Your accounting method determines when you report income and expenses on your tax return. Most businesses choose an accounting method when they file their first return and generally must continue using the same method each year unless they receive IRS approval to change it.
Cash Accounting Method
The Cash Method is the most common method used by sole proprietors and small businesses.
With the Cash Method:
- Report income when you receive it.
- Deduct expenses when you pay them.
This includes income that is either actually received or constructively received, meaning the funds are available to you without restriction.
Example: If a customer pays you in January 2027 for work completed in December 2026, you generally report the income on your 2027 tax return.
Accrual Accounting Method
The Accrual Method reports income when it is earned and expenses when they are incurred, regardless of when payment is made.
With the Accrual Method:
- Report income when you earn it.
- Deduct expenses when the obligation occurs.
Example: If repairs are completed in December 2026 but you pay the bill in January 2027, you generally deduct the expense on your 2026 tax return.
Which Method Should I Use?
Most sole proprietors use the Cash Method because it's simpler and easier to maintain. Businesses that carry inventory or need more detailed financial reporting may use the Accrual Method.
Why It Matters
Your accounting method affects:
- When income becomes taxable
- When expenses can be deducted
- Your annual business profit or loss
Using the same method consistently helps ensure your Schedule C is reported accurately from year to year.
Additional Information
For more information regarding accounting methods, refer to Publication 538.