Cash basis accounting is discouraged, although not prohibited by the IRS. There are a lot of things that taxpayers can do to try to manipulate the system. Cash basis taxpayers can make large payments to their suppliers to lower their overall tax burden. Companies can also delay billings at the end of the year to defer income received to future periods. Although The IRS prohibits this type of behavior under the rule that cash payments recognized in the current period can only relate to current-year expenses. Nonetheless, it is a difficult issue for the IRS to police.

If a business has inventory at the end of the year, they have to report under the accrual method. This is because inventory purchases can be so large that businesses could use them to manipulate their taxable income so that no tax is due. The cash basis is also not allowable for any “C” corporation, partnership that has a “C” corporation for a partner, or a tax shelter. However, within these restrictions, the cash basis is allowable for an entity with average annual gross receipts of $5 million or less for the three tax years ending with the prior tax year, as well as for any personal service corporation that provides at least 95% of its activities in the services arena.