How Can I Change Accounting Methods?
Changing methods requires special permission from the IRS
The Internal Revenue Service allows businesses to use either the accrual accounting method or the cash accounting method to track and report financial data. Business owners also have the option of using a combination of both accounting systems. There's a lot of flexibility here, but there's one catch – you must continue to use whatever method you choose when you first inform the IRS that you've elected to track and report that way during the first year of your business operation.
This isn't quite as carved-in-granite as it sounds, however. You can reach out to the IRS in advance and request permission to change accounting methods. As long as you do so, you should be fine, but failure to make the request can result in penalties imposed by the IRS.
Getting IRS Approval
If you elect to change things up at any time after you've set up your accounting method and filed your first business income tax return, you must file a current Form 3115 to request the change. This is the case whether you want to change your overall accounting method or just the accounting treatment of any particular item.
Changes in accounting method that require approval from the IRS include switching from a cash basis method to an accrual basis method or vice versa – switching from an accrual basis method to a cash basis method. You must also request an official OK from the IRS to make a change in the method or basis used to value your inventory. Changes in your depreciation or amortization methods generally require approval, but some changes in the straight-line method are permitted without special permission from the IRS.
If you're unsure if your situation qualifies for this special dispensation, consult with a business tax professional to make sure because the rules are complex.
When and Where to File Form 3115
You can request approval for a change in accounting methods in one of two ways.
File Form 3115 in duplicate for an automatic change request. Attach the original Form 3115 to your federal income tax return for the year of the change, including extensions. A copy of Form 3115 must also be filed with the IRS National Office no earlier than the first day of the year of the change and no later than when the original is filed with the federal income tax return for the year of change.
The process is similar for an advance consent request. Form 3115 must be filed during the tax year for which the change is requested. According to the IRS, "If the tax year is a short period, file Form 3115 by the last day of the short tax year. File the Form 3115 with the IRS National Office. Form 3115 should be filed as early as possible during the year of change to provide adequate time for the IRS to respond prior to the due date of the filer's return for the year of change."
Find the most recent IRS Form 3115 and published instructions.