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MM, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 16
Experience:  CPA with several years experience in both domestic & international tax.
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# tax

Welcome and thank you for giving me the opportunity to assist you with your tax question.

Customer: replied 4 years ago.

how to calculate 481(a) adjustment for accrued vacation, changed from 2.5 month rule, to cash:

amount accrued 12.31.11 = (20,000)

amount paid by 3.15.12 = 15,000

amount accrued 12.31.12 = (25,000)

what is the 481(a) adjustment? and what is my book-tax difference amount?

I will opt out and let another expert with more expertise than I in this area assist you. You do not need to reply to me as this will delay another expert answering your question.

Thank you.

Hello,

Firstly- I would like to note that you may need to file for an accounting method change via Form 3115 if the 2.5 month payment was followed for more than one year.

With that said, in regards XXXXX XXXXX above problem, the 481(a) adjustment will equal 15,000 unfavorable. The current year book-tax adjustment will equal \$5,000 unfavorable.
MM, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 16
Experience: CPA with several years experience in both domestic & international tax.
Customer: replied 4 years ago.

One follow-up question: if now we are a cash basis, the ending accrued vacation as of 12/31/12 was (\$25,000), my cumulative temporary difference should be \$25,000, right? How can I reconcile if the current year book-tax difference is an unfavorable \$5,000? Shouldn't my current book-tax difference be \$20,000 unfavorable?

I would appreciate further information- specifically, when will the method change take effect? In the original question, my feedback was based on the cumulative adjustment occurring in 2013, when the accrued vacation balance will be 0 at the end of the year for tax purposes.

Also - will you be changing all books and records to follow cash basis? If not, an issue may exist, because the tax code requires 'clear reflection' of income and arguably, switching to cash basis when books and records are on an accrual basis may not provide a clear reflection of income for tax purposes.
Customer: replied 4 years ago.

Thanks for your response. My original question about "cash basis" may not be correct. We changed our method for 2012 tax return, because we found out that our vacation policy only allows vesting when the employees are employed at the end of the year. We failed the all-event test. So we cannot deduct the amount received by the employees by the 15th of the 3rd calendar month after the end of tax year. Books and records are on accrual basis.

Kendrick,

Thanks for the feedback. That makes more sense. On a recent client, the IRS also questioned the deduction after year end. Below is a summary of the anticipated adjustment as a result.

A 481(a) adjustment is intended to adjust historically for the proper deduction that would have been taken had the proper method been followed. With that said, in this context, in 2011, \$15,000 was over-deducted. If the correct method was followed, no deduction would have been taken for the \$15,000. This will be the 481(a) adjustment related to the 2011 year. Note the 481(a) adjustment is a cumulative adjustment which is meant to get the accounts to the correct starting point.

12/31/11 Accrued Vacation - (20,000)
12/31/12 Accrued Vacation - (25,000)

This results in an unfavorable addback of \$5,000, because the accrual increased. A favorable deduction will occur when the accrual decreases.

In future years, the net deduction/addback will equal the change in accounts. This is still considered following the accrual method, but the primary difference is payments made within 2.5 months after year-end will not be deductible in the respective year.