Cash vs. Accrual Accounting for Taxes

Your accounting method decides when income and expenses count for tax purposes. Two businesses with identical sales and costs can show different profit in a given year depending on whether they use the cash method or the accrual method. Most small businesses prefer the cash method because it is simpler and tracks actual money in and out. This guide explains the difference, who is allowed to use each method for 2025 returns and 2026 planning, and how to switch.

How the methods work

Cash method. You report income in the year you actually or constructively receive it. Constructive receipt means the money was credited to your account or otherwise made available to you without restriction, so you cannot defer income by delaying a deposit or holding a check. Expenses are generally deducted when paid. You generally cannot deduct something you paid for far in advance if it creates an asset lasting well past the year. Most individuals and many small businesses use the cash method.

Accrual method. You report income when you have earned it and your right to it is fixed, and you deduct expenses when the obligation is fixed and economic performance has occurred, meaning the goods or services have been provided. Advance payments can generally be deferred only to the next tax year. A recurring item exception lets some expenses be deducted in the year accrued if economic performance occurs within 8½ months after year-end or by the return's due date, if earlier, and other conditions are met. Expenses owed to a related cash-method person are deductible only when paid.

Hybrid methods. A combination is allowed if it clearly reflects income and is used consistently, with limits. If you use cash for income, you must use cash for expenses. Businesses with inventory often use accrual for purchases and sales and cash for everything else.

Who can use the cash method

The general rules:

• Sole proprietors and most small businesses can use cash if it clearly reflects income.
• Corporations other than S corporations, and partnerships with a corporate partner, generally cannot use cash unless they meet the gross receipts test.
• Tax shelters cannot use the cash method.
• Businesses with inventory must generally use accrual for purchases and sales, unless they are small business taxpayers.

A small business taxpayer is one whose average annual gross receipts for the three prior tax years are $31 million or less for 2025, adjusted for inflation each year, and who is not a tax shelter. For tax years beginning in 2026 the amount is $32 million. Related businesses under common control may need to be combined when testing, so check with a professional if you own more than one business.

Small business taxpayers can use the cash method even with inventory, and they can choose not to keep formal inventories. They may treat inventory as non-incidental materials and supplies or follow their financial accounting treatment. See inventory and cost of goods sold.

Why the choice matters

• Timing of tax. The cash method gives some control over timing, but not unlimited control. You cannot hold checks or backdate to shift income.
• Cash flow match. Cash is easier to understand, but accrual can show profit before cash arrives, which may create tax due on receivables.
• Lenders and investors. Banks and investors often expect accrual financial statements even if your tax return uses cash. See accounting and financial statements and working capital.
• Growth. A business approaching the gross receipts threshold should plan ahead for a switch.
• Related rules. The method also interacts with the business interest limit and the uniform capitalization rules, which use the same gross receipts test.

Changing your method

You generally need IRS consent to change an accounting method, requested on Form 3115. Many changes qualify for the automatic procedures, which carry no user fee:

• File the original Form 3115 with your timely filed return, including extensions, for the year of change.
• Send a signed copy to the IRS National Office no earlier than the first day of the year of change and no later than the date you file the original.
• Compute a section 481(a) adjustment, which captures the effect of the change so nothing is counted twice or missed. A negative adjustment (a deduction) is generally taken in the year of change. A positive adjustment (extra income) is generally spread over four years.

Changing methods repeatedly or without approval can lead to problems on audit. Consult a professional before switching.

Common mistakes

• Using cash when the business is required to use accrual.
• Changing methods on a return without filing Form 3115.
• Missing the gross receipts test because related businesses were not combined.
• Treating the method used for bookkeeping as the same as the tax method.
• Keeping the books on a bank-account basis and missing receivables and payables.

How we can help

We help owners pick the method that fits their records, review whether the gross receipts test is met, prepare Form 3115 and the adjustment, and set up bookkeeping that works for both tax and lenders. See our bookkeeping, accounting and financial statements and virtual CFO services, or contact us.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.