Businesses must choose a tax year and an accounting method to report income and expenses. Both must clearly reflect income and be applied consistently.
Tax Years
A tax year is the 12‑month period used to keep records and file returns. A business may use:
- Calendar year — January 1 to December 31
- Fiscal year — any 12‑month period ending on the last day of a month other than December
- 52–53‑week year — always ends on the same weekday each year
A taxpayer adopts a tax year by filing the first return. Some entities must use a required tax year under the Internal Revenue Code.
Partnerships, S corporations, and PSCs may adopt a fiscal year only with IRS approval using Form 1128, Form 2553, or Form 8716 (Section 444 election).
A calendar year must be used if no books exist, no annual period exists, the fiscal year does not qualify, or the Code requires it.
52–53‑Week Year
A business may elect a 52–53‑week year if books are kept on that basis. The year must always end on:
- The last occurrence of a chosen weekday in a month, or
- The weekday closest to the month’s end
Election requires attaching a statement to the return. For depreciation and amortization, it counts as a full 12‑month year.
Accounting Methods
An accounting method determines when income and expenses are reported. A business chooses a method on its first return and must use it consistently. Changing a method requires IRS approval using Form 3115.
Permissible methods:
- Cash method
- Accrual method
- Special methods
- Hybrid method
A method must clearly reflect income.
Small Business Taxpayer Exception
A taxpayer meets the §448(c) gross receipts test if average annual gross receipts for the prior 3 years do not exceed $31 million (2025). Aggregation rules apply.
If the test is met, the taxpayer may:
- Use the cash method
- Avoid inventory capitalization
- Avoid percentage‑of‑completion for certain contracts
If the test is not met, the taxpayer generally must use accrual, capitalize inventory, and use percentage‑of‑completion for long‑term contracts.
Cash Method
Income is reported when actually or constructively received. Expenses are deducted when paid.
Constructive receipt occurs when funds are available without restriction. Prepaid expenses may be deducted only when the benefit applies, unless the 12‑month rule applies.
Entities barred from using the cash method include:
- C corporations failing the gross receipts test
- Partnerships with a C corporation partner failing the test
- Tax shelters
Accrual Method
Income is reported when:
- The right to receive it is fixed
- The amount is determinable
- Performance occurs
Expenses are deductible when:
- Liability is fixed
- Amount is determinable
- Economic performance occurs
Advance payments may be deferred one year but not beyond.
Percentage‑of‑Completion Method
Required for most long‑term contracts under IRC §460.
Exceptions:
TCJA exceptions:
- Small business taxpayer contracts completed within 2 years
- Home construction contracts (80%+ residential costs)
OBBBA exceptions (after July 4, 2025):
- Small business taxpayer contracts completed within 3 years
- Residential construction contracts (80%+ residential costs)
Hybrid Method
A taxpayer may combine methods if the overall system clearly reflects income.
Multiple Businesses
A taxpayer may use different methods for separate and distinct businesses if each has its own complete set of books.