The two methods of accounting that businesses can use for this purpose are respectively known as cash and accrual basis of accounting. Under cash basis accounting, revenue and expenses generally 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 payments are actually made or received. Although the cash basis method is simpler and perhaps less administratively burdensome, it 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." Legislation has been proposed that would change the tax accounting requirements for businesses. Similar discussions on cash and accrual accounting were held prior to the enactment of the Tax Reform Act of 1986 (TRA86; P.L. 99-514 ). This report provides a brief explanation of cash and accrual accounting, and it reviews relevant legislative history surrounding TRA86. On the one hand, the cash method of accounting is simpler. As a general rule, the following businesses were prohibited from using the cash method: (1) Subchapter C corporations with average gross receipts over $5 million; (2) partnerships that had a subchapter C corporation with average gross receipts over $5 million as a partner; (3) tax shelters; and (4) businesses that had average gross receipts in excess of $1 million that carried inventory. Recent Legislative Proposals

The proposals to change the method of accounting for tax purposes predate the 1986 tax reform and continue to be a policy consideration for Congress and the executive branch. Since TRA86, there have been other proposals to modify the tax code as it relates to cash accounting. Several bills introduced in the 113 th Congress, including the Small Business Accounting and Tax Simplification Act ( H.R. 947 ), the Start-up Jobs and Innovation Act ( S. 1658 ), and the Small Business Tax Certainty and Growth Act ( S. 1085 ), would have expanded the use of cash basis accounting by raising the average gross receipts limit to $10 million from $5 million. 1 would have restricted cash accounting for some businesses. It would have required certain partnerships, S corporations, and PSCs that currently use the cash method to use the accrual method if their average gross receipts exceed $10 million. The President's budget proposal differs from the congressional proposals by increasing the average gross receipts limit to $25 million instead of $10 million. One general option is to expand the number of businesses allowed to use cash accounting by either including all businesses regardless of legal structure or increasing the average gross receipts threshold. According to Table 1 increasing the threshold to $10 million would allow 96% of C corporations to use cash accounting. 2 in the 110 th Congress and H.R. Limit Cash Accounting or Require Accrual Accounting

Alternatively, Congress could eliminate cash accounting for all businesses or restrict the use of cash accounting for certain types of businesses based on legal structure. One provision of the Tax Reform Act of 2014 ( H.R.
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.