In our C Corp. we use the Accrual method of accounting. Nevertheless, in our past Federal Inc. tax returns, my accountant (actually, ex-accountant) has been deducting the State Inc. Taxes PAID in the FY, instead of the accrued tax.

I want to start deducting the accrued tax, starting this FY's return. Our FY just ended in July. Which is the most acceptable way of doing this?

Alternative A: deduct the amount actually paid (cash basis); in other words. Last FY's state income tax PLUS the accrued for this year? In this case, we would be charging 2 years worth of State Inc. tax...

Altenrative B: just deduct the accrued this year.

I obviously believe "B" might be more acceptable to the IRS, but on the other hand, it will go against consistency with previous years,. but some day we will have to make the switch.

What do you recommend we do?

Thank you...

It looks as though you had a hybrid accounting method since the state income tax has been deducted using the cash method. To correctly fix that you would need to file Form 3115, Change in Accounting Method. This would allow you to properly handle the double deduction question. It has been a while since I have filed a 3115, but you should qualify for one of the automatic changes that do not need IRS approval which would allow you to go ahead an accrue the taxes for the year ended July. You should review Form 3115 and the instructions.

Thank you very much for your quick and precise reply.