Cash or accrual accounting: which can a small business use?

Two methods, one choice

An accounting method is the set of rules you use to decide in which tax year income and expenses count. Publication 334 explains that you can generally use cash, accrual, a combination, or a special method, as long as it clearly reflects income and you use it consistently. Most small businesses end up choosing between the first two.

The cash method is the simpler one. The publication says most individuals and many sole proprietors with no inventory use it because cash-method records are easier to keep. The accrual method matches income and expenses to the year they belong to, regardless of when money moves. Neither is more correct; the question is which you are allowed to use and which you have already adopted.

How the cash method works

Under the cash method you include in gross income all items of income you actually or constructively receive during your tax year, and if you receive property or services you include their fair market value. Constructive receipt is the important idea: income counts when an amount is credited to your account or made available to you without restriction, even if you do not take possession of it. The publication’s examples are specific. Interest credited to your bank account in December 2025 counts in 2025 even if you do not withdraw it until 2026. A check received on December 30, 2025 counts in 2025 even though you cannot deposit it until January 3, 2026. A contractor entitled to a $10,000 payment that was available in December 2025, but who asked to be paid in January, must include it in 2025. You cannot postpone income by holding checks.

Expenses work the same way in reverse: you generally deduct them in the year you actually pay them. The exception is prepaid costs. An expense paid in advance is deductible only in the year to which it applies. If you pay $1,000 in 2025 for a one-year insurance policy that starts July 1, you deduct $500 in 2025 and $500 in 2026.

How the accrual method works

Under an accrual method you generally report income in the year earned and deduct or capitalize expenses in the year incurred. Income counts in the year in which all events that fix your right to receive it have occurred and you can determine the amount with reasonable accuracy. The publication’s example: you sell a computer on December 28, 2025, bill the customer in the first week of January 2026 and are paid in February 2026. The sale is 2025 income.

For expenses, the all-events test is paired with an economic performance requirement: you generally cannot deduct or capitalize an expense until economic performance occurs, which for goods or services provided to you means as they are provided. If you buy office supplies in December 2025, receive them and the bill in December and pay in January 2026, you deduct the cost in 2025. Special rules cover advance payments, which you can generally elect to include a year later but no further, and estimated income, where a later difference is picked up in the year you learn the exact amount.

The calculator, and what it shows

Enter the year you did the work, the year you were paid, and your method. Under cash the income lands in the year you were paid; under accrual it lands in the year the right to payment was fixed. Try 2025 and 2026: a December 2025 invoice paid in February 2026 is 2026 income to a cash-method business and 2025 income to an accrual-method one. For a seasonal business with an unpaid December invoice, that difference can move thousands of dollars between returns, which also changes self-employment tax and estimated payments for both years.

The tool is a timing illustration. It does not handle advance payments, installment sales, or the special elections the publication mentions.

When inventory forces accrual, and who is exempt

Publication 334 says that if inventory is necessary to account for your income, you must generally use an accrual method for sales and purchases. That sounds restrictive, but it comes with an exception for the small business taxpayer: if you have average annual gross receipts of $31 million or less for the three prior tax years (indexed for inflation) and are not a tax shelter, you can choose not to keep an inventory, as long as your method of accounting for inventory clearly reflects income. Treating inventory as non-incidental materials and supplies, or following your financial accounting treatment, qualifies.

If you do keep inventory, you must generally use accrual for purchases and sales and value the inventory each year to figure cost of goods sold in Part III of Schedule C. A combination method is allowed: for example, accrual for purchases and sales and cash for everything else, but with limits. If you use the cash method for figuring income you must use cash for expenses, and if you use accrual for expenses you must use accrual for income. A combination that includes the cash method is treated as the cash method.

Related persons and changing methods

An accrual-method business cannot deduct expenses and interest owed to a related person who uses the cash method until payment is made and the amount is includible in the related person’s income. Related persons include siblings, a spouse, ancestors and lineal descendants, with others listed in section 267 of the Internal Revenue Code.

The publication says you choose an accounting method when you file the first income tax return that includes a Schedule C for the business, and that after that you must generally get IRS approval to change it. You must also use the same method to figure taxable income and to keep your books. A separate and distinct business with complete separate books can use its own method. Do not switch just because one year looks better; changing is a conversation with a preparer.

Limits of this page

This page covers the sole-proprietor view in Publication 334. Corporations and partnerships have additional rules, including who must use accrual. For how timing interacts with a bad debt deduction see are business bad debts deductible, and for prepaid insurance see is business insurance deductible.

Sources

• IRS Publication 334, Tax Guide for Small Business (2025): Accounting Methods, in chapter 2 (Accounting Periods and Methods). Page last reviewed or updated by the IRS April 30, 2026. Read November 2, 2026.

Edition read: Publication 334 (2025), for use in preparing 2025 returns. Dollar limits and thresholds quoted on this page are for 2025 and can change; check the current publication and form instructions for your tax year. This page summarizes the publication and does not replace it. Marked for human review.