade or business clearly shows income. An accounting method clearly shows income only if it treats all items of gross income and expense the same from year to year. More than one business. When you own more than one business, you can use a different accounting method for each business if the method you use for each clearly shows your income. You must keep a complete and separate set of books and records for each business.