In general, taxable income must be computed according to the method of accounting used by a taxpayer to keep its books, unless otherwise provided by the Internal Revenue Code (IRC or Code) or Treasury regulations (IRC §446(a)). Therefore, a taxpayer who consistently follows generally accepted accounting principles (GAAP) to calculate his business income for financial statement purposes will usually use this same method to calculate his taxable income. If, however, that method “does not clearly reflect income”, the calculation of taxable income must be made using a method which, in the opinion of the Commissioner, clearly reflects income (IRC §446(b)).
Continuing Living Communities Thousand Oaks, LLC c. Commissioner (TC Memo 2022-31) discusses the extent of the Commissioner’s power to require a different accounting policy with respect to initial charges not included in income at the time of payment. In this case, it was undisputed that the petitioner (“Continuing Life”, a limited liability company classified as a partnership for tax purposes) used a method permitted by GAAP, but the IRS found that the method did not clearly reflect income.