In: Accounting
Green Corporation is required to change its method of accounting for federal income tax purposes. The change will require an adjustment to income to be made over three tax periods. Joe, the sole shareholder of Green, wants to better understand the implications of this adjustment for E&P purposes. Joe gets dividend distributions from Green every year. Explain to Joe the impact of the adjustment on E&P.
Help with clear explanation please!
Taxpayer changes its accounting method ususally to make an adjustment to prevent double counting of the affected income or deducted item. Timing is very important to tax administration, and the IRS does not think it should be left to taxpayers. It is forbidden to change accounting methods, even from an incorrect to a correct one, without IRS permission. In many cases permission is granted automatically, but an application is still required.
When a taxpayer changes its accounting method, some income or deductions might never be taken into account. For example, if a cash method taxpayer earns income in Year 1 but does not receive payment until Year 2, it generally recognizes the income in Year 2. If it changes to the accrual method for Year 2, it can say that it should not recognize the income in Year 2 because on the accrual method it should have recognized the income in Year 1. The income could escape tax entirely if not for the required one-time adjustment.