If Your Business Uses Incorrect Accounting, You May Need to Follow It Every Year
The Tax Court decided the IRS was right to force a taxpayer to use incorrect accounting that they have used for many years. The Tax Court determined that a S-corporation could not exclude from income checks that were received in the prior year but not deposited or reported until the following year.
Although everybody (even the taxpayer, IRS and Tax Court) acknowledged that this accounting was incorrect, because the IRS had relied on the original reporting and the prior year was closed, the doctrine of consistency required the shareholders to stick with their initial reporting. [Squeri v. Comm'r, T.C. Memo. 2016-116.]
In really strange accounting, the company’s sales excluded checks that were actually received in the last quarter of that year. Rather, each year's gross receipts included checks received in the fourth quarter of the prior year, but deposited the following January.
My 2 cents:: Besides bad accounting and tax reporting; this is a bad business practice that can cripple a business financially. Cashflow was probably poor as Q4 checks were not deposited until next year which means some checks were held up to 3 months. Also holding checks can result in checks that (a) get lost, (b) stolen (c) canceled by the issuer or (d) expired as some checks have 90 days or less to be cashed.
Note: Cash businesses who receive checks but don’t deposit them are considered paid and must report the undeposited checks as income under the “constructive receipt” doctrine.