Key takeaways
- Under the cash method, you generally deduct an expense in the year you pay it, per IRS Publication 538.
- Most freelancers and sole proprietors use the cash method because it’s simpler and matches the bank account.
- C corporations and partnerships with a C corporation partner can generally use the cash method only if average annual gross receipts for the prior three years are $32 million or less, for tax years beginning in 2026 (Rev. Proc. 2025-32).
- Once chosen, changing your method generally needs IRS approval using Form 3115.
What is cash vs accrual accounting?
Every business has to answer one timing question: when does a sale or a purchase “count”? The answer decides which month your reports show it in and, for taxes, which year you report the income or claim the deduction.
With the cash method, the answer is “when the money moves.” A client pays in January for work done in December, so it’s January income. With the accrual method, the answer is “when it’s earned or owed.” The December work is December income, even though the cash arrives later.
Record every expense with the right date for your books using the Manage Receipt app.
Key differences
| Cash method | Accrual method | |
|---|---|---|
| Income recorded | When received | When earned |
| Expenses recorded | When paid | When incurred (owed) |
| Tracks unpaid invoices and bills? | No | Yes, as receivables and payables |
| Matches your bank balance? | Closely | Not always |
| Shows true monthly performance? | Partly | Yes |
| Effort | Low | Higher |
Which suits a small business?
For most freelancers, consultants and small service businesses, the cash method is the practical choice. It’s easier to keep, it lines up with your bank statement, and you never pay tax on income you haven’t collected yet.
Accrual makes more sense when you carry inventory, send many invoices on long terms, need financial statements for a lender or investor, or want monthly reports that reflect the work actually done. Some businesses keep accrual books for management and file taxes on the cash method where the rules allow it; ask your tax professional before mixing methods.
The IRS limits who can use the cash method. C corporations and partnerships with a C corporation partner generally qualify only if they pass the gross receipts test: average annual gross receipts of $32 million or less for the three prior tax years (the figure for tax years beginning in 2026). Tax shelters can’t use the cash method at all. Small businesses that meet the test also get simpler inventory rules. Most sole proprietors filing Schedule C choose their method on their first return.
How each method affects expenses
This is where receipt dates matter. The date on the receipt, the invoice date and the payment date can fall in different months or even different tax years.
A web designer receives a $900 invoice dated December 18, 2026 for a year of hosting that starts January 1, 2027, and a $240 invoice dated December 20 for December contractor work. Both are paid by bank transfer on January 8, 2027.
| Expense | Cash method | Accrual method |
|---|---|---|
| $240 December contractor work | 2027 (paid in January) | 2026 (incurred in December) |
| $900 hosting for 2027 | 2027 (paid in January) | 2027 (it covers 2027 service) |
Under the cash method, paying in December instead of January would have moved the $240 into 2026. Prepaid costs like the hosting follow special rules under either method: you generally deduct them in the year they apply to, unless the IRS 12-month rule lets you deduct them when paid. See prepaid expense.
- Keep the receipt or invoice and proof of the payment date.
- Note service periods on annual subscriptions and insurance.
- At year end, list bills received but not paid; under the cash method they belong to next year.
Keep every receipt dated and in order
Manage Receipt reads the date from each receipt you scan or forward, so you can pull expenses for any period and see exactly which ones fall before or after December 31. That makes year-end timing questions quick to answer, whichever method you use.
Explore AI Expense ReportsFrequently asked questions
Can small businesses use cash accounting?
Yes. Most sole proprietors, freelancers and small businesses can use the cash method. C corporations and partnerships with a C corporation partner generally need average annual gross receipts of $32 million or less over the prior three years for tax years beginning in 2026. Tax shelters cannot use it.
Which is better, cash or accrual accounting?
Neither is better for everyone. Cash accounting is simpler and matches your bank, which suits most freelancers and service businesses. Accrual gives a truer picture of monthly performance and suits businesses with inventory, long payment terms or lenders who want accrual-based statements.
Can I switch from cash to accrual accounting?
Yes, but for taxes you generally need IRS approval by filing Form 3115, and some changes qualify for automatic consent. The switch can create adjustments to income. Talk to a tax professional before changing, and pick the right method on your first return if you can.
Does my accounting method change how much tax I pay?
Over the life of a business, usually not much, because the same income and expenses are counted either way. What changes is timing: which year an item lands in. That can shift tax between years, which matters around December 31 and in years when your income jumps or drops.