Cash vs. Accrual After Crossing the Gross Receipts Threshold
Ridgeway Fabrication is a C corporation with average annual gross receipts of $31 million for the three-year testing period ending 2024. It has used the cash method since inception and has no inventory of merchandise (it fabricates to order and holds minimal raw materials). In 2025, gross receipts are projected to exceed $31 million. The controller wants to know whether Ridgeway must switch to the accrual method, whether the change is automatic, and how to handle the year of change. Ridgeway is not a tax shelter and is not required to use inventories under the small-business inventory rules.
1. Must Ridgeway change to the accrual method for 2025, and what is the threshold being tested?
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The cash-method eligibility for a C corporation depends on the gross receipts test under §448(c): average annual gross receipts for the three prior tax years must not exceed the inflation-adjusted threshold ($31 million for 2024, indexed). The test looks backward, not at the current year's projection. For 2025, the relevant testing period is 2022–2024. Since average receipts for that period are $31 million (at the threshold, not above it), Ridgeway remains eligible for the cash method in 2025 even if 2025 receipts exceed the threshold. The projection for 2025 only matters for the 2026 tax year (testing period 2023–2025). Judgment point: do not switch based on the current-year forecast; apply the three-year lookback and confirm whether the average exceeds (not equals) the threshold.
2. If Ridgeway must change in 2026, is IRS consent required, and how is the §481(a) adjustment handled?
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A change from cash to accrual is a change in method of accounting requiring IRS consent, generally via Form 3115. However, under the automatic change procedures (Rev. Proc. 2022-14, as updated), a qualifying small business changing from cash to accrual under §448 may use the automatic consent procedures-no user fee, filed with the timely filed return for the year of change. The §481(a) adjustment (the cumulative difference between cash and accrual income/expense) is taken into account in the year of change. For a positive adjustment (additional income), the taxpayer generally spreads it over four years (the year of change and the next three) under §481(c) for this type of change, unless the adjustment is negative, in which case it is taken entirely in the year of change. The taxpayer must also confirm no §481(a) adjustment is duplicated and attach the required statement.