Cash or Accrual Accounting for Small Contractors: Which One for Taxes?

Should my small contracting business use cash or accrual accounting for taxes?

Many small contractors can choose either method for taxes, subject to IRS rules, and cash is simpler while accrual shows true job profitability (BRIX). Which one you actually file under is a call for your accountant, because it depends on your size and the kind of contracts you run.

The simplest way to think about it: cash basis follows the bank account, and accrual basis follows the work (BRIX). Cash records income when payment arrives and expenses when you pay them. Accrual records income when you earn it, usually when you invoice, and expenses when you incur them, no matter when the cash moves.

That is why your bookkeeper and your tax preparer can both be right. Your bookkeeper wants accrual so you can see which jobs make money. Your tax preparer may file on cash because it is simpler and follows the money you actually received. Those two can live side by side, as the fourth section below explains.

If I take a 35% deposit before starting, is that taxable income this year?

On cash accounting, a deposit generally counts as income when you receive it, so a December deposit would normally land in this year's return. Accrual can treat it differently, and the rules on advance payments have details, so confirm with your accountant before December 31.

Contractors typically ask for around one-third of the total at signing (r/Contractor), so one deposit can be a big piece of your year's cash. Say you sign a $40,000 kitchen remodel in December and collect a 35% deposit of $14,000 on December 20. If you file on cash, that $14,000 is probably December income even though no work has started, and if the materials won't be bought until January, nothing offsets it this year.

That is the situation behind the scary tax bill. The money in your account is real, but part of it is already spoken for by materials and crew pay you haven't covered yet.

Before year end, do this:

• Write down the date each deposit hit the account and which job it belongs to.
• Keep deposit money separate, or at least know how much of it is for materials you haven't bought.
• Set aside a share for taxes instead of spending it all on the next job.
• Call your accountant in November, not April, and bring a list of deposits received and jobs not started.

How are progress payments counted under cash versus accrual?

Under cash, each progress payment counts in the period it lands in your account. Under accrual, income follows the work, so you count it as you earn or invoice it, and money for work you haven't done yet is not earned on your books.

Payment schedules vary a lot. For example, one residential contractor takes 35% at signing and then 25/25/15 on milestones defined in the contract (r/Contractor). Say that same schedule applies to the $40,000 job, with payments of $14,000, $10,000, $10,000 and $6,000, and the job crosses New Year's.

The gap shows up at year end. Cash can make a December deposit look like profit, and accrual waits until the work backs it up.

Can I keep accrual books for job costing but file my taxes on cash?

Yes, you can keep management books on accrual and file taxes on cash, and QuickBooks lets you run reports either way (BRIX). Your accountant decides what goes on the return.

One commenter on a bookkeeping forum says many people keep books on accrual and convert to cash at year end outside QuickBooks Online, and that if you aren't the tax preparer, the preparer can handle that conversion so you may not need separate cash books at all (r/Bookkeeping). Ask your preparer if they are comfortable doing it that way.

What about your invoicing software? Most field service apps record invoices, deposits and payments and pass them to your books, so the accounting method is set on the books side. Some, like Jobber, sync invoices and payments to QuickBooks Online. Housecall Pro's bookkeeping service describes a modified cash-based approach that can manage some accrual adjustments (Housecall Pro). Check what your own tool and your bookkeeper actually do before assuming.

Which method shows me whether a job actually made money?

Accrual shows job profit better because it matches costs to the work, but neither method tells you much unless materials, sub bills and labor are tagged to each job. Your bank balance alone will mislead you.

Say the $40,000 job has $14,000 in materials, $8,000 in sub bills and 200 labor hours at a $35 cost per hour, which is $7,000. If all of that is tagged to the job, the cost is $29,000 and the job made $11,000, or 27.5% of the price. If you only looked at the bank in December, you would see $14,000 and think the job was ahead, when most of the $29,000 in costs was still to come.

To see real job profit:

• File every receipt to the job the day you get it.
• Log crew hours by job, not just by day.
• Enter sub bills when you receive them, not when you pay them.
• Compare the estimate to the actual cost when the job closes.

On bigger jobs, one bookkeeper commenter says percentage-of-completion should ideally be one journal entry each month tied to work in progress (r/Bookkeeping). Our free job cost calculator works for a quick check on one job. In MagicBuild, receipts are filed to the job and you can see job profit, and it syncs with QuickBooks. You can read what MagicBuild does if you want the details.

Can I switch from cash to accrual, and do I need IRS approval?

Maybe, but it depends on your situation, and changing a tax accounting method usually involves paperwork with the IRS, so don't switch on your own. Your accountant can tell you whether you need approval and how to handle the transition.

The switch is tricky because the first year can double count income or miss it. Say you invoiced a job in December but got paid in January. If you change methods at the wrong moment, that money could be counted twice or not at all, which is why the accountant sorts out the adjustment.

There is also an opinion that construction firms shouldn't be on cash from the start. One bookkeeper commenter says exactly that (r/Bookkeeping). Treat that as one view. The right method for your business depends on your size, your contracts and your accountant's advice.

Questions to bring to your accountant:

• Which method am I on now, and was it chosen on purpose?
• Would a switch change my tax bill this year or in future years?
• What paperwork does the change involve, and who files it?
• Can I keep accrual books for job costing and still file on cash?

When should I ask a CPA about this instead of guessing?

Ask before you act, not after: when a large deposit lands near year end, when your jobs start crossing tax years, or when you want to change methods. A short call costs far less than fixing a bad year.

Here are the moments that should trigger a call:

• You are about to collect a large deposit in November or December.
• Your bookkeeper and your tax preparer disagree about the method.
• You are growing and taking bigger jobs with long schedules.
• You are thinking about switching methods or software.
• You can't tell from your books whether last year's jobs made money.

Bring a list of open jobs with the contract price, payments received, payments still due, and costs paid to date. If your records already tie each receipt and payment to a job, that conversation takes minutes instead of hours. Rules on tax methods vary, so your accountant or your state's revenue department is the place to confirm anything specific to you.

If you want one place to keep estimates, deposits, receipts and job profit, you can try MagicBuild free for 14 days at start a free trial. Or use the free job cost calculator first to check what your last job really made.