Accounting Methods

The rules of the road

• §446(a): use the method used for the books. §446(b): if that method does not clearly reflect income, the IRS may prescribe one that does.
• The corporation picks its method on the first return without asking. After that it changes only with consent — see Form 3115 below.
• Three methods: cash (income when received, deductions when paid); accrual (income when earned, deductions when incurred); hybrid (accrual for sales and cost of goods sold, cash for everything else).

Cash method

• Income in the year actually or constructively received, in money, property or services. Expenses when paid (Reg. §1.446-1(c)(1)(i)).
• Capital expenditures and prepaid expenses that extend substantially beyond year-end are capitalized and recovered over their life, cash method or not.
• The 12-month rule (Reg. §1.263(a)-4(f)): a prepayment is fully deductible when paid if the benefit does not extend beyond the earlier of (a) 12 months after the benefit begins, or (b) the end of the tax year after the year of payment. A prepaid annual premium is deducted when paid; a prepaid two-year premium is prorated.
• Prepaid interest never qualifies (§461(g)). It is allocated to the period it covers, even by a cash-basis taxpayer, even if the period is under 12 months.

Who may use the cash method (§448)

• A C corporation may use the cash method only if it is a qualified farming corporation, a qualified personal service corporation (law, medicine, engineering, accounting, actuarial science, consulting, performing arts — substantially all owned by the professionals), or it passes the gross receipts test.
• Gross receipts test: average annual gross receipts, from all sources including tax-exempt interest, for the three prior tax years, at or below the threshold. A corporation not around for three years uses the years it has.
• updated 2026 The course’s $25 million is indexed: $26M for 2019–2021, $27M for 2022, $29M for 2023, $30M for 2024, $31M for 2025. check 2026 figure per Rev. Proc. 2025-32. added 2026 For tax years beginning after December 31, 2025, the threshold is $80 million for a manufacturing taxpayer (the 2025 law). The same figure drives the inventory exception, the §263A UNICAP exemption and the §163(j) exemption.
• Only the current year’s test matters; the pre-2018 requirement to have passed it every year since 1985 is gone.

Inventory

• If inventories are material to income, the accrual method is required for sales and cost of goods sold (Reg. §1.446-1(c)(2)(i)) — unless the corporation passes the gross receipts test.
• Below the threshold, §471(c) lets the corporation either treat inventory as non-incidental materials and supplies (deducted when used or consumed) or follow whatever its books do. added 2026 Final regulations: Reg. §1.471-1(b) (T.D. 9942, January 2021). A corporation moving to this treatment files Form 3115 under the automatic procedures.

Accrual method

Income

• Income is included when all events have occurred that fix the right to receive it and the amount can be determined with reasonable accuracy (Reg. §1.446-1(c)(1)(ii)). Collection is irrelevant; a receivable that goes bad is a bad-debt deduction later.
• added 2026 §451(b), added by the 2017 act and not covered in the course: for a corporation with an applicable financial statement (audited, SEC or government-filed), the all-events test is met no later than when the revenue is taken into account on that statement. Book revenue sets the outside date. Reg. §1.451-3.

Advance payments

• An advance payment is one that is income under the taxpayer’s method in the year received but is recognized as revenue in a later year on its financial statement, and that is for services, goods, intellectual property, software, warranties ancillary to those, subscriptions, memberships, or the use of property ancillary to services (hotel rooms, booth space, banquet facilities).
• Not an advance payment: rent (with narrow exceptions), insurance premiums, payments on financial instruments including prepaid interest, third-party warranties, §83 property.
• Two permitted methods under §451(c): full inclusion in the year received, or the deferral method — include what the financial statements recognize this year and the entire remainder next year. The deferral is one year, no further. The election is a method of accounting and sticks until the IRS consents to a change.
• updated 2026 Rev. Proc. 2004-34, cited throughout the course, was superseded for tax years beginning after 2020 by Reg. §1.451-8, which carries the same one-year deferral into the regulations. Reg. §1.451-5 (advance payments for goods) was withdrawn in 2019; goods now run through §1.451-8 too.
• A refundable security deposit under a lease is not income; the lessor has to give it back.

