Controversies started several years ago when the Internal Revenue Service targeted these companies if they used the cash method of accounting C and most of them did. It said service businesses that sell merchandise must use the accrual method.

Under the cash method, businesses generally report income and deduct expenses at time of payment. Under the accrual method, businesses generally report income when they have a right to receive payment and deduct expenses when they have the liability.

Switching to the accrual method could put some companies out of business. They then must pay the IRS before receiving payment from customers because this method includes accounts receivable in taxable income. Also, the accrual method, hellishly more complicated than the cash method, sometimes overwhelms business owners who can't afford certified public accountants to interpret its intricacies.

The requirement to convert, foisted on many service companies, applied no matter how many years they used the cash method. The IRS required one painting contractor business that used the cash method for its 30-year life to convert to the accrual method. It cost the company $200,000 in taxes and penalties.

Most businesses accept the change without challenge though they must pay pickup taxes from prior years plus penalties and interest. Challenging taxpayers, however, often win in court. But to win, they have to go to court.

Now the good news: After consistent losses, the IRS says it gives up Cbut only in some situations. Here are the new rules: Generally, the IRS will not challenge use of the cash method by companies with annual average gross receipts of $10 million or less if their "principal" business is providing services, even if they sell merchandise "incident" to those services.

Here are two major exceptions to the new policy: Some large C corporations and partnerships with C corporation partners must still use the accrual method. (more at Dealing With IRS)

Released 2-18-02