I'm nearly complete and preparing to launch my business. However, I've noticed that taxes aren't as simple as everyone makes them out to be. I'm mostly confused about cash vs accrual accounting for my situation.
I'm planning on calling the IRS tomorrow for more clarification, but I'd like some opinions from other people. Anyway, to my question -
I'm going to make my business a sole proprietorship. My business sells a single piece of software available only via download. The IRS however says that most businesses that sell things have an inventory. I don't understand how this would apply to me. I do not stock anything, the downloads are available free and the user is simply purchasing a license key from me. There's no stock of these either - they're generated on demand. Do you guys thing that I would be okay with cash based accounting?
IRS do not provide tax advice. You should call a tax adviser (EA or CPA) who can help you.
Taxes are significantly more complicated than TurboTax commercials make them appear. If you're starting a business you must have a reputable and professional tax adviser who will walk you through all the issues, educate you on how to manage your books, and will prepare and set up all the needed accounts and tables for you (capital and expense accounts, depreciation tables - these are needed for (almost) all businesses. Some businesses will require more, especially in a Corp or LLC (Partnership) settings).
One of the things you'll get educated about is the accounting methods. What is cash, what is accrual, when this one is better, and when that one is better. Maybe you don't have a choice? Maybe you can use hybrid methods? Talk to a pro.
Inventory may not apply to you, but capitalization of your development expenses certainly does. How do you do that? Talk to a pro.
IRS won't help you - they're not allowed anyway, and whatever they tell you will be the most conservative interpretation of the law. You don't have to follow what they tell you, different interpretations are available. At times, IRS interpretation contradicts settled law (existing Tax Court and Supreme Court precedents). Your tax adviser will guide you through the best interpretations, and best options available to you.
It doesn't have to be as bleak as the other answer suggests. I've run several businesses over decades and the one time I hired a specialist accountant it went badly wrong. They kept making basic errors and even got their clients involved in a tax scam, which they said was perfectly legal and within the rules. When the tax authorities took them to court, they said their "advice" should have been checked by their clients, so the fines and penalties weren't their responsibility. Thousands of clients were each thousands of dollars out of pocket (big scandal). Not sure who they thought we should "check their advice" with though, as we'd hired them to be our accountants and handle our taxes.
Anyway, after that I realised I couldn't trust anyone with this stuff any more, so I learned to do all my business and personal taxes, financial statements, etc myself. Now I have a couple of spreadsheets and it is trivial.
Of course, I don't mean to imply that all accountants are incompetent, but you do have to be careful who you put your trust in. As always, IMHO, YMMV, etc.