14.1 Cash vs. Accrual Method
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 2025): $31 million 3-year average (Rev. Proc. 2024-40, inflation-adjusted from $30M in 2024).
- Small Business Taxpayer: cash method even with inventory; same $31M test for §448, §263A UNICAP, and §471(c).
- Tax Shelters: NEVER allowed cash method (§448(a)(3)).
- 12-month rule: prepaid expenses deductible if benefit ≤12 months and does not extend beyond end of following tax year.
Why This Matters for the Exam
Accounting methods are heavily tested. Know cash vs. accrual differences, the Gross Receipts Test, and who is prohibited from cash method.
Exam Note: For the July 1, 2026 – February 28, 2027 testing window, you are tested on accounting method rules as of December 31, 2025 (Tax Year 2025). The OBBBA (signed July 4, 2025) did NOT change §448, §451, or §453, but it permanently restored §163(j) ATI to an EBITDA basis and restored §174 domestic R&E to immediate expensing (covered in 14.7 and 14.8).
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 (§448(c)) — Inflation-Adjusted Threshold
| Tax Year | Threshold | Source |
|---|---|---|
| 2023 | $29 million | Rev. Proc. 2022-38 |
| 2024 | $30 million | Rev. Proc. 2023-34 |
| Tax Year 2025 | $31 million | Rev. Proc. 2024-40 |
| 2026 (projected) | TBD | Rev. Proc. 2025-XX |
Test: Average annual gross receipts for the 3 prior taxable years does not exceed the threshold. This same $31M figure governs three related small-business exceptions: §448 (cash method), §263A (UNICAP), and §471(c) (inventory).
Small Business Taxpayer Benefits (Tax Year 2025, ≤$31M)
| Benefit | Code Section | Description |
|---|---|---|
| Cash method | §448(c) | Allowed even if a C-corp, partnership with C-corp partner, or has inventory |
| Inventory simplification | §471(c) | Treat inventory as non-incidental materials & supplies OR follow book method |
| UNICAP exemption | §263A(i) | Exempt from capitalization rules |
| §163(j) exemption | §163(j)(3) | Business interest limit does NOT apply (see 14.7) |
| §460 long-term contract exemption | §460(e) | Cash/completed-contract OK for certain construction |
Prohibited from Cash Method
| Entity | Cash Method Allowed? |
|---|---|
| C-Corp (meets $31M test) | Yes |
| C-Corp (fails $31M test) | No |
| Partnership with C-Corp partner (meets test) | Yes |
| Partnership with C-Corp partner (fails test) | No |
| Personal Service Corporation | Always Yes (special rule) |
| Tax Shelters | NEVER (§448(a)(3)) |
Real-World Scenario (Tax Year 2025)
Scenario: C-Corp's prior-3-year gross receipts: $28M (2022), $30M (2023), $32M (2024).
- 3-year average (for 2025): ($28M + $30M + $32M) / 3 = $30.0M.
- Tax Year 2025 threshold: $31M.
- Result: Qualifies as a small business taxpayer for 2025 ($30.0M < $31M). May use the cash method, is exempt from §263A UNICAP, may use §471(c) inventory simplification, and is exempt from §163(j) business interest limit.
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 2025 gross receipts limit?" ($31M)
The key is to remember: Cash = received/paid. Accrual = All Events Test. $31M threshold for 2025 (§448, §263A, §471(c) all use the same number). Tax Shelters = never cash. 12-month rule for prepaid expenses.
C-Corp with $25M average gross receipts (3-year, ending 2024). Can it use cash method for Tax Year 2025?
Dec 1, 2025: Pay $12,000 for 12-month insurance (Dec 2025–Nov 2026). 2025 deduction under the 12-month rule?
Which entity is NEVER allowed cash method?