Last reviewed October 7, 2026 · By the NYBACS advisory team
Short answer
Cash basis records income when money is received and expenses when they are paid; accrual basis records income when it is earned and expenses when they are incurred, whatever the timing of cash. Many small US businesses may use the cash method for tax, but C-Corps above an inflation-adjusted gross receipts threshold must use accrual, and investors, lenders and auditors generally expect accrual-based financial statements.
Key takeaways
- The tax method and the reporting method can differ: a startup may file on the cash method while giving investors accrual-based statements, with the difference reconciled.
- A C-Corp, or a partnership with a C-Corp partner, can use the cash method for tax only if its average annual gross receipts for the prior three years do not exceed an inflation-adjusted threshold — $31 million for tax years beginning in 2025 and $32 million for 2026.
- Gross receipts of related businesses can be aggregated for this test, so a small US subsidiary of a larger group should check how it applies.
- Annual subscriptions collected upfront show the difference most clearly: cash basis records a spike, accrual spreads revenue over the service period through deferred revenue.
- Changing a tax accounting method generally requires IRS consent, usually requested on Form 3115.
The same month under each method
Take a US software company in March:
- On March 1 it collects USD 12,000 for a 12-month subscription.
- It completes USD 5,000 of consulting work in March, invoiced on March 31 and paid in April.
- Its March cloud hosting bill of USD 3,000 arrives and is paid in April.
| March results | Cash basis | Accrual basis |
|---|---|---|
| Subscription revenue | 12,000 | 1,000 |
| Consulting revenue | 0 | 5,000 |
| Hosting expense | 0 | (3,000) |
| March profit | 12,000 | 3,000 |
Neither figure is wrong; they answer different questions. Cash basis shows what came into the bank. Accrual shows what the business earned and what it cost to earn it. The 11,000 of subscription money not yet earned sits on the accrual balance sheet as deferred revenue, a liability that unwinds over the next eleven months.
Who can use the cash method for US tax
The cash method is widely available to small businesses, but there are limits under section 448 of the Internal Revenue Code:
- C-Corps and partnerships with a C-Corp partner may use the cash method only if they meet the gross receipts test — average annual gross receipts for the three prior tax years at or below the inflation-adjusted amount ($31 million for tax years beginning in 2025, $32 million for 2026).
- Tax shelters cannot use the cash method regardless of size.
- Aggregation rules can combine the gross receipts of commonly controlled businesses, which matters for a US subsidiary of a larger group.
Businesses that meet the gross receipts test also have simplified options for inventory. Single-member LLCs owned by individuals and most small partnerships of individuals are generally free to choose, subject to the requirement that the method clearly reflects income.
Why investors, lenders and auditors want accrual
Accrual accounting matches revenue with the costs of earning it, so it shows real margins and real trends. That is why US GAAP — the framework audits and most investor reporting follow — requires it.
Practical consequences for a startup:
- ARR and revenue reported to investors should be consistent with accrual revenue, not cash collected.
- Gross margin is meaningless on a cash basis if hosting or fulfillment bills are paid irregularly.
- Revenue recognition under ASC 606 determines when contract revenue is earned, especially for multi-element deals combining software, setup and services.
- Diligence teams will convert cash-basis numbers to accrual anyway, often finding the business less profitable than presented.
Running both: book basis and tax basis
Many growing companies keep accrual books and file on the cash method while they still qualify, or keep cash books during the year and add accrual adjustments at quarter- and year-end. Either approach works if differences are tracked in a schedule — deferred revenue, accrued expenses and prepaid costs are the usual items — and reconciled on Schedule M-1 or its equivalent.
A common middle ground is the modified cash basis, which follows cash for most items but records fixed assets, loans and some accruals. It can be acceptable for internal and bank reporting, but should be labeled clearly.
Switching methods
Changing the overall tax accounting method — cash to accrual, or the reverse — is a change in accounting method that generally requires IRS consent through Form 3115. Some changes qualify for automatic consent procedures; others require a ruling request. The change usually creates a section 481(a) adjustment so income is neither duplicated nor omitted in the transition year.
Plan the switch for the start of a tax year, before a fundraise or audit forces it, and agree the approach with the company's tax preparer before filing.
Switching the books to accrual for reporting purposes is a separate decision and does not by itself require IRS consent. A company can move its management and investor reporting to accrual at any time, keep filing on the cash method while it remains eligible, and track the differences. What it should not do is let the tax return drift from cash to accrual, or back, without a deliberate method change — inconsistent treatment between years is how income ends up counted twice or not at all.
Common mistakes to avoid
- Assuming cash basis is mandatory because the company is small, or that accrual is required simply because the company is a C-Corp.
- Reporting annual prepayments as revenue in the month received in investor updates.
- Switching methods on a tax return without filing Form 3115.
- Mixing methods in the same books — recording some bills when received and others when paid.
- Ignoring gross receipts aggregation for a US subsidiary of a larger foreign group.
- Failing to label the basis of statements sent to banks or investors.
NYBACS 360° support
How NYBACS helps
- Recommends the right reporting basis for your stakeholders and keeps the books on it consistently.
- Maintains deferred revenue, accrued expense and prepaid schedules that bridge accrual books and cash-basis tax filings.
- Coordinates with your tax preparer on method eligibility, including group aggregation questions, and any Form 3115 filing.
- Converts historical cash-basis books to accrual ahead of a fundraise or audit.
- Produces accrual-based reporting packs for a foreign parent's group consolidation.
Frequently Asked Questions
Can an LLC use the cash method?
Generally yes. A single-member LLC owned by an individual, or a partnership of individuals, can usually choose cash. The limits apply mainly where a C-Corp is a partner, where the entity is a tax shelter, or where inventory rules require otherwise.
Does accrual mean paying tax on money I have not received?
It can. Under accrual, income is generally taxed when earned and invoiced, even if the customer pays later. That is one reason eligible small businesses often prefer the cash method for tax.
What is modified cash basis?
A hybrid that uses cash for most income and expenses but records certain items, such as fixed assets, loans and sometimes payables, on an accrual-like basis. It should be labeled clearly on any statement shared outside the company.
Which method do banks prefer?
For routine onboarding or KYC reviews, cash-basis statements are usually acceptable. For credit applications, many lenders prefer accrual statements because they show receivables, payables and obligations more completely.
Is accrual accounting much more work?
It adds monthly entries for accruals, deferrals and prepaid items, but for most startups the extra effort is modest once schedules are set up. The cost of converting later, under deadline pressure, is usually higher.
