Pooling or Interest Method Definition

The pooling or interest method is a method of accounting for closely held corporations in which the income and expenses are combined in a single account.

The corporation is taxed on this amount, and then each shareholder takes an individual share of the income or loss.

Why Would You Use the Pooling or Interest Method?

The pooling or interest method of accounting is an option that can be used by close corporations.

There are two reasons why a corporation would want to use the pooling or interest method:

1) There must be no accumulated undistributed income; and

2) Any gain on the distribution of earnings is taxed only once at the corporate level.

Advantages of Using This Accounting Technique

Here are three advantages that often motivate businesses to use the pooling or interest method:

  1. Simplicity – The pooling or interest method is simple because it only requires one set of books to maintain for both income and expense records.
  2. Minimal Paperwork – The pooling or interest method also records income and expenses on one tax form as opposed to separate forms for each shareholder’s respective transactions, which reduces paperwork.
  3. Less Expense – Implementing this type of accounting technique may save money because there are not as many tax forms to file.

Disadvantages of Using This Accounting Technique

The disadvantages associated with using this accounting technique stem mainly

  1. No Special Rules – The pooling or interest method doesn’t have any special tax rules, which makes it less advantageous because the legal structure of the corporation must be compatible with general accounting standards.
  2. No Special Tax Benefits – The pooling or interest method produces no special tax benefits, which is another reason to use it only if there are no other alternatives.
  3. Social Security Taxes May Apply – Employees who work for closely held corporations cannot take advantage of the exclusion provided by the social security taxes because these types of corporations are not allowed to write off wages as business expenses under this type of accounting technique.

Examples of When You Should Use the Pooling or Interest Method

As mentioned, the pooling or interest method is advantageous for closely held corporations in which the net income and loss are distributed evenly among shareholders.

This option can also be used when a corporation has accumulated undistributed income, because this type of accounting doesn’t require that it distribute the earnings annually.

In addition, it’s best to use the pooling or interest method when a corporation has only one shareholder.

The Bottom Line

The pooling or interests method is a method of accounting for closely held corporations in which the income and expenses are combined in a single account.

The corporation is taxed on this amount, and then each shareholder takes an individual share of the income or loss.

There are advantages to using the pooling or interest method because it’s simple, reduces paperwork, and is less expensive.

However there are also disadvantages associated with this accounting technique including tax rules that don’t apply, no special tax benefits of use, and social security taxes may apply. So you should only consider using this method if there are no other alternatives.

The pooling or interest method is a method of accounting for closely held corporations in which the income and expenses are combined in a single account.
The pooling or interest method is called such because the net income and loss are combined in a single account and then distributed to shareholders, entailing that it's done by way of interests (or shares), not expenditures.
This method entails that all corporations; pay federal income tax on the aggregate net income or loss for that year.
Advantages of using the pooling or interest method are simplicity, minimal paperwork, and less expense.
Disadvantages of using this method are that there are no special rules, no special tax benefits, and social security taxes may apply.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.