Alice, Bill, and Charles each received an equal number of shares when they formed King Corporation a number of years ago. King has used the cash method of accounting since its inception. Alice, Bill, and Charles, the shareholder-employees, operate King as an environmental engineering firm with 57 additional employees. King had gross receipts of $4.3 million last year. Gross receipts have grown by about 15% in each of the last three years and were just under $5 million in the current year. The owners expect the 15% growth rate to continue for at least five more years. Outstanding accounts receivable average about $600,000 at the end of each month. Forty-four employees (including Alice, Bill, and Charles) actively engage in providing engineering services on a full-time basis. The remaining 16 employees serve in a clerical and support capacity (secretarial staff, accountants, etc.). Bill has read about special restrictions on the use of the cash method of accounting and requests information from you about the impact these rules might have on King’s continued use of that method. Prepare a memorandum for your tax manager addressing the following issues: (1) If the corporation changes to the accrual method of accounting, what adjustments must it make? (2) Would an S election relieve King from having to make a change? (3) If the S election relieves King from having to make a change, what factors should enter into the decision about whether King should make an S election?
Your manager has suggested that, at a minimum, you should consult the following resources:
• IRC Secs. 446 and 448
• Temp. Reg. Sec. 1.448-1T
• H. Rept. No. 99-841, 99th Cong., 2d Sess., pp. 285–289 (1986)