“Are you cash or accrual?” sounds like a bookkeeping detail. It is really a question about timing: in which tax year a job’s money counts as income, and in which year a supplier’s bill counts as an expense. Over the life of a business the totals come out the same. The year they land in does not, and for a contractor whose jobs and bills straddle New Year, that changes this year’s tax. Here is what each method counts, who gets to choose, the special rule for construction contracts, and how to change your mind later.
What each method counts, and when
The IRS sets out both in Publication 538, Accounting Periods and Methods.
The cash method. “You include in your gross income all items of income you actually or constructively received during the tax year,” and you generally “deduct expenses in the tax year in which you actually pay them.” Constructive receipt closes the obvious loophole: income counts “when an amount is credited to your account or made available to you without restriction,” and “you do not need to have possession of it.” A payment credited to your account in December belongs to December’s year even if you do not enter it in the books until January.
The accrual method. “You generally report income in the year it is earned and deduct or capitalize expenses in the year incurred.” Income counts when the all events test is met: “when all events have occurred which fix your right to receive the income and you can determine the amount with reasonable accuracy.” An expense counts when a similar test is met and economic performance has occurred, which for materials or services bought from others happens “as the property or services are provided.” The publication’s own example: office supplies received with their bill in December and paid in January are deducted in December’s year.
The same December, both ways
Say a remodeler finishes a $14,000 bathroom on 18 December and sends the final invoice that day. The homeowner pays on 9 January. The tile and fixtures, $3,200 on the supply house account, were delivered in November, and the statement is paid on 15 January.
| Item | Cash method | Accrual method |
|---|---|---|
| $14,000 job income | Next year (paid 9 January) | This year (the work is done and the amount is set) |
| $3,200 materials | Next year (paid 15 January) | This year (delivered and billed) |
| Effect on this year’s profit | None | $10,800 more |
A deposit runs the other way. Under the cash method a deposit is income the day it lands. Under an accrual method it is an advance payment: Publication 538 says you generally report it in the year you receive it, though for a payment that meets the publication’s conditions an accrual taxpayer “can elect to postpone including the advance payment in income until the next year,” and “cannot postpone including any payment beyond that tax year.”
Neither result is wrong. Cash taxes you on money you have; accrual taxes you on work you have finished. Which suits you depends on whether your year usually ends with more money owed to you or more bills owed by you.
Who may choose: the gross receipts test
The limit is section 448 of the Internal Revenue Code. It bars three kinds of taxpayer from the cash method: a C corporation, a partnership that has a C corporation as a partner, and a tax shelter (a term the code defines). A sole proprietor is not on the list, and neither is an S corporation that is not a tax shelter.
Even a C corporation or such a partnership may use the cash method if it meets the gross receipts test: average annual gross receipts for the three prior tax years at or under a limit that began at $25 million and is adjusted for inflation. For tax years beginning in 2026, Revenue Procedure 2025-32 sets it at $32 million. Related businesses under common control are counted as one.
The same test makes you a “small business taxpayer,” and that matters for materials. The 2025 Schedule C instructions, which put the threshold at $31 million for that year, say that unless you are a small business taxpayer “you must use an accrual method for sales and purchases of inventory items.” A small business taxpayer “can choose not to keep an inventory” and may account for it by treating it as nonincidental materials and supplies; how that applies to the materials you buy for jobs is a question for your preparer. For the great majority of small trade businesses, the answer to “may I choose?” is yes.
The construction contract rule
Section 460 adds a rule for jobs that cross a year end. A long-term contract is one for building, installation or construction that is “not completed within the taxable year in which such contract is entered into,” and the default for those is the percentage of completion method: income reported as the work progresses.
Two exceptions in section 460(e) cover most small contractors:
“Construction contract” is broad: building, reconstruction or rehabilitation, or “the installation of any integral component to, or improvements of, real property.” So a kitchen that starts in November and finishes in February is usually outside the percentage of completion requirement. A long commercial job is where the rule can bite, and that is a conversation for your preparer before you sign, not after.
Which suits a small trade business
Cash is simpler. Income is what came in and expenses are what went out, so the books match the bank statement, and you are taxed on money you actually have. It also gives a little room at year end, because paying a bill in December instead of January moves the deduction. That room has limits, among them the 12-month rule for prepaid expenses and the rule that materials count as they are used; both are in The December Tax Checklist for Contractors.
Accrual shows the work. Income lands in the month the job was done, next to the materials it used, which is the picture job costing needs. The price is tracking what customers owe and what you owe, and paying tax on invoices that have not been paid yet.
You can also mix. Publication 538 allows “any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently,” with limits: if you report income on the cash method, you must report expenses on it too. Two “separate and distinct” businesses may use different methods, but only with “a complete and separate set of books and records” for each, which is one more reason to keep business money separate in the first place.
Whatever the return uses, look at two lists every week: what customers owe you and what you owe suppliers. A cash-basis profit and loss shows neither, and both belong in a 13-week cash forecast.
Choosing, and changing later
Publication 538: “You choose an accounting method when you file your first tax return,” and “you must use the same accounting method from year to year.” On Schedule C it is line F: cash, accrual or other.
To switch later, the Schedule C instructions say you “must generally file Form 3115,” and make a section 481(a) adjustment “to prevent amounts of income or expense from being duplicated or omitted.” A net positive adjustment is generally spread over four years; a net negative one is generally taken in the year of change. Some changes are automatic; the instructions point to Revenue Procedure 2025-23 for the list.
Five questions for your preparer
- Do we meet the gross receipts test, counting any related business?
- Should job materials be treated as nonincidental materials and supplies?
- Which of my jobs cross the year end, and does section 460 touch any of them?
- How are deposits handled under my method?
- If a change would help, is it an automatic one, and what is the section 481(a) adjustment?
General information, not legal or tax advice. Rules change and vary by state; check with the agency named above or a professional for your situation.