Discussion:Change to Cash Basis - Sec 481(a)
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Discussion Forum Index --> Tax Questions --> Change to Cash Basis - Sec 481(a)
| 19 January 2008 | |
| Hello All,
Was wondering if anyone could confirm something for me. I am working on a client who has switched from accrual to cash (truck repair shop). I have completed Form 3115 and computed the 481(a) adjustment, which was basically backing out A/R and A/P. The current year books have been prepared on the cash basis so the current year books INCLUDE the adjustment for the A/R and A/P. Please confirm for me that the 481(a) adjustment that I computed on Form 3115 does NOT flow to the 1120S on a separate line anywhere. It is just for informational purposes for the IRS - correct? The reason I am asking is that the negative adjustment I computed is already included in the books and in the tax return. THANKS SO MUCH! | |
| 19 January 2008 | |
| I don't believe that's the case, whatever the cumulative adjustment is at the time of the switch has to be reported for tax purposes otherwise, you'll end up double counting the net P&L effect. Say, for example your trucking client had AR of $100 and AP of $50...they'd have a net negative adjustment of $50 which if you didn't report (deduct) for tax purposes would mean that you had reported $50 of net income on the accrual basis and then after the switch to cash would result is picking up the same $50 as AR is collected and AP paid. I typically reported the net adjustment as other income and labeled it as "Net §481 adjustment" so it was abundantly clear if ever questioned. If memory serves me correctly, I think you can elect to pick up the §481 adjustment over four years under §481(c)). However you decide to reflect it (in the year of change or over 4 years) will result in an M-1 adjustment. Unfortunately, I haven't had this situation recently and the memory gets fuzzy after a week or so! | |
Southparkcpa (talk|edits) said: | 19 January 2008 |
| Yes
I agree with JEII, the 481 adjustment should be an M1 item. Matt | |
| 19 January 2008 | |
| Actually, the section 481(a) adjustment is a negative so it will be reported in full in the year of change. I am not going to make it a M-1 adjustment because we are now keeping the books on the cash basis. What I was trying to confirm is that I made the journal entries in the books to remove A/R and A/P to sales and purchases accordingly. I wasn't sure if I had to report the difference separately on the 1120S as the 481(a) adjustment or if I just leave the books as is and the difference is just reflected in the sales and purchases.
Thanks! | |
Southparkcpa (talk|edits) said: | 19 January 2008 |
| To get your Ret Earnings (AAA) to balance don't you need to show the adjustment on schedule M2?
If I remember, removing AR and AP is 66 percent of the battle, you must now compute AAA as if it were cash basis effective 1/1/07. Then an M2 adjustment is made to get schedule L to balance. Your opening AAA is accrual, your closing is cash. How do you plan on getting the AAA to balance without showing the adjustment?
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Ksnoopytax (talk|edits) said: | 20 January 2008 |
| Your book balance sheet is going to show the client's accrual book balance sheet and then you will do an M-1 for the 481(a) adjustment. If the current year books were prepared using cash basis you would need to prepare them on accrual basis and then show the M-1 adjustment for the year of change. | |
| 20 January 2008 | |
| I'm not quite sure why you would have to prepare the current year books on the accrual basis when you are filing an automatic change request to file on the cash basis. My thinking was that the 481(a) adjustment is equal to the A/R and A/P at 12/31/06. So, assume my client has 100K in A/R at 12/31/06 and 40K in A/P then the Section 481(a) adjustment would be minus (60K). In other words, the 2007 profit computed on the cash basis was 200K less the 481(a) adjustment of 60K (because that income was reported on 2006 tax return) would result in a net profit of 140K in 2007.
I just wasn't sure if I need to report the income and expenses on the 1120S on the cash basis reflecting 200K profit and then show the 481(a) adjustment of -60K separately or if I just report the income and expenses net of the A/R and A/P adjustment showing the 140K. Maybe I am heading down the wrong path . . . | |
| 20 January 2008 | |
| I don't think anybody disagrees with maintaining the current year books on the cash basis to coincide with the method change. However, at the time of the change is where §481 applies.
In your scenario, the IRS procedure would have you would report the 2007 book (cash basis) income of $200K and the §481 (M1) adjustment of ($60) to arrive at your net of $140. Under your approach, you'll report book net income of $140 and no M-1. If you go with your plan, there has to be an M-2 adjustment in order for AAA to rollforward. Under the prescribed reporting procedure involving the method change your client will have a 481(a) adjustment. Either way the taxable income result is the same it's just a matter of reporting...one seems to fit within the IRS prescribed system and the other doesn't. | |
| 21 January 2008 | |
| Ahhh . . . that is what I was missing. So, basically, the return that I have prepared is correct except that I need to report Net Income per Books on M-1 as the profit without the reversal of the 12/31/06 A/R & A/P (strictly cash receipts and cash disbursements profit) and then report the negative sect 481(a) adjustment on M-1 the reversal of the A/R & A/P from 12/31/06).
Thank you for your help! Greatly appreciated! | |
| 21 January 2008 | |
| I feel like I am overthinking this, but what I also have to change on the return is report the income and expenses as on cash basis also (without the a/r and a/p reversal) and then include the negative 481(a) adjustment as an "other expense" - am i correct??
Initially, I reported the income and expenses on the tax return as the cash basis #'s including the a/r and a/p reversal - although the net income is the same either way, it should be shown separately. Thanks again! | |
| 22 January 2008 | |
| You could do present it either way...I prefer to show the 481 as an "other" income or deduction item and call it §481 adjustment to make it crystal clear in case anyone asks...but, that's just a matter of preference. | |
