By Mark E. Battersby

Nothing is forever. And nowhere is this more evident than in the way you account for income and expenditures.

The funny thing about federal tax laws is they require transactions to be handled in a certain way. Accounting methods affect when something is deductible, not whether it is deductible.

You can decide how best to account for your practice’s income and expenditures. However, the accounting method chosen when the operation began might not be the best accounting method today.

Changing accounting methods may mean a lower tax bill. If, however, the IRS requested the change it can mean a higher tax bill. Either way, an adjustment is necessary to ensure there is no distortion of income or expenses.

The decision to change

You may want to change your accounting method for a couple reasons.

1. To reduce federal and state income taxes by deferring income or accelerating certain deductions.

2. To correct a previous error and, consequently, claim allowable deductions or report income items it may have missed in the past.

When tax rules mention a “change in accounting method,” they are not only referring to the basic method of accounting for income, profits, and losses, but also the way specific transactions are accounted for.

For example: If your incorporated practice routinely treats all payments made to its principal as dividends, the IRS may require some of those payments be labeled as “compensation.”

Dividends, while not deductible by the practice, benefit from a temporary 15 percent tax rate to the recipient. Compensation on the other hand, while a deductible expense for the practice, is income taxed at the recipient’s personal tax rate.

Of course, it is equally likely you may learn you’ve been using an impermissible accounting method. Voluntarily changing the method can offer protection in the event of an audit and shield your practice from potential penalties and interest.

Getting permission

Generally, you can’t change your practice’s method of accounting without obtaining advance permission from the IRS. In fact, under our tax laws, the IRS can dictate the method of accounting it feels most clearly reflects the income your current accounting method fails to do.

If the chiropractor fails to request IRS approval for a change of accounting methods, the absence of IRS consent to the change will not be taken into account if, and when the IRS imposes penalties (or additions to tax) for errors.

When obtaining consent, there are two processes.

1. Automatic consent

2. Nonautomatic consent

The most common automatic changes involve a switch from the cash method of accounting to an accrual method or vice versa, a change in the method or basis used to value inventory, and a change in the method of figuring depreciation.

A small loophole

Under our tax rules, those practices required to use inventories had to use the accrual method of accounting. Several years ago, however, the IRS exempted some taxpayers from having to use this method and from having to account for inventories.

Generally, qualifying small business taxpayers (those with average gross receipts of $1 million or less), were exempted from the tax law’s requirement to use the accrual method of accounting and permitted to use optional inventory methods.

This group can instead use the cash method of accounting and treat inventorial items as materials and supplies. If they choose to use the accrual accounting method, they can legitimately treat inventorial items as materials and supplies that are not incidental.

They can also use an accrual method and treat inventorial items as inventory. However, in the case of a cash method taxpayer, the cost for those inventorial items cannot be