Under the cash method, you report income in the year you actually or constructively receive it, and deduct expenses in the year you pay them. IRS Publication 538 explains constructive receipt: income is constructively received when an amount is credited to your account or made available to you without restriction. Holding a customer’s cheque in a drawer until January does not move the income to January.

• Simple. Your bank statement and your taxable income are close relatives.
• Defers tax on unpaid invoices. You are not taxed on money you haven’t collected yet.
• Gives some timing control over when you pay deductible bills — within the rules.

The weakness is that cash-basis books can mislead. A month with big customer payments looks like a great month even if the work was done in the previous one, and a large unpaid bill doesn’t show up anywhere.

Under the accrual method, income and expenses are recorded when the underlying events happen, not when cash moves.

• Expenses: the all-events test and economic performance. Per Publication 538, an accrual-basis business needs all the events that fix the fact of the liability to have occurred and the amount to be determinable with reasonable accuracy, and generally can’t deduct an expense until economic performance occurs (IRC §461(h)) — roughly, when the goods or services are provided. There are exceptions, such as the recurring-item exception.
• Income: when the right to it is fixed. If you also have an “applicable financial statement” (typically audited), income generally can’t be reported later than when you record it as revenue there (§451(b)).
• Advance payments. If a customer pays you before you deliver, §451(c) generally requires inclusion in the year of receipt, with an election to defer part of it to the next year when your financial statements report it later.

The upside is a truer picture of performance: revenue sits in the period you earned it, and unpaid bills show as liabilities. The downside is that you can owe tax on money you haven’t collected, and the books take more discipline (accounts receivable and payable have to be right).

Two details worth knowing. An accrual-basis business that has already counted an unpaid invoice as income can deduct it as a bad debt if it later proves uncollectible; a cash-basis business never counted it, so there is nothing to deduct. And §267 can delay an accrual-basis deduction for an amount owed to a related cash-basis person until that person is paid.

For tax, the cash method is a default for many businesses, but IRC §448 takes it away from three groups. Publication 538 lists them: regular C corporations, partnerships that have a C corporation as a partner, and tax shelters. Sole proprietors, S corporations and ordinary partnerships (including a multi-member LLC taxed as a partnership with no corporate partner) aren’t on that list.

Even the barred groups can use cash in two cases:

• The gross receipts test (§448(c)). Your average annual gross receipts for the 3 prior tax years don’t exceed the inflation-adjusted $25 million. The figure is $31 million for 2025 (IRS Form 8990 instructions) and $32 million for 2026 (Rev. Proc. 2025-32). It is indexed each year, and related businesses are aggregated when you run the test. Tax shelters can’t use this route.
• Qualified personal service corporations. A C corporation whose activities are substantially all in health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting, and whose stock is substantially held by the people performing those services (or retirees, estates and certain heirs). Farming businesses are also excepted.

Inventory is the other trigger. Publication 538 says that if inventory is needed to account for your income, you must use an accrual method for purchases and sales. A business that sells products can therefore end up on a hybrid: cash for everything else, accrual for stock.

There is a relief valve. Under §471(c), a small business taxpayer — one that is not a tax shelter and meets the §448(c) gross receipts test (the same $32 million for 2026) — doesn’t have to keep formal inventories. It can instead treat inventory as non-incidental materials and supplies or follow the method in its books and records, and the 2021 final regulations confirm it can then use the cash method overall. The same test also exempts qualifying businesses from the uniform capitalisation rules (§263A(i)) and, for long-term construction contracts expected to finish within two years, from percentage-of-completion accounting (§460(e)).

Over the line, those reliefs go away: a seller of goods with receipts above the threshold is generally back to inventories, and, as a result, to accrual accounting for purchases and sales.

Your accounting method is chosen on your first return. After that, Publication 538 is blunt: if you want to change it, you must generally get IRS approval. Simply filing next year’s return on the other basis is not a change; it is an unapproved one.

• The form is Form 3115, Application for Change in Accounting Method. Many common changes (including those for small business taxpayers) fall under the IRS’s automatic procedures: you attach Form 3115 to the timely filed return for the year of change and send a signed copy to the IRS. Other changes need a non-automatic request to the IRS National Office, with a user fee.
• The §481(a) adjustment. Switching can double-count or skip income, so the law makes an adjustment. Per the Form 3115 instructions, a negative (favourable) adjustment is generally taken in one year, and a positive one over four years (the year of change plus three) — or two years if the business is under examination.
• Going accrual-to-cash is possible only once you qualify (for example, you pass the gross receipts test again).