As a business owner, you’re responsible for keeping your business’s books in shipshape. To do that, you need to choose an accounting method and stick with it. But as your small business grows, you might need to rethink your accounting method.
If you’re looking to shake up your accounting method as your business expands, learn about Form 3115 and how to file it.
What is Form 3115?
Form 3115, Application for Change in Accounting Method, is the form business owners must use to switch accounting methods. You can use the form to request:
- A change in your overall accounting method
- A change in the accounting treatment of an item
If you choose to switch accounting methods, you need to file Form 3115 with the IRS. Any changes in your accounting method require IRS approval. Before you move forward with changing from cash basis to accrual basis or vice versa, you must get the official OK from the IRS.
Failure to request a change in your accounting method can result in penalties imposed by the IRS. To avoid penalties, make sure you reach out to the IRS to find out whether or not you must file Form 3115.
Before you go further into the realm of IRS Form 3115, let’s briefly recap the three accounting methods:
- Cash basis
- Modified cash-basis or hybrid
Cash-basis accounting is the simplest accounting method. Many small businesses tend to use it because it’s easy to use and understand.
The cash-basis method only uses cash accounts. With cash basis, you record income when you receive it and only report expenses when you pay them.
You can record things like income, expenses, and cash with this method. But, you can’t record things like inventory or loans.
Because you can only use cash accounts with cash basis, you won’t deal with long-term liability accounts or advanced accounts, like Accounts Receivable.
Modified cash-basis accounting
Modified cash-basis accounting, also known as the hybrid method, is a mixture between cash-basis and accrual accounting.
Because modified cash basis uses elements from the other two accounting methods, it uses accounts from both the cash-basis and accrual methods. Modified cash basis lets you record both short-term items (e.g., utility bills) as well as long-term items (e.g., property).
With modified cash-basis accounting, you only record expenses and income when you receive or pay money.
The accrual-basis method is the most complex accounting method. It uses more advanced accounts, such as Accounts Payable and Accounts Receivable. You can also track long-term liabilities using the accrual method.
With accrual, you must record income when your transactions take place, regardless of whether or not there’s a transfer of money. You also need to record expenses when you’re billed.
The accrual method also uses double-entry bookkeeping.
Answering your Form 3115 questions
Now that you have some background on the different accounting methods, you can begin diving into all things Form 3115. Check out the answers to all of your burning Form 3115 questions below.
Who needs to file Form 3115?
The IRS defines a tax Form 3115 filer as the “person or entity required to file Form 3115, whether on its own behalf or on behalf of another entity.”
In most cases, business owners will fill out Form 3115 to request a change in their accounting method. However, individual taxpayers, estates, and accountants can also fill out the form.
Here’s a list of types of businesses and individuals who may need to file Form 3115:
- S corporation
- Controlled foreign corporation
- 10/50 corporation
- Qualified personal service corporation
- Exempt organization
- Insurance co. (Section 816 and 831)
- Other individuals or businesses
What should you include on Form 3115?
Form 3115 requires a lot of detailed information about you, your business, and your books.
On Form 3115, you must include things like your:
- Identification number (e.g., EIN)
- Phone number
You also need to include other details like the type of applicant you are (e.g., corporate business owner), tax year information, and accounting details and totals.
After you fill out your form, attach a few supporting documents. Attach your business’s income statement as well as balance sheets from the previous year. Also include any adjustments you made in your books.
You must also attach a statement specifying the accounting method you used when preparing the balance sheets.
Where do you send Form 3115?
Again, you must send Form 3115 to the IRS. File Form 3115 during the tax year when you request to change your accounting method.
Unless the IRS tells you differently, file Form 3115 under the automatic change procedures. The IRS needs two copies of Form 3115. One copy goes with your federal income tax return for the year of change. This copy can either be:
- E-Filed with the rest of your tax return
- Mailed to the IRS with your tax return
You must file the second copy of Form 3115 no earlier than the first day of the year. Send this copy directly to the IRS.
Once the IRS receives Form 3115 from you, they will review your request and get back to you.
For more Form 3115 filing instructions and information, contact the IRS or review the IRS’s instructions for the form.
Is there a deadline for Form 3115?
There isn’t a hard “deadline” for Form 3115. You can file Form 3115 any time after the first day of the year of the change. The earlier you file Form 3115, the more time the IRS has to iron out any issues.
Do you use the accrual method? What about cash basis? Patriot’s accounting software handles cash-basis, accrual, and hybrid accounting. Choose the method that works best for you and easily record income and expenses. Get your free trial today!
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This is not intended as legal advice; for more information, please click here.