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 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.
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?