Accounting Method

Your accounting method determines how you report your income and expenses. There are two main accounting methods when filing tax returns. The cash accounting method is the most often used by most taxpayers.

Cash Accounting Method

With the Cash accounting method, the taxpayer reports all items of income in the year he or she actually or constructively receive them. A taxpayer constructively receive income when it is credited to his or her account or in any way becomes available to him or her. With the cash accounting method, the taxpayer deducts expenses in the year he or she pays them.

Examples of the cash accounting method:

1. John completes a construction job in November 2007 and is paid in 2007. He must report that income on his 2007 tax return. If John were paid for the November job in January 2008, then the income would be reported until John files is tax return for the 2008 year because he received his pay in 2008.

2. Jill receives a valid paycheck on December 31, 2007. This is part of her 2007 gross income even if she cashes the check in January 2008.

3. Mike receives a bill from the hospital in December 2007. He does not pay the bill until January 2008. He cannot include this bill in his itemized deduction because he did not pay the expenses in that tax year.

Accrual Accounting Method

The accrual accounting method, on the other hand, reports income in the year the taxpayer earns it and deduct expenses in the year the taxpayer incurs them.

Example of accrual accounting method:

If John in the above example used the accrual accounting method instead of the cash accounting method, then he would report the income from the job completed in November on his 2007 tax return even if he was not paid until January 2008.