Cash Method or Accrual Method: How Timing Changes Tax
When income and expenses count for tax, who must use accrual, and how a small business switches methods.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
The cash method counts income when you receive it and expenses when you pay them. The accrual method counts income when it is earned and expenses when they are incurred, regardless of when cash moves. Most small businesses may choose either for tax; larger C corporations and partnerships with C corporation partners must generally use accrual.
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How do the two methods differ in practice?
| Situation | Cash method | Accrual method |
|---|---|---|
| Invoice sent in December, paid in January | Income next year | Income this year |
| Supplier bill received in December, paid in January | Expense next year | Expense this year |
| Customer prepays for next year's service | Income when received | Income when received, unless the business elects to defer it — and then no later than the next year |
| Unpaid invoice written off | No deduction (never counted as income) | Bad debt deduction |
The cash method gives owners more control at year end: deferring billing or accelerating payment of bills shifts taxable income. The accrual method gives a truer picture of profit and is what lenders and buyers expect to see.
Who must use the accrual method?
A C corporation, or a partnership with a C corporation partner, must use accrual unless it passes the gross receipts test — average annual gross receipts for the prior three years at or below an inflation-adjusted ceiling ($31 million for 2025 and $32 million for 2026). Tax shelters must use accrual at any size. Sole proprietors, S corporations, and partnerships without C corporation partners are not forced onto accrual by this rule.
What about businesses with inventory?
Inventory used to force many small retailers and manufacturers onto accrual. Since 2018, a business that passes the gross receipts test may use the cash method even with inventory, and may either treat inventory as non-incidental materials and supplies or follow the method used in its books and financial statements. Under the materials-and-supplies approach, inventory cost is deducted in the year the goods are provided to customers (or the year they are paid for, if later), not simply when bought.
Can books and tax return use different methods?
Yes. Many businesses keep accrual books for management and lenders and file on the cash method, reconciling the difference at year end. The tax return must use one method consistently.
How do you change methods?
A change of accounting method generally requires IRS consent, requested on Form 3115. Many common changes — including a small business switching between cash and accrual — are "automatic," meaning consent is granted by filing the form with a timely return and sending a copy to the IRS. The change creates a one-time catch-up adjustment so no income is skipped or counted twice. A positive adjustment (more income) is generally spread over four years; a negative one is taken in the year of change.
Frequently asked questions
Can I pick a method each year?
No. Once you adopt a method on your first return, you must use it until you obtain consent to change.
Does the cash method let me deduct prepaid expenses?
Partly. A cash-method business can generally deduct prepaid expenses that do not extend beyond the earlier of 12 months after the benefit begins or the end of the following tax year. Longer prepayments are spread out.
Is accrual better when I plan to sell the business?
Buyers usually value the business on accrual numbers. You can keep cash-method tax returns and still present accrual financial statements.
What if my receipts later exceed the threshold?
A C corporation, or a partnership with a C corporation partner, that fails the gross receipts test must change to accrual effective for the year it fails, filing Form 3115.
Official sources
The IRS explains: “A corporation or partnership, other than a tax shelter, that meets the gross receipts test can generally use the cash method.” — Internal Revenue Service, Publication 538 (01/2022), Accounting Periods and Methods, https://www.irs.gov/publications/p538
The IRS explains: “File this form to request a change in either: an overall method of accounting or the accounting treatment of any item.” — Internal Revenue Service, About Form 3115, Application for Change in Accounting Method, https://www.irs.gov/forms-pubs/about-form-3115
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk chooses the method that fits your business, files Form 3115 when a change pays, and keeps the books and return reconciled. See pricing or book a free fit call.
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