9048 / Are any taxpayers required to use the accrual method of accounting, rather than the cash basis method?

Editor’s Note: The 2017 tax reform legislation expanded the gross receipts test discussed below to include entities with annual gross receipts that do not exceed $31 million in 2025 ($30 million in 2024 and $29 million in 2023, as indexed for inflation).

Generally, C corporations, partnerships in which a C corporation is a partner and tax shelter arrangements (see Q 8687) are required to use the accrual basis method of accounting.¹

However, several exceptions exist to permit certain C corporations and partnerships with C corporation shareholders to use the cash basis method. Farming businesses² that are organized as C corporations are permitted to use the cash basis method of accounting. Similarly, small businesses organized as C corporations are permitted to use the cash basis method if the corporation (or partnership with C corporation shareholder) has annual gross receipts that do not exceed $31 million (for 2025).³

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Planning Point: Revenue Procedure 2018-40 provides the procedures by which small businesses that satisfy the newly expanded gross receipts test can obtain automatic consent to change to the cash basis accounting method for tax years beginning after December 31, 2017. The guidance provides information as to which sections of Form 3115 the taxpayer is required to complete, and also provides that only one Form 3115 must be filed if the taxpayer is making concurrent accounting changes. Further, the guidance provides that it is a modification to previously existing guidance in Revenue Procedures 2015-13 and 2018-31, and that the procedures in those releases will continue to apply unless otherwise noted.

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Certain personal service corporations are also permitted to use the cash basis method of accounting. Further, the IRS has specifically determined that the prohibition on C corporations using the cash basis accounting method does not apply to limited liability companies.⁴

Generally, taxpayers that maintain inventory are required to use the accrual basis method with respect to purchases and sales of that inventory unless the taxpayer obtains the IRS’ consent to use the cash basis method. Typically, the IRS will consent to such a change if the cash basis method clearly reflects the taxpayer’s income.⁵ See Q 9058 for a more specific discussion of the methods that may be used to account for inventory.

Prior to the 2017 tax reform legislation, the cash basis method could also be used by most other taxpayers whose average annual gross receipts did not exceed $1 million⁶ and could be used by select taxpayers whose average annual gross receipts did not exceed $10 million.⁷

The 2017 Tax Reform Legislation

The 2017 tax reform legislation provides that the cash method of accounting can be used by taxpayers that satisfy the gross receipts test regardless of whether the purchase, production or sale of merchandise is an income producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25 million for the three prior tax years (the “gross receipts test”) to use the cash method. The $25 million amount is indexed for inflation beginning after 2018, to $31 million in 2025, $30 million in 2024, $29 million in 2023, $27 million in 2022 and $26 million in 2021.⁸

As under prior law, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other pass-through entities are allowed to use the cash method without regard to whether they meet the gross receipts test, so long as the use of such method clearly reflects income.

Taxpayers who meet the gross receipts test are also exempt from the application of IRC Section 263A uniform capitalization rules.⁹ Previously existing exemptions that are not based on the taxpayer’s gross receipts continue to apply.

These changes would be considered a change in accounting method that is made with the consent of the Treasury Secretary for IRC Section 481 purposes.¹⁰ The new rules are effective for tax years beginning after December 31, 2017.