Cash Method of Accounting for Construction Contractors

As a contractor, you want to ensure you follow all the tax rules and regulations, especially choosing the proper accounting method to report your income and expenses. One of the most common methods contractors use is the cash method of accounting.

What is the Cash Method of Accounting?

The cash method of accounting is a simple way to report your income and expenses. You basically report income when you receive payment and expenses when you pay them.

Is the Cash Method Right for You?

While the cash method is a good option for most contractors, some restrictions exist on who can use it.

If you're a C corporation or a partnership with a C corporation partner and your average annual gross receipts for the past three years are more than $25 million, you can't use the cash method. This restriction also applies to tax shelters.

S corporations can use the cash method unless their average annual gross receipts for the past three years exceed $25 million. In that case, they must use the accrual method of accounting for their non-exempt long-term contracts.

If you're required to account for inventory, you must use the accrual method. 

How Does the Cash Method Work?

With the cash method, you report income when you receive payment and expenses when you pay them. If you receive payment for a job you completed in December of Year 1 but wait to pick up the check until January of Year 2, you still report the income in Year 1 because you had unrestricted access to it.

The cash method follows the Treasury Regulation § 1.446-1(c)(1)(i), which requires you to report income when you receive it and deduct expenses when you pay them.

In general, Treasury Regulation § 1.461-1(a)(1) states that you can deduct expenses in the year of payment. However, if you make an expenditure that creates an asset with a useful life extending beyond the taxable year, you may not be able to deduct the entire amount in the same year you made it.

The "one-year rule" in the case of Zaninovich v. Commissioner, 616 F.2d 429 (9th Cir. 1980) helps you distinguish between currently deductible expenses and capital expenditures with a longer useful life. In this case, the court allowed a full deduction for prepaid rent in the year of payment.

In conclusion, the cash method of accounting is a simple and straightforward way for most contractors to report their income and expenses. However, there are restrictions on who can use it, so make sure to check with a tax professional to see if it's the right option for your business.