Cash accounting, which the tax rules call the cash receipts and disbursements method, computes taxable income by including every item of gross income in the taxable year in which it is actually or constructively received, and generally deducting expenditures in the taxable year in which they are actually made (26 CFR 1.446-1(c)(1)(i)). It is one of the overall methods a taxpayer may use in computing taxable income, sitting alongside an accrual method rather than beneath it (26 U.S.C. 446(c)). Two things settle a cash-basis year: whether the entity is one the Code lets use the method at all, and where the receipts and payments actually fall at the year end.
Constructive Receipt, and the Limit on It
Receipt is not possession, and the regulation says so directly. Income although not actually reduced to a taxpayer’s possession is constructively received in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given (26 CFR 1.451-2(a)).
The same paragraph sets the boundary, and the boundary is the half that gets dropped. Income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions (26 CFR 1.451-2(a)).
So the year-end question on a cash-basis file is not whether the money was touched. It is whether anything real stood between the client and the money.
Who May Not Use Cash Accounting
The Code bars three taxpayers from the method: a C corporation, a partnership which has a C corporation as a partner, and a tax shelter (26 U.S.C. 448(a)). Three exceptions run against that bar, and only one of them turns on size. What happens on the return when a barred entity tests back in is worked through in the accrual to cash adjustment.
The Gross Receipts Test Belongs to the Year of the Return
The size exception is indexed, so the figure moves with the year being filed rather than staying put. For taxable years beginning in 2026, a corporation or partnership meets the gross receipts test of section 448(c) if its average annual gross receipts for the 3-taxable-year period ending with the taxable year which precedes such taxable year do not exceed $32,000,000 (IRS, Rev. Proc. 2025-32, section 4.30).
Two mechanics inside that test settle more files than the headline number does.
The first is aggregation. All persons treated as a single employer under subsection (a) or (b) of section 52, or subsection (m) or (o) of section 414, are treated as one person for the test (26 U.S.C. 448(c)(2)). A client with commonly controlled entities does not get to test each of them on its own receipts.
The second is the short year. Gross receipts for any taxable year of less than 12 months are annualized, by multiplying the gross receipts for the short period by 12 and dividing the result by the number of months in the short period (26 U.S.C. 448(c)(3)(B)). A stub first year does not read as a small year.
Which receipts go into that average is a separate question, and the statutory base the indexing starts from, the reduction for returns and allowances, and the gap between receipts and revenue on the books are all set out in gross revenue.
Failing the test forces a change of method. A corporation or partnership that fails the gross receipts test for any tax year cannot use the cash method and must change to an accrual method, effective for the tax year in which it fails, and the entity files Form 3115 to request the change (IRS, Publication 538).
A Qualified Personal Service Corporation Is Outside the Bar at Any Size
This is the exception that reaches accounting practices, and it carries no receipts ceiling at all. Paragraphs (1) and (2) of subsection (a) do not apply to a qualified personal service corporation (26 U.S.C. 448(b)(2)).
The term is defined by two tests, one about what the corporation does and one about who holds its stock (26 U.S.C. 448(d)(2)).
The IRS puts a number on the first test. A corporation meets the function test if at least 95% of its activities are in the performance of services in the fields of health (including veterinary services), law, engineering (including surveying and mapping), architecture, accounting, actuarial science, performing arts, or consulting (IRS, Publication 538).
The second test is a continuous condition rather than a year-end snapshot. A corporation meets the ownership test if substantially all of its stock is owned, directly or indirectly, at all times during the year by employees performing services for the corporation in a qualifying field, by retired employees who performed those services, by the estate of either, or by someone who acquired the stock by reason of such an employee’s death, and in that last case only for the 2-year period beginning on the date of death (IRS, Publication 538). For that test a person is not considered an employee unless the person performs more than minimal services for the corporation.
Losing either test costs the method. A corporation that fails the function test for any tax year, or fails the ownership test at any time during any tax year, must change to an accrual method of accounting effective for the year in which it fails (IRS, Publication 538).
Farming Has a Second Statute to Clear
The third exception is a trade. Paragraphs (1) and (2) of subsection (a) do not apply to any farming business (26 U.S.C. 448(b)(1)).
Section 448 is not the only bar a farming business faces. Except as otherwise provided by law, the taxable income from farming of a corporation engaged in the trade or business of farming, or of a partnership engaged in that business if a corporation is a partner in it, is computed on an accrual method of accounting (26 U.S.C. 447(a)). A corporation is treated as not being a corporation for that rule if it is an S corporation, or if it meets the gross receipts test of section 448(c) for the taxable year (26 U.S.C. 447(c)). So a farming C corporation over the receipts threshold computes its farming income on an accrual method whatever the section 448 exception allows.
