Cash vs. Accrual Accounting for Taxes: Which Method a Small Business Can Use
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How we wrote this: A summary of the "Accounting Methods" and "Inventories" sections of IRS Publication 334 (2025 edition) and IRS Publication 538, Accounting Periods and Methods (both linked below), checked October 29, 2026. This is general information, not tax advice.
Your accounting method decides which tax year income and expenses land in. Most of the time the totals over several years are the same either way; the timing is what changes. That timing matters around December, when an invoice is paid, a check arrives or a bill is due.
What an accounting method is
Publication 334 defines it as a set of rules used to determine when and how income and expenses are reported. It covers your overall method and the treatment of any material item. The IRS lists these options:
- the cash method
- an accrual method
- special methods for certain items
- a combination of the above
You choose a method when you file your first return that includes a Schedule C for the business. Two ground rules: you must use the same method to figure taxable income and to keep your books, and the method must clearly show your income.
The cash method
Publication 334 says most individuals and many sole proprietors with no inventory use the cash method because the records are easier to keep.
- Income: you include all items you actually or constructively receive during the tax year. If you're paid in property or services, you include their fair market value.
- Expenses: you generally deduct them in the year you actually pay them. Some advance payments can't be deducted right away, and some costs must be capitalized.
Constructive receipt
You don't need cash in hand. Income is constructively received when it's credited to your account or made available to you without restriction. Two IRS points worth knowing:
- In the IRS example, a contractor was told in December that a $10,000 payment was available but asked to be paid in January. The payment still counts as December's year, because it was available.
- A valid check received by year-end counts as income in that year, even if you can't cash or deposit it until the next year.
If someone receives income as your agent, you're treated as receiving it when they do.
The accrual method
Under an accrual method, Publication 334 says you generally report income in the year it's earned and deduct or capitalize expenses in the year incurred, so income and expenses are matched to the right year.
- Income is included when all events that fix your right to receive it have occurred and you can determine the amount with reasonable accuracy. In the IRS example, a computer sold on December 28 and paid for in February is income in the year of the sale.
- Expenses generally count when the liability is fixed, the amount can be determined with reasonable accuracy, and economic performance has occurred. In the IRS example, supplies received with a bill in December but paid in January are deductible in December's year.
One trap: you can't deduct amounts owed to a related person who uses the cash method until you pay and they include it in income.
Inventory and the small business exception
Publication 334's general rule: if you produce, buy or sell merchandise, you must keep an inventory and use an accrual method for purchases and sales of merchandise.
The exception is for a small business taxpayer, which the 2025 Publication 334 defines as a business with average annual gross receipts of $31 million or less for the 3 prior tax years (the figure is indexed for inflation) that isn't a tax shelter. A small business taxpayer can choose not to keep an inventory, but must still use a method for inventory that clearly reflects income: treating inventory as non-incidental materials and supplies, or following its financial accounting treatment. Publication 538 has the details.
Mixing methods
The IRS allows some flexibility:
- Business vs. personal: you can use accrual for the business and cash for personal items.
- Two or more businesses: each can use a different method if they're separate and distinct, with complete and separate books.
- Combination methods have limits: if you use cash for income, you must use cash for expenses; if you use accrual for expenses, you must use accrual for income. A combination that includes the cash method is treated as the cash method.
Changing methods later
After your first return, changing your method generally requires IRS approval using Form 3115, Application for Change in Accounting Method, under either automatic change procedures or advance consent. Publication 334 notes you may have to pay a user fee; the Form 3115 instructions explain which changes qualify for automatic approval.
Which one fits?
The IRS doesn't pick for you, but it does point out the cash method's simpler records for businesses without inventory. If you invoice clients, our invoice late fee calculator and the records guide help keep the paper trail either method needs. Timing also affects your estimated tax payments.
Quick checklist
- Pick a method on your first Schedule C return; use it for books and taxes.
- Cash: count money when received or made available; a year-end check counts that year.
- Accrual: count income when earned and expenses when incurred.
- Selling goods? Check whether you meet the small business taxpayer test.
- Switching later: Form 3115.