Deductions

• Deductible when the all-events test is met — the fact of the liability is established and the amount is reasonably estimable — and economic performance has occurred (§461(h)).
• Economic performance: for property or services provided to the corporation, when they are delivered or accepted. For property or services the corporation must provide, when it provides them. For workers’ compensation and tort liabilities, as paid.
• Reserves and estimates on the books — warranty reserves, allowance for doubtful accounts, estimated coupon redemptions — are not deductible until performance. Capital One (2011) lost its deduction for estimated airline-mile redemption costs for exactly this reason.
• Recurring item exception (§461(h)(3)): a non-tax-shelter corporation may deduct a liability before performance if the all-events test is met, performance occurs within 8½ months after year-end, the item recurs and is treated consistently, and the amount is immaterial or the accrual better matches income.
• Property taxes may be accrued ratably over the assessment period (§461(c)).

Capitalization and the de minimis safe harbor

• §263(a): capital expenditures — land, buildings, machinery, equipment, furniture, leasehold improvements, and anything that permanently improves property — are capitalized and recovered through depreciation or amortization. Inventory costs are capitalized under §263A.
• Two exits: the §179 election, and the de minimis safe harbor (Reg. §1.263(a)-1(f)). With a written policy in place at the start of the year, expense items costing up to $2,500 per item or invoice ($5,000 if the corporation has an applicable financial statement and the statement expenses them too). Not for land or inventory. Annual election by statement attached to the return.
• Prepaid expenses under either method follow the 12-month rule above. updated 2026 The course cites Publication 535 for this; that publication was discontinued after 2022. The rule now lives in Publication 334 and the regulations.

Hybrid method

• Accrual for sales and cost of goods sold (because inventory is material), cash for other income and expenses (Reg. §1.446-1(c)(1)(iv)). The reverse combination is not allowed: a taxpayer on the cash method for gross income must use cash for expenses, and one on accrual for expenses must use accrual for gross income.
• With the §471(c) inventory exception now available below the receipts threshold, a small corporation can usually be fully cash-basis instead; the hybrid method matters mainly for corporations above the threshold.

Changing a method — Form 3115

• §446(e): no change in the overall method or in the treatment of a material item without consent. No retroactive changes, even from an impermissible method.
• Automatic consent is available if the change is on the current List of Automatic Changes and the corporation meets that change’s conditions, has not made or requested an overall-method change in the five years ending with the year of change, has not changed the same item in those five years, and is not liquidating or reorganizing in the year of change. Rev. Proc. 2015-13 is the general procedure; updated 2026 the list is now Rev. Proc. 2025-23 check (the course cited Rev. Proc. 2018-31).
• Automatic: attach Form 3115 to the timely filed return for the year of change and send a copy to the IRS Ogden office. No fee. Non-automatic: file during the year of change with the National Office and pay the user fee in the current Rev. Proc. 2026-1 check.
• updated 2026 Form 3115 was revised in December 2022; the December 2018 version the course mentions is obsolete. The §481(a) adjustment mechanics are on the Depreciation Decisions page.

Study questions 3–7

• SQ 3. Oliver’s Restaurant, cash basis, calendar year, pays a $6,000 12-month premium December 1. Deduction: $6,000. The coverage ends November 30 next year, within the 12-month rule.
• SQ 4. Jaco Corp, cash basis, June 30 year-end, prepays an 18-month premium of $3,600 on May 1. Deduction: $400 — 2/18. Eighteen months fails the rule, so prorate.
• SQ 5. Jane’s Card Shop gives the bank a 12-month note on October 1 that includes $2,000 of prepaid interest. Deduction: $500 — 3/12. Prepaid interest is always prorated.
• SQ 6. Modern Electronics, accrual, sells 12-, 18- and 24-month service contracts on March 1 for $1,200, $3,600 and $4,800. Deferrable at December 31: $4,600 — 2/12 × 1,200 + 8/18 × 3,600 + 14/24 × 4,800. Ten months of each were earned this year; all of the balance is income next year.
• SQ 7. WRVC radio, accrual, signs a one-year contract November 1, does $4,000 of work in Year 1 and $8,000 in Year 2, and pays its $12,000 of costs in February of Year 2. Deduct $4,000 in Year 1 and $8,000 in Year 2 — economic performance.

Private reference, not client advice. Notes taken from a 2019 continuing-education course (Thomson Reuters Checkpoint Learning, C Corporations — Overview of Corporate Income Tax); figures and rules brought current to 2026 in October 2026 (P.L. 119-21, Rev. Proc. 2024-40, Rev. Proc. 2025-32). Verify current-year amounts before relying on them.