Rules for Cash-Basis Taxpayers

The Internal Revenue Service (IRS) allows any individual or organization to choose between the cash and accrual accounting methods for reporting income tax. Although you can choose the accrual method, most individual taxpayers use the cash method. Before changing your accounting method, it’s important to understand cash-basis rules and the tax implications of switching to an accrual basis.

When you calculate your income taxes on a cash basis, the IRS requires you to report all payments of cash or its equivalent as gross income in the tax year you receive it, provided it’s not tax-exempt. A cash equivalent is property that you receive that has no other value except for the cash payment it entitles you to, such as checks and money orders. The cash method of accounting ignores the tax year in which you earn income. For example, if you receive a bonus in 2012 for your work in 2011, you report the bonus as 2012 income.

You also record deductions in the year in which they occur, rather than the year to which they apply. For example, you can claim a deduction for all property taxes paid in 2011, even if some or all of the taxes pertain to the previous year.

Using the accrual basis of accounting, the dates when you receive payments and pay expenses are irrelevant. Instead, the rules focus on the tax year to which they apply. To illustrate, when using the accrual method, you report the employment bonus as gross income on your 2011 tax return regardless of when you actually receive it, since this is the year in which you earned it. If you pay property taxes in 2011 that are for a previous year, this deduction applies to the earlier year because that is when you accrued the liability.

The cash method is simplest, as you merely record transactions in the year in which they occur. The accrual method is generally only useful to taxpayers who operate a business.