Your business may be eligible to choose between the cash or accrual method of accounting for tax purposes. While the cash method often provides significant tax advantages — especially for small businesses — the accrual method can be a better fit in certain circumstances.
Choosing the right method isn’t just a compliance issue; it can have a meaningful impact on your tax liability and cash flow. Here’s what you need to know to make the most beneficial choice for your business.
Current Rules for Small Businesses
Under the tax code, “small businesses” generally have the flexibility to use either the cash or accrual method — or in some cases, a hybrid approach.
Before the Tax Cuts and Jobs Act (TCJA), the gross receipts threshold that defined a small business ranged from $1 million to $10 million, depending on the business’s structure, industry, and whether inventory was a material income-producing factor.
The TCJA simplified and expanded small business eligibility by establishing a single gross receipts threshold, indexed for inflation. For 2024, a business qualifies as small if its average annual gross receipts for the prior three years are $30 million or less (up from $29 million in 2023).
Additional benefits for qualifying small businesses include:
- Use of the cash method of accounting,
- Simplified inventory accounting,
- Exemption from the uniform capitalization (UNICAP) rules,
- Exemption from the business interest deduction limit, and
- Other streamlined tax provisions.
Note that some businesses may still use the cash method even if they exceed the threshold, including:
- S corporations,
- Partnerships without C corporation partners,
- Farming businesses, and
- Certain personal service corporations.
However, tax shelters are always ineligible for the cash method, regardless of size.
Why the Cash Method Often Makes Sense
For many small businesses, the cash method offers key advantages:
- Tax flexibility: Income is recognized when received, and expenses are deducted when paid. This allows strategic timing of income and deductions — for instance, delaying invoices until the next year or prepaying expenses to reduce current-year taxable income.
- Better cash flow alignment: Because taxes are based on actual cash inflows and outflows, you’re less likely to pay tax on income you haven’t yet received.
- Simplicity: The cash method generally requires less recordkeeping and is easier to manage without a full accounting department.
When the Accrual Method May Be Better
Despite its advantages, the cash method isn’t always the best fit. Some businesses may benefit more from the accrual method, especially if:
- Accrued expenses consistently exceed accrued income, which could reduce taxable income.
- The business wants to deduct bonuses paid within the first 2½ months of the following year.
- There’s an opportunity to defer taxes on certain advance payments, such as customer deposits.
Additionally, if you prepare financial statements in accordance with GAAP, you’re required to use the accrual method for reporting purposes. While you can still use the cash method for tax purposes, doing so requires maintaining two sets of books — which can increase administrative complexity.
Thinking About Switching Methods?
If switching from accrual to cash — or vice versa — would result in a tax advantage, it’s important to factor in both the immediate tax impact and the administrative costs. A change in accounting method typically requires filing Form 3115 (Application for Change in Accounting Method) and may require IRS approval.
Need Help Evaluating Your Options?
We can help you assess whether your current accounting method is still the most advantageous and assist with the IRS process if a change is warranted.
Contact us today to schedule a consultation.
