Usually, a small business owner will choose to use the cash method of accounting for simplified recordkeeping reasons. However, sometimes business owners may prefer the accrual method of reporting. As shown in a new case, Garibyan, TC Memo 2025-106, 10/9/25, this doesn’t give you free rein to “cook the books.”
First, let’s quickly review the basics. There are two basic methods, as well as several hybrids, of accounting for income and expenses.
1. Cash method: This is the simplest method of accounting. Briefly stated, income is reported in the tax year it is received and expenses are deducted in the year they are paid. Besides the convenience of using this method, you can defer tax on income while realizing current tax benefits from expenses. This also provides a clear picture of cash flow.
Thus, many small businesses opt for the cash method of accounting. Note, however, under the recent Tax Cuts and Jobs Act (TCJA), the cash accounting method isn’t available to a C corporation with average annual receipts over the last three years above $25 million (indexed to $30 million in 2026). The TCJA change is permanent
2. Accrual method: Conversely, accrual accounting recognizes income when earned and expenses are incurred. Using this method is more time-consuming, but it provides a comprehensive financial overview, including earned income and incurred expenses. Some businesses use the accrual method for books but rely on the cash method for tax purposes.
New case: The taxpayer and his younger brother started and operated a hospice care business in California. The business, which was as formed as C Corporation, depends almost entirely on third parties for its income, usually private and public insurers.
The brother adopted the accrual method of accounting for keeping the company’s books. Major problem: The corporate ledger rarely showed income and expenses as they accrued during the year. The IRS audited the returns of both the C corporation and the individual returns of the brothers for the 2015 and 2016 tax years.
Based on its review, the IRS concluded that the C Corporation had underreported its gross income by more than $200,000 and that the taxpayer also underreported his income for both years. As a result, it disallowed more than $450,000 in deductions. Eventually, the parties ended up in Tax Court.
Unfortunately for the taxpayer, the Tax Court found that the evidence weighed heavily in favor of the IRS. Among other issues, it pointed to suspicious journal entries, uncategorized deductions and inaccuracies in the way that accounts receivable and payable were entered. Although some deposits were deemed to be nontaxable, by and large the Tax Court upheld the disallowances made by the IRS.
Moral of the story: The brothers in this case were inexperienced in tax and accounting matters. They relied on professional accounting firms to keep the books and provide guidance. Attend to your clients’ needs by carefully and thoroughly analyzing their situation, helping them make informed choices and strictly adhering to all the recordkeeping rules.
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