The Tax Cuts and Jobs Act (TCJA) opened up the eligibility guidelines for using the cash method of accounting, making the cash method available to more businesses than was previously allowed. The IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it could be advantageous to analyze whether switching methods would be beneficial.
Cash vs. Accrual
Generally, cash-basis businesses recognize income when it is received and deduct expenses when they are paid. Accrual-basis businesses, on the other hand, recognize income when it is earned and deduct expenses when they are incurred, without regard to the timing of cash receipts or payments.
A business is permitted to use the cash method of accounting for tax purposes unless it is:
- Expressly prohibited from using the cash method, or
- Expressly required to use the accrual method.
Cash Method Advantages
The cash method offers several advantages, including:
Simplicity. It is typically easier and cheaper to implement and maintain.
Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by postponing invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business does not enjoy this flexibility. For example, to defer income, delaying invoices would not be enough; the business would have to put off shipping products or performing services.
Cash flow benefits. Because income is taxed in the year it is received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.
Accrual Method Advantages
In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that are not available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.
The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).
If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. With this said, the business should weigh the cost of maintaining two sets of books against the potential tax benefits to be received
Making a Change
Keep in mind that the cash and accrual are the two primary tax accounting methods, but they are not the only methods available to use. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.
If your business is eligible for more than one tax method of accounting, your local Blue & Co. tax advisor can help you determine whether switching methods would be more beneficial for your business and can execute the change for you if appropriate.