Many businesses have a choice between using the cash or accrual method of accounting for tax purposes. The cash method often provides significant tax benefits for those that qualify, though some businesses may be better off using the accrual method. That’s why it’s wise to take a closer look at both options and work with a trusted CPA firm to determine the most advantageous approach.
Cash vs. Accrual: What’s the Difference?
Let’s start with the basics.
The cash method of accounting recognizes income when it’s actually received and deducts expenses when they’re actually paid. This makes it easier to track real-time cash flow and gives you some flexibility with timing income and expenses. For example, you can defer income by sending out invoices in January instead of December, or speed up deductions by prepaying expenses in December.
On the other hand, the accrual method recognizes income when it’s earned and expenses when they’re incurred, regardless of when the money changes hands. This gives a more accurate picture of financial performance, which is why it’s required for businesses that follow Generally Accepted Accounting Principles (GAAP).
While both methods have their place, a CPA firm can help you weigh the pros and cons based on your business structure, industry, and long-term goals.
Expanded Eligibility Under the Tax Cuts and Jobs Act (TCJA)
The Tax Cuts and Jobs Act of 2017 significantly expanded eligibility for the cash method. Before the TCJA, small businesses faced varying gross receipts thresholds (between $1 million and $10 million), depending on their industry, entity type, and whether they held inventory.
The TCJA changed that. Now, businesses with average annual gross receipts of $29 million or less (for tax year 2023) can generally use the cash method. That threshold is indexed annually for inflation.
This is a game changer. Many businesses that previously had to use the accrual method may now qualify for the cash method, opening the door to better cash flow management and tax deferral opportunities. A knowledgeable CPA firm can evaluate whether your business qualifies under the updated rules.
Even better, some businesses can still use the cash method even if they exceed the threshold, including:
- S corporations and partnerships with no C corporation partners,
- Farming businesses,
- Certain personal service corporations.
Keep in mind: Tax shelters are never eligible for the cash method, regardless of size.
Why Many Businesses Prefer the Cash Method
For small and midsize businesses, the cash method offers some key advantages:
- Tax Flexibility: You can control the timing of income and deductions to minimize tax liability.
- Simplified Recordkeeping: You only account for money when it comes in or goes out.
- Improved Cash Flow: You’re taxed only on the cash you actually have, not on receivables.
This can be especially helpful for seasonal businesses or those with unpredictable revenue cycles. A CPA firm can assist in creating a tax strategy that leverages these benefits while staying compliant with IRS rules.
When the Accrual Method is a Better Fit
While the cash method offers flexibility, the accrual method has its own strengths. It may be more appropriate if:
- Your business follows GAAP and produces financial statements for lenders or investors.
- Your accrued expenses typically exceed your accrued income.
- You want to take advantage of deducting year-end bonuses paid within the first 2.5 months of the following tax year.
- You receive advance payments and want to defer income recognition to future periods.
In short, accrual accounting can give a clearer view of profitability and may offer some unique tax deferral opportunities. A CPA firm can help run projections to see how accrual might impact your taxes over time.
Should You Switch Methods?
Even if switching to the cash method (or accrual) appears beneficial, there are a few considerations before making the change:
- Compliance: If you prepare financial statements under GAAP, you’re required to use the accrual method for those reports.
- Recordkeeping: Using different methods for tax and financial reporting means maintaining two sets of books.
- IRS Approval: Changing your tax accounting method generally requires filing Form 3115 with the IRS.
A professional CPA firm can guide you through this process and help assess whether the long-term benefits outweigh the administrative costs of making a switch.
A Side-by-Side Example
Imagine a business that earns $500,000 in December but doesn’t receive the payment until January. Under the accrual method, the business pays tax on that income in December. Under the cash method, the income isn’t taxed until the next year.
If that business has significant expenses in December, the timing of when those expenses are paid (vs. incurred) also changes when deductions are taken. Understanding this timing difference is crucial to accurate tax forecasting, and a CPA firm can help model these scenarios.
Don’t Guess Your Way Through Tax Strategy
The accounting method you choose has ripple effects throughout your business, from tax obligations to financial planning and loan applications. Choosing the right method, and knowing when to make a change, requires a deep understanding of your financials and IRS rules.
This isn’t something you want to guess on. Partner with a CPA firm that can:
- Review your eligibility for the cash method,
- Project the tax impact of a method change,
- Prepare and file the necessary IRS forms, and
- Help align your accounting method with your business goals.
Let Burton McCumber & Longoria Help You Decide
At Burton McCumber & Longoria, we help businesses just like yours navigate the ins and outs of tax accounting. As a full-service CPA firm, we specialize in making complex tax strategies simple and practical.
Whether you’re looking to lower your tax burden, improve cash flow, or align your books with your growth strategy, our team is ready to help. Contact us today to explore whether switching your accounting method makes sense—and if so, how to do it with confidence.