Key Takeaways
- Cash method: income when received, expenses when paid.
- Accrual method: income when earned (All Events Test), expenses when economic performance.
- Gross Receipts Test (Tax Year 2024): $30 million 3-year average.
- Small Business Taxpayer: cash method even with inventory.
- Tax Shelters: NEVER allowed cash method.
- 12-month rule: prepaid expenses deductible if benefit ≤12 months.
Cash vs. Accrual Method
Why This Matters for the Exam
Accounting methods are heavily tested. Know the differences, the Gross Receipts Test, and who is prohibited from cash method.
Exam Note: For the May 2025 - February 2026 testing window, you are tested on accounting method rules as of December 31, 2024 (Tax Year 2024).
Expect at least 4-5 questions on accounting methods.
Cash Method
| Element | Rule |
|---|---|
| Income recognition | When actually or constructively received |
| Expense recognition | When paid |
| Best for | Services, small retail |
| Tax planning | Easy (control timing) |
Accrual Method
| Element | Rule |
|---|---|
| Income recognition | When All Events Test met |
| Expense recognition | When All Events Test + Economic Performance |
| Best for | Large inventory businesses |
| Tax planning | Difficult (based on contracts) |
The All Events Test (Accrual)
| Requirement | Description |
|---|---|
| 1 | Right to receive is fixed |
| 2 | Amount can be determined with reasonable accuracy |
The 12-Month Rule (Cash)
| Requirement | Description |
|---|---|
| Prepaid expense | Deductible in year paid if: |
| 1 | Benefit ≤12 months after first benefit |
| 2 | Does not extend beyond end of following tax year |
Gross Receipts Test
| Tax Year | Threshold |
|---|---|
| 2023 | $29 million |
| Tax Year 2024 | $30 million |
| 2025 | $31 million |
Test: 3-year average of prior years.
Small Business Taxpayer Benefits
| Benefit | Description |
|---|---|
| Cash method | Allowed even with inventory |
| Inventory exception | Treat as non-incidental materials |
| UNICAP exemption | Exempt from §263A |
Prohibited from Cash Method
| Entity | Cash Method Allowed? |
|---|---|
| C-Corp (meets test) | Yes |
| C-Corp (fails test) | No |
| Partnership with C-Corp partner (meets test) | Yes |
| Partnership with C-Corp partner (fails test) | No |
| Tax Shelters | NEVER |
Real-World Scenario
Scenario: C-Corp has receipts: $10M (Year 1), $35M (Year 2), $40M (Year 3).
- 3-year average: ($10M + $35M + $40M) / 3 = $28.3M.
- Tax Year 2024 threshold: $30M.
- Result: Qualifies for cash method ($28.3M < $30M).
On the Exam
Expect 4-5 questions on methods, typically:
- Method Questions: "Can this C-Corp use cash method?"
- 12-Month Questions: "Prepaid insurance—deductible when?"
- Threshold Questions: "What is the gross receipts limit?"
The key is to remember: Cash = received/paid. Accrual = All Events Test. $30M threshold (Tax Year 2024). Tax Shelters = never cash. 12-month rule for prepaid expenses.
C-Corp with $25M average gross receipts. Can it use cash method?
Dec 1, 2024: Pay $12,000 for 12-month insurance (Dec 2024-Nov 2025). 2024 deduction?
Which entity is NEVER allowed cash method?