Issue 6 - May 2004

Finance & Taxes By Mark E. Battersby
Good accounting makes good sense

Increasingly slow insurance reimbursements and the ever-slower payments from second-party payers have caused havoc in the practices of many chiropractors. Cash flow problems aside, how can you accurately account for late receipts and inaccurate payments without distorting your practice’s tax bill? One answer lies with the accounting method you use.

An expense becomes a tax deduction when a bill is received or when a service is contracted for — or when your practice actually parts with the money to pay that expense. Similarly, a dollar becomes income to your practice when fees are actually received.

Surprisingly, many chiropractors continue to track the income and expenses of their practices using the old checkbook and receipts method. This is legal and often meets the requirements of the tax law.

Unfortunately, this rudimentary cash method of accounting is not always the best method for the practice. It does not allow you to reap the maximum benefit of the tax rules, which would increase your profitability and reduce your practice’s tax bills. But switching from it to a better method is not easy — even if the Internal Revenue Service requires you to do so.

ACCOUNTING METHODS
Obviously, no one accounting method fits every practice and business. Similarly, no single accounting method is required by our tax law. However, your practice must use a system that clearly shows its income and expenses. And you must use the same accounting method every year.

What options are available for your practice? Among the most commonly used accounting methods are the cash method and the accrual method.

Under the cash method, you report income in the year that it is received and deduct expenses in the year that they are paid.

Under an accrual method, you generally report income in the tax year it is earned, regardless of when payment is actually realized. And you deduct expenses in the tax year you incur them, regardless of when payment is actually made.

Special methods of accounting can be used for certain types of income and expenses, as well as hybrid or combination methods that use elements of both cash and accrual accounting methods. A practice can use any combination of cash, accrual and special methods of accounting so long as the combination clearly reflects income and is used consistently.

In fact, you may use different methods to account for business and personal income. Income from the practice, for example, may be computed under an accrual method, even if the practice’s principal uses the cash method to compute personal income. Obviously, you should consult with your tax advisor about the accounting method or methods most suitable to your practice and the way it operates.

WHO CAN AND CANNOT
The less complicated cash method of accounting (or any combination of methods that include the cash method) cannot be used for:

• A corporation (other than an S corporation) with annual gross receipts exceeding $5 million;

• A partnership with a corporation (other than an S corporation) as a partner, with annual gross receipts exceeding $5 million; or

• A tax shelter.

Fortunately, exceptions to these rules exist for a family corporation with gross receipts of $25 million or less for each prior tax year beginning after 1985 or a qualified personal services corporation. Your practice may be considered to be a qualifying small business taxpayer if gross receipts did not exceed $1,000,000 in each of the three preceding tax years after 1998. A qualified small business is, of course, eligible to use the cash method of accounting.

CHANGING HORSES IN MIDSTREAM
You do not require IRS approval to choose the initial accounting period or method for your practice. Once you put an accounting method in place, however, and the practice’s first tax returns have been filed, you will usually need to get IRS approval to make any changes.

A change in accounting method can mean anything from changing the overall system of accounting to changing the tax treatment of any material item on the tax return. A material item, according to the rules, is one that affects the proper time or inclusion of income or allowance for a deduction.

Specifically, you need IRS approval for several types of changes such as:

• A change from the cash method to an accrual method or vice versa;

• A change in the method of basis used to value any of the operation’s inventories;

• A change in the method of figuring depreciation. The IRS does not have to approve changes that:

• Correct a math or posting error;

• Fix an error in figuring tax liability (such as an error figuring a tax credit); or

• Adjust any item of income or deduction that does not involve the proper time for including it in income or deducting it.

HOW TO GEt PERMISSION
If you are changing accounting methods, you (or your accountant) have to file Form 3115, “Request For Change In Accounting Method,” during the tax year for which the change is being requested.

Businesses that voluntarily change their method of accounting with the IRS’s permission and those that are compelled by the IRS to make a change because the method used does not clearly reflect their business income must make certain adjustments to income in the year of that change. Adjustments are necessary in order to prevent duplication or omission of items of income or expenses.

Using an acceptable accounting method on a consistent basis will not only reduce the chance of a confrontation with the IRS, it can also help a chiropractor better manage his or her chiropractic practice.

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer and author with offices in suburban Philadelphia. He can be contacted at 610-789-2480.

Disclaimer: The author is not engaged in rendering tax, legal or accounting advice. Please consult you professional adviser for any issue related to your practice.