Tax Basics: Cash Versus Accrual

We discussed cash versus accrual accounting in this blog post

If you don't know what cash and accrual accounting are it would be a good idea to watch that video first. Once you know what cash and accrual basis accounting are let's talk about who is allowed to use the cash basis and who is allowed to use the accrual basis for tax purposes.

Because of the reporting issues with cash basis accounting many taxpayers are required to use the accrual basis. Whichever method you choose you must stick to that method for your business, if you want to change you have to ask the IRA for permission. However, you don't have to use the same basis for each business you own, you also are not required to use the same basis for your personal fiances as you are for your business finances. In general you cannot use the cash method if you are a corporation with an average annual gross receipt over $5 million or your business is a partnership and one of the partnerships meets that requirement. There are some exclusions for s-corporations.

What is the gross receipts test? Essentially you must pass a test for all tax years after 1985 to use the cash method. To compute the gross receipts test you take the gross receipts for the year and the two preceding years and divide by three. If that is $5 million dollars or less for every year after 1985 you pass the gross receipts test.

Another exception is for personal service corporations, these businesses are allowed to use the cash method.

Farming businesses on the other hand have special IRS consideration, instead of a $5 million limit they have a $25 million dollar limit on revenue if they are a corporation or if they are a partnership and one of their partners is a corporation with revenue over $25 million. They may also be required to use the accrual method if they are a tax shelter. But farmers are not limited to the normal methods that typical taxpayers are, they have other methods that they can use such as the crop method. These are discussed in Publication 225 (check out the link below) and we will discuss them at a later date.

Publication 538 outlines the methods normal tax payers are permitted to use and the limitations on each. We have linked the publication below.

In general the guidelines I have wrote here are broad and do not cover all of the limitations, they are also subject to change. Prior to deciding on a method you should contact your tax professional and do your homework.

Helpful Links:

IRS Publication 538 (outlines methods permitted for normal tax users)

IRS Publication 225 (Farmer's Tax Guide)

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