Cash vs Accrual Accounting: One Freelancer's Month, Both Ways

Cash vs accrual accounting is a question about timing. Cash basis records income when the money reaches you, and expenses when you pay them. Accrual basis records both when the work happens. Run one freelancer's March through each method and the profit figures land $1,100 apart. Most sole proprietors may pick either; the IRS gross receipts test decides for C corporations and partnerships with a C corporation partner.

The choice shapes what your income tracker shows in a slow month and what your accountant puts on Schedule C. Below is one month of business, recorded twice.

What Is the Difference Between Cash and Accrual Accounting?

The IRS states both methods in a single paragraph of Publication 538. Under the cash method, "you generally report income in the tax year you receive it, and deduct expenses in the tax year in which you pay the expenses." Under the accrual method, "you generally report income in the tax year you earn it, regardless of when payment is received. You deduct expenses in the tax year you incur them, regardless of when payment is made."

Two follow-on rules do the real work.

For cash basis, "receive" is broader than "deposited." Publication 538 defines constructive receipt: income is received "when an amount is credited to your account or made available to you without restriction." A client's check that reaches you on December 30 and sits undeposited is December income.

For accrual basis, "earn" and "incur" have tests attached. Income belongs to the period in which the all-events test is met, meaning "all events have occurred which fix your right to receive the income and you can determine the amount with reasonable accuracy." An expense needs that test plus economic performance, which for services provided to you "occurs as the property or services are provided." Delivery is the trigger on both sides.

One Freelancer's March, Recorded Two Ways

Maya runs a solo web design practice as a sole proprietor on a calendar year. Everything that happened in her business in March 2026, in order:

The same month, two profit figures

Cash basis asks one question of each line: did money move in March? Accrual asks a different one: was the work done in March, whoever was holding the cash?

Why the two figures differ

Eight events, two answers, a gap of $1,100. Cash basis reports about 29% more March profit.

Nothing is missing from either column. The desk rent and the screen repair land in March under both methods, because they were used and paid in the same month. The other six lines move, yet every dollar still gets counted exactly once under each method. The two disagree only about which month owns it.

That is why the gap matters. Maya's cash number says March was her best month of the quarter, while her accrual number says she delivered less work than she collected for. If she is pricing her next project, those readings point in opposite directions. Our guide to profit versus cash flow works through what happens when a business reads one as the other.

Side by side

Who Is Allowed to Use the Cash Method?

Publication 538 names three taxpayers that generally cannot use the cash method: a corporation other than an S corporation, a partnership with such a corporation as a partner, and a tax shelter as defined in section 448(d)(3). Sole proprietorships and S corporations are not on that list.

The excluded corporations and partnerships get back in through the gross receipts test. Publication 538 puts it plainly: "A corporation or partnership, other than a tax shelter, that meets the gross receipts test can generally use the cash method." You compute the figure by adding gross receipts for the three prior tax years and dividing by three.

The threshold is indexed for inflation, which is why an article written two years ago prints the wrong number. For tax years beginning in 2026, Rev. Proc. 2025-32, section 4.30, qualifies an entity whose average annual gross receipts for the preceding three-year period "does not exceed $32,000,000." The 2025 figure printed in the Schedule C instructions is $31 million.

That number reaches sole proprietors from a different direction: merchandise. The Schedule C instructions say that unless you are a small business taxpayer, "you must use an accrual method for sales and purchases of inventory items," and they define a small business taxpayer as one with average annual gross receipts of $31 million or less for the three prior tax years, indexed for inflation, that is not a tax shelter. A designer with no inventory is unaffected. A shop with stock on the shelves has to check.

You record the answer on line F of Schedule C, whose instructions read: "Generally, you can use the cash method, an accrual method, or any other method permitted by the Internal Revenue Code. In all cases, the method used must clearly reflect income." Our Schedule C walkthrough covers the rest of the form.

How to Choose Your Method

Four questions settle it for most small businesses.

Do you hold inventory? If you produce, purchase, or sell merchandise and your three-year average gross receipts clear the small business taxpayer threshold, accrual for those purchases and sales is not optional.

Is your business a C corporation, or a partnership with a C corporation partner? Run the gross receipts test first.

How long is the gap between doing the work and getting paid? Maya's clients pay on net 15 and net 30, which is what produced her $1,100 gap. A business paid at the counter has almost no gap, so cash basis tracks reality closely. A business invoicing on net 60 across a December year end can report a strong year on cash while its accrual books show the opposite.

What do you need the numbers for? Cash basis answers "can I pay myself this month?" Accrual answers "did the work I did this month earn money?" Both come from the same eight transactions.

Whichever you pick, the underlying records are the same documents, dated. Accrual asks more of them, because it needs invoice and bill dates on top of payment dates. Pulling those out of an expense tracker takes minutes; pulling them out of a shoebox takes a weekend. Our piece on pre-accounting covers the capture workflow both methods rest on.

How to Switch Methods Later

Your first return is a free choice. Publication 538: "Generally, you can choose any permitted accounting method when you file your first tax return. You do not need to obtain IRS approval to choose the initial accounting method. You must, however, use the method consistently from year to year and it must clearly reflect your income."

After that, changing costs paperwork. A switch from cash to accrual or back is on Publication 538's list of changes requiring IRS approval, and Form 3115, Application for Change in Accounting Method, is how you request it. You file it to change "an overall method of accounting or the accounting treatment of any item."

Switching also creates a one-time reconciliation, without which income could be counted twice or dropped. The Schedule C instructions call it a section 481(a) adjustment and give the case directly: if you change to the cash method and had accrued sales in the prior year that you were paid for in the current one, "you must report those sales in both years as a result of changing your accounting method" and make the adjustment to prevent the duplication.

Common Misconceptions About Cash and Accrual Accounting

"The $32 million threshold decides whether I can use cash basis." It decides for the entities section 448 excludes: C corporations, partnerships with a C corporation partner, and tax shelters. A sole proprietor is outside that list. The threshold reaches one only through the inventory rule in Schedule C Part III, and only if merchandise is part of the business.

"I can hold a client's check until January to move the income into next year." Constructive receipt closes that door. Publication 538 is explicit: "You cannot hold checks or postpone taking possession of similar property from one tax year to another to postpone paying tax on the income." The income belongs to the year it was made available to you.

"On cash basis I can prepay in December and deduct the whole thing." Not for anything stretching well past the year end. Publication 538 says an expense you pay in advance "is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule," which covers benefits ending within 12 months or by the end of the following tax year. Its own example: $3,000 paid in 2021 for a three-year policy does not deduct in full in 2021.

Key Takeaways

• Cash basis records money in and out; accrual basis records work delivered and obligations incurred. Maya's March produced $4,830 on cash and $3,730 on accrual from an identical set of eight transactions.
• The gap comes from payment terms. Point-of-sale businesses see the two methods converge, and net 30 or net 60 invoicing pushes them apart, most sharply around a year end.
• Section 448 restricts C corporations, partnerships with a C corporation partner, and tax shelters. For tax years beginning in 2026, Rev. Proc. 2025-32 sets the gross receipts threshold that lets them back onto the cash method at $32,000,000.
• Merchandise is how that threshold reaches sole proprietors: without small business taxpayer status, sales and purchases of inventory items go on accrual whatever the entity type.
• Your first return sets the method with no IRS approval needed, while changing it later means Form 3115 and a section 481(a) adjustment.