Certain entities cannot use the cash method of accounting and reporting, or any combination of methods that includes the cash method:
A corporation with average annual gross receipts of over $5 million. This does not include S corporations,
A partnership with a corporation (other than an S corporation) as a partner, that has average annual gross receipts of over $5 million, and
Tax shelters.
Gross Receipts Test
A corporation or partnership that is not a tax shelter, and that meets the gross receipts test for every tax year beginning after 1985, is not prohibited from using the cash method (but the uniform capitalization rules may still apply).
The gross receipts test is that average annual gross receipts for each of those years (after 1985) must be $5 million or less. The average for each year is calculated by the taking the gross receipts for that tax year plus the gross receipts for each of the two preceding years, and dividing the total by three. For any year the corporation or partnership fails to meet the gross receipts test (its average gross receipts for the year exceed $5 million), it must start using the accrual method that year.
Qualified Personal Service Corporation
A qualified personal service corporation is also not prohibited from using the cash method of accounting for income and expenses. In order to be a qualified personal service corporation, there are two tests that have to be met: the function test and the ownership test.
To meet the function test, at least 95% of the personal service corporation’s activities must be in the fields of health, veterinary services, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.
To meet the ownership test, at least 95% of the stock must be directly or indirectly owned by:
the employees who are performing the types of services included among those that qualify under the function test,
retired employees who had performed those services,
the estate of one of these employees, or
a beneficiary who received stock in the personal service corporation as a result of an employee’s death.
If a personal service corporation fails to meet either the function or ownership test, it must change to an accrual method of accounting starting in that tax year.