Combination or Special Methods

Income tax rules allow you to use a combination, or hybrid method, combining the cash and accrual methods, provided that this method clearly reflects your income and is used consistently.  But the tax rules also state that if you use the cash method to report income, you must also use the cash method to report expenses, and if you use the accrual method to report income, you must also use the accrual method to report expenses.  There are certain special items in the income tax law that require special accounting and reporting treatment for tax purposes.  These include long-term contracts, installment sales, and depreciation, depletion, and amortization expenses.

Changing Accounting Methods

Once you have chosen the accounting method you will use and have filed your first income tax return, you have to continue to use the same method each year.  If you want to change your overall method, or the accounting treatment of any particular item, you will need IRS approval.  You request approval by filing Form 3115, Application for Change in Accounting Method.

A change in accounting method includes a change in your overall accounting method and also a change in the method you use to treat a significant, or material item.  The following are examples of changes that require IRS approval:

• A change from the cash method to the accrual method or vice versa.
• A change in the method or basis used for valuing inventory.
• A change in the method used to calculate depreciation or amortization.

Corrections of errors, adjustments of items of income or expenses that do not involve the timing of the income or deduction, and certain adjustments in the useful lives used to calculate depreciation do not constitute changes in accounting method.

There are two ways to obtain IRS approval of a change in accounting method:

• Automatic change request procedures, or
• Advance request consent procedures.