Businesses generally have two choices when deciding which accounting method is best suited for them: cash or accrual. There are many differences between the two but knowing the tax benefits can help business owners make the decision.
Let’s Take a Step Back
Under the Tax Cuts and Jobs Act (TCJA), the definition of a "small business" for tax purposes was simplified, and the gross receipts threshold was set at $25 million (adjusted for inflation). For 2024, businesses with average annual gross receipts of $30 million or less over the past three years are considered small businesses and can typically use the cash method.
Small businesses also benefit from simplified inventory accounting, exemptions from uniform capitalization rules, and fewer limits on business interest deductions. Some businesses, like certain S corporations, partnerships without C corporation partners, and personal service corporations, can use the cash method even if they exceed the threshold. Tax shelters, however, are ineligible for cash accounting.
Advantages: Cash Method and Accrual Method
The cash method offers flexibility by recognizing income when received and deducting expenses when paid. This gives businesses more control over when to recognize income or take deductions. For example, you can defer income by delaying invoices or accelerate deductions by prepaying expenses.
Accrual method businesses, on the other hand, recognize income when it’s earned and expenses when they’re incurred, regardless of payment timing. This provides less flexibility but may be better for businesses whose accrued expenses are greater than accrued income, which could reduce tax liability. The accrual method also allows you to deduct year-end bonuses paid early in the following year and defer taxes on some advance payments.
Switching Methods
Switching from one accounting method to another might offer tax benefits, but it can come with administrative costs. If your financial statements are prepared using Generally Accepted Accounting Principles (GAAP), you’ll need to use the accrual method for reporting, but for tax purposes, use the cash method. This may be confusing and a lot to keep up with so using an experienced Accountant is highly suggested. Note, switching accounting methods may also require IRS approval.
Contact us to help determine the best method for your business. Hire us as your trusted Accountant to integrate the perfect method into your business.