Considering cash: advantages and availability of the cash method of accounting.

• Author: Johnston, Lori Anne

The question of a taxpayer's ability to use the cash receipts and disbursements method of accounting (the cash method) is often met with confusion or misunderstanding. One common misconception is that the cash method is only appropriate for individuals and small businesses. While it is true that statutory restrictions significantly limit the use of the cash method, the number of taxpayers who are eligible to use it is larger than commonly perceived.

There are also misperceptions concerning the cash method's desirability given the accrual method's better matching of income and expenses, more accurate picture of a firm's financial state, and last but certainly not least, its use under GAAP. These considerations, however, are not necessarily controlling for all taxpayers. When they are not required to use the accrual method, taxpayers should consider the benefits provided under the cash method. These benefits include:

1. The cash method is simple to implement and to maintain and does not require the level of internal accounting structure and expertise necessary for taxpayers under the accrual method. This simplicity can translate to significant administrative savings.

2. The cash method allows a better matching of cash available for income tax payments with the recognition of corresponding revenue. This ensures that funds are available for tax payments and is particularly beneficial to taxpayers with restricted or uneven cash flows.

3. The cash method of accounting often defers recognition of income to a later period, allowing taxpayers to receive the time value of money for deferred tax payments. When the deferral continues year after year, the cash method's benefit can approach permanence assuming that (a) the taxpayer receives payments after services are rendered; (b) there is no increase in tax rates; and (c) the taxpayer remains in business. To the extent tax rates decrease, a portion of the time value of money converts into a permanent benefit.

Taxpayers that are required to use or prefer the accrual method for book purposes can realize the second and third benefits above by adopting the cash method for federal income tax purposes only. This means that, unlike what commonly is believed, the availability of the cash method is not limited by the presence of GAAP reporting requirements.

Taxpayers prohibited from using the cash method

Sec. 448(a) provides a list of taxpayers that may not use the cash method of accounting. First, Sec. 448(a)(3)...