An accounting method is the method used to determine when you report income and expenses on your return. An accounting method is chosen when you file your first tax return. You must use the same accounting method from year to year. If you wish to change your accounting method, you need permission from the IRS.
What is the Cash Accounting Method?
The Cash Method of accounting is the most commonly used. Using the Cash Method of accounting, you report all items received as gross income at the time you receive them. This is true whether you actually or constructively received the income. Constructively received means that an amount is credited to your account or made available to you without any restrictions as to when you can withdraw it. Generally, you would also report your expenses in the year that they are paid.
What is the Accrual Accounting Method?
The Accrual Method of accounting reports income in the year it is earned and pays expenses in the year they are incurred. Using this method, you would report your income on the earliest date possible; the date you receive payment, when the income is due to you, when you earn the income or when the title has passed to you. If you estimated the income and the actual amount differs, take the difference when you determine the actual amount. Expenses are designated to the tax year in which they occurred.
For example: if you made repairs to your building in December 2020 but did not pay for the service until January 2021, the expense can be deducted in 2020.
For more information regarding accounting methods, refer to Publication 538.