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Tax accounting in the United States facts for kids

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U.S. tax accounting is a special way of keeping track of money for tax reasons in the United States. It's different from how most other countries do it. The U.S. has its own set of rules for taxes, which are separate from the usual accounting rules called Generally Accepted Accounting Principles (GAAP).

How Tax Accounting Works

The main rules for tax accounting come from a law called the Internal Revenue Code. A specific part, Section 446, explains the basic ideas. It says that businesses and people should be consistent in how they keep their tax records. This means they should use the same method for their tax accounting as they do for their regular financial accounting.

Choosing a Method

There are different ways to do tax accounting. Section 446 allows for a few main types:

  • Cash method: This is like keeping track of your personal money. You record income when you actually receive the cash. You record expenses when you actually pay them.
  • Accrual method: This method records income when you earn it, even if you haven't received the money yet. It records expenses when you owe them, even if you haven't paid them yet. This is often used by larger businesses.
  • Other methods: The Internal Revenue Service (IRS), which is the U.S. tax agency, can approve other ways of accounting. You can even combine different methods.

If a business has more than one type of activity, it can use a different accounting method for each one. For example, a business might use one method for selling products and another for providing services.

When the IRS Can Change Your Method

Once you choose a tax accounting method, the IRS has the power to change it if they think your method doesn't clearly show how much money you've earned. Their goal is to make sure your income is reported correctly for tax purposes.

Changing Your Tax Accounting Method

If you want to change the way you do your tax accounting, you usually need to get permission from the IRS. There are two main ways to do this:

  • Getting approval: You can ask the IRS for a special letter of approval.
  • Automatic changes: For some common changes, you can just fill out a form and send it to the IRS. This is called an automatic change.

If you start using a new method without asking the IRS, you might face penalties. It's always best to follow the rules and get permission if needed. If you want to go back to an old method, you also need to ask the IRS for permission.

Tax Accounting in Other Countries

In many countries around the world, the profit a business makes for tax purposes is usually the same as the profit shown in its regular financial records (its "book profit"). Then, they make a few small adjustments based on tax laws. So, in these countries, the regular accounting rules mostly decide how much profit is taxed.

However, the U.S. is different because its tax accounting rules are quite separate from its regular accounting rules. Some other countries, like the Netherlands, also have big differences between their tax accounting and their regular business accounting. These differences often happen when tax rules are used to help with economic or social goals, not just to figure out profit.

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