Cash Versus Accrual Accounting: Tax Policy Considerations (CRS Report for Congress)
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| Release Date |
April 24, 2015 |
| Report Number |
R44002 |
| Report Type |
Report |
| Authors |
Raj Gnanarajah, Analyst in Financial Economics; Mark P. Keightley, Specialist in Economics |
| Source Agency |
Congressional Research Service |
Summary:
Two methods of accounting are generally available to businesses: cash basis and accrual basis accounting. Under cash basis accounting, revenue and expenses are recognized and recorded when cash is actually paid or received. Under accrual basis accounting, revenue is recorded when it is earned and expenses are reported when they are incurred, regardless of when payment is actually made or received. On the one hand, the cash basis method is simpler and arguably less administratively burdensome on businesses. On the other hand, cash accounting may result in a less accurate measure of economic income and allow for a deferral of tax liability. The Joint Committee on Taxation (JCT) considers cash accounting a departure from "normal income tax law" and thus classifies it as a tax expenditure.
Current tax law requires that most companies with average gross receipts in excess of $5 million use the accrual basis of accounting. Some companies are allowed to use either the cash or accrual basis methods of accounting for tax purposes. Examples of companies that may be excepted from using accrual basis tax accounting regardless of total average gross receipts include sole proprietors and certain qualified Personal Service Corporations (PSCs) in such fields as health, law, engineering, accounting, performing arts, and consulting firms, as well as farms that are not corporations or do not have a corporate partner.
Some Members of Congress and the Administration have put forth proposals that would expand the number of firms allowed to use cash accounting by increasing the average gross receipts limit test. The Tax Reform Act of 2014 (H.R. 1) introduced in the 113th Congress would have expanded cash accounting by increasing the average gross receipts limit test to $10 million, but it would have also restricted the use of cash accounting for certain other firms. Although allowed to use cash accounting under current law, certain partnerships, subchapter S corporations, and PSCs with average gross receipts in excess of $10 million would not have been allowed to use cash accounting under the provisions of H.R. 1. Also introduced in the 113th Congress, the Small Business Accounting and Tax Simplification Act (H.R. 947), Start-up Jobs and Innovation Act (S. 1658), and Small Business Tax Certainty and Growth Act (S. 1085) would have all allowed certain firms with average gross receipts of $10 million or less to use cash accounting. Similarly, S. 341 introduced in the 114th Congress would raise the average gross receipts test limit to $10 million. The President's FY2016 budget proposal also calls for expansion of cash accounting by changing the threshold from $5 million to $25 million.
This report provides a brief explanation of cash and accrual accounting. It then examines the legislative history surrounding the Tax Reform Act of 1986 (P.L. 99-514), which set most of the current policies related to cash accounting for tax purposes. It also discusses recent policy proposals to change accounting requirements for tax purposes. The report concludes by discussing a number of policy considerations Congress may find useful.
