If you are newly self-employed you may have heard the terms cash basis method of accounting versus accrual basis and may be wondering what cash basis eligibility is and how you should be accounting for your business income and expenses.
In general, most individuals and many sole proprietors with no inventory can use the cash method so if you are driving for Uber or Lyft or are making money as a freelancer you most likely able will be able to use the cash method of accounting. Under the cash basis method you include income you actually or constructively receive during the year and deduct expenses for your business in the year you actually pay them.
Am I Eligible for Cash Basis Accounting?
If you produce, purchase, or sell merchandise in your business you would be keeping an inventory requiring you to use the accrual method to account for your business income and expenses, however, there is an exception to this rule. If your average annual income for the past 3 years is $1 million or less and your business is not a tax shelter you are eligible for the cash basis method. There are more exceptions to this rule too. If you are a qualifying small business who:
- Has average annual gross receipts for the last three years more than $1 million but not more than $10 Million
- You are not prohibited from using the cash method
- Your principal business activity is an eligible business
What if I didn’t Own My Business for 3 Years?
If you are just getting started in your business you can base your average income on the period of time you have been in existence.
The majority of individuals, partnerships, and S corporations are eligible to use the cash basis method of accounting. The cash basis method is a simple, straightforward method to use and may save you money on your taxes since you only account for your income on your taxes when it is received.
Don’t worry about knowing all of the rules for cash basis versus accrual method. At tax-time, TurboTax will ask you simple questions about your business income and expenses and give you your business tax deductions you deserve based on your entries. You can also use QuickBooks Self-Employed, which will help you separate your business and personal expenses and automatically export the information to your tax return in TurboTax.