Schedule C Line F: Choosing Your Accounting Method

Self-employed individuals use Schedule C of Form 1040 to report their business’s annual profit or loss. Line F on this form requires you to identify your business’s accounting method, which determines the rules for reporting your income and expenses to the IRS.

Understanding Your Accounting Method

The accounting method you choose must clearly reflect your income and be used consistently each year. If you decide to change your method, you must get approval from the IRS by filing Form 3115, Application for Change in Accounting Method. The two most common methods for small businesses are the cash and accrual methods.

Cash Method

The cash method is the most straightforward approach for small businesses. You recognize income in the tax year you actually or “constructively” receive it. Constructive receipt means funds are credited to your account or made available without restriction, like a check you have received but not yet deposited. You deduct expenses in the tax year you pay them.

For example, if a freelance writer completes an article in December 2024 but is not paid the $1,000 until January 2025, they report the income on their 2025 tax return. If that writer bought a new printer in December 2024, they would deduct the expense on their 2024 return, the year it was paid.

Accrual Method

Under the accrual method, you report income in the tax year you earn it, regardless of when payment is received. An expense is recorded when it is incurred, not when you pay the bill. This approach matches revenues with their related expenses, providing a more accurate picture of a business’s financial health.

Using the same freelance writer example, the $1,000 of income would be reported on the 2024 tax return because that is when the income was earned. The timing of the payment in 2025 is not a factor. This principle also applies to expenses; if the writer was billed for office supplies in December 2024 but paid in January 2025, the expense would be deducted on the 2024 return.

Choosing Between Cash and Accrual

Most small businesses that do not manage inventory are free to choose between the cash and accrual methods. The cash method is often preferred for its simplicity because it aligns with the flow of cash in a bank account, making bookkeeping more intuitive.

However, IRS regulations require the use of the accrual method for businesses that have inventory. If you produce, purchase, or sell merchandise, you must use an accrual method for purchases and sales. This rule ensures that the costs of goods are properly matched with the income from their sale.

An exception to this inventory rule exists for small business taxpayers meeting a gross receipts test. For 2024, a business meets this test if its average annual gross receipts for the three preceding tax years are $30 million or less. This threshold is adjusted for inflation and is set to be $31 million for 2025. Businesses under this threshold can use the cash method even with inventory.

Completing Line F on Schedule C

After determining your accounting method, completing Line F is straightforward. The line presents three checkboxes, and you will select the one that applies to your business.

If you use the cash method, you will check box (1). For those who have chosen or are required to use the accrual method, you will check box (2). The form also provides a third option, box (3), labeled “Other.”

This third box is for less common hybrid methods, which might combine elements of both cash and accrual accounting under specific IRS rules. For instance, a business might use the accrual method for inventory and sales but the cash method for other items of income and expense. If you check box (3), you must also write a brief description of the method you use on the line provided on the form.