Making the Decision between Cash or Accrual Accounting for Contractors
Choosing the appropriate accounting method, cash vs. accrual, is one of the first decisions business owners should make. Contractors may use one or both methods for internal accounting and handling contracts.
Cash vs Accrual Method
- Cash method – accounts for revenue only when money is received and for expenses only when the money is paid out. This method does not recognize accounts receivable or accounts payable.
- Accrual method – accounts for revenue when it is earned and expenses when they are incurred. Revenue is recorded even if the cash has not yet been received.
Contractors may use one or both tax accounting methods:
- One overall method for reporting general company income and expenses
- One or both methods for long-term contracts
The choice of accounting method depends on the type of contract you have, the contracts’ completion status at the end of the tax year, and average annual gross receipts.
Cash Method Benefits for Small Contractors
Small contractors may be able to use the cash method to improve cash flow. This method defers taxes on long-term contract revenue until the cash is actually received.
What does the IRS consider small contractors?
- C-corporations with a 3-year average of annual gross receipts less than $5 million
- Partnerships with a 3-year average of annual gross receipts less than $5 million in which one of the partners is a C-corporation
- Partnerships without C-corporation partners and S-Corporations with a 3-year average of annual gross receipts less than $10 million
Which accounting method is allowable and most appropriate for tax purposes is not a question that can be easily answered in all cases. If you would like to learn more about your options when choosing the cash or accrual accounting method, please contact an Anders advisor.