What Counts as a Tax Shelter
Tax shelter takes its meaning here from section 461(i)(3), determined after applying paragraph (4) of that subsection, and an S corporation is not treated as a tax shelter merely because it has to file a notice of exemption from registration with a state agency, provided that notice is required of every corporation offering securities for sale in that state (26 U.S.C. 448(d)(3)).
What a Cash-Basis Ledger Carries in a Firm’s Work
A cash-basis ledger has no receivable and no payable, because a fee is not recorded until it is received and a cost is not recorded until it is paid, which is the split set out in payable versus receivable. What it carries instead is a cutoff problem, since the year a fee lands in is decided by the receipt and not by the engagement that earned it.
The deduction side is not simply the day the bank paid. An expense paid in advance is deductible only in the year to which it applies, unless it qualifies for the 12-month rule, under which a taxpayer is not required to capitalize amounts paid to create certain rights or benefits that do not extend beyond the earlier of 12 months after the right or benefit begins or the end of the tax year after the tax year in which payment is made (IRS, Publication 538). That timing is worked through in defer expenses.
A Worked Example
Say a firm on the cash method finishes a block of December work, collects part of the fee, has a further fee set apart and made available to it on the second to last day of the month, and leaves some of its own December supplier invoices unpaid. On those inputs the December figures fall out like this.
December fees billed 52,000
Collected in cash during December 18,000
Set apart and made available on December 30 6,000
Uncollected and unavailable at the year end 28,000
December costs paid in December 7,500
December supplier invoices unpaid at the year end 3,200
Included in December income 24,000
Deducted in December 7,500The amount set apart counts even though the firm did not draw it, because it was made available to draw. The uncollected fees and the unpaid supplier invoices appear nowhere, because on this method neither event has happened yet, and the same facts would produce a different December on an accrual method.
Cash Accounting and GAAP
Cash basis is not generally accepted accounting principles, and the auditing standards say so by putting it in a separate category. A special purpose framework is a financial reporting framework other than generally accepted accounting principles, and cash basis is the first basis it names: a basis of accounting that the entity uses to record cash receipts and disbursements and modifications of the cash basis having substantial support, for example recording depreciation on fixed assets (AICPA, AU-C section 800, paragraph .07).
The same paragraph supplies the label practitioners use out loud. The cash basis, tax basis, regulatory basis and other basis of accounting are commonly referred to as other comprehensive bases of accounting (AICPA, AU-C section 800, paragraph .07).
Being outside GAAP does not put these statements outside professional work. The objective of the auditor applying generally accepted auditing standards to financial statements prepared in accordance with a special purpose framework is to address the special considerations relevant to accepting the engagement, to planning and performing it, and to forming an opinion and reporting on the statements (AICPA, AU-C section 800, paragraph .06).
The words about modifications having substantial support are what separate a modified cash basis from an improvisation.
What Separates Cash Accounting From an Accrual Method
The two methods disagree about which event closes the year. Cash accounting is settled by an act, the payment or the availability of the money. An accrual method is settled by tests applied to the right to receive and to the liability incurred, and those tests are set out in accrual accounting.
Common Questions
The name is narrower than the method. All items which constitute gross income, whether in the form of cash, property, or services, are included for the taxable year in which they are actually or constructively received (26 CFR 1.446-1(c)(1)(i)).
The general rule says the same thing about both sides of the ledger. Items of gross income and expenditures which are elements in the computation of taxable income need not be in the form of cash, and it is sufficient that such items can be valued in terms of money (26 CFR 1.446-1(a)(3)). A client paid in property or in services has cash-basis income in the year of receipt.
Timing, and what settles it. Cash accounting fixes the year by receipt and by payment, so a fee earned in one year and collected in the next is income in the second. An accrual method fixes the year by the tests in accrual accounting, so the same fee is income in the first.
The instructive examples sit at the edge, where the cash has not obviously moved. Amounts payable on interest coupons which have matured and are payable but have not been cashed are constructively received in the taxable year during which the coupons mature, unless it can be shown that there are no funds available for payment of the interest during that year (26 CFR 1.451-2(b)).
It runs the other way too. Where a dividend is declared payable on December 31 and the corporation follows its usual practice of paying dividends by checks mailed so that shareholders would not receive them until January of the following year, those dividends are not considered to have been constructively received in December (26 CFR 1.451-2(b)).
They sit in four different places. Income is included when actually or constructively received and expenditures are deducted when actually made (26 CFR 1.446-1(c)(1)(i)); receipt is measured by availability rather than by possession (26 CFR 1.451-2(a)); the entity has to be one the statute permits (26 U.S.C. 448); and the method a return has already been filed on cannot be swapped without the Commissioner’s consent on Form 3115, which is the procedure covered in the accrual to cash adjustment.
Firms carrying more cash-basis cutoff and cleanup work than they can staff locally can put a real block of it through Accountably’s trial task before anything client facing depends on it.
