What Is a Cash Basis Taxpayer?

A cash basis taxpayer is a type of taxpayer who chooses to report income and allowed deductions during the tax year in which the income and deductions occur. This is different from other approaches to paying taxes, which would focus more on when the transactions were implemented and not on when they were successfully completed. The cash basis taxpayer reports income and allowable expenses based on when those transactions were completed, essentially following the same guidelines that have to do with cash basis accounting.

The approach of the tax basis taxpayer is somewhat different from the process of using accrual accounting measures to report income and deduct allowable expenses. With the latter approach, transactions are counted as they are initiated, meaning that the taxpayer would include outstanding receivables and promissory notes that are due in a future year in the tax information for the current year. The cash basis taxpayer would not do so, since those transactions have not yet been realized as cash. This means that the returns from a promissory note will not be included until the note is actually paid, and income from receivables not addressed until payments for the outstanding invoices are received and recorded.

One of the benefits that a cash basis taxpayer enjoys is reporting income that is actually received during the tax year and paying any taxes due on that realized income. At the same time, any prepaid expenses in which those payments occur during the tax year, even if the services or benefits are not used until the next tax year, will often be eligible for use as a deduction. To an extent, this is a more straightforward way of managing taxes. At the same time, certain types of deductions that have to do with cash payments pending but not yet realized are not allowed using this approach. Depending on the nature and size of the business operation, this may be a benefit or a liability in terms of keeping the tax burden as low as possible.

Regulations regarding the use of this approach to managing taxes will vary from one national revenue agency to the next, making it necessary to understand the specific rules and limitations that the cash basis taxpayer must observe in order to prepare and submit accurate and timely payments for taxes owed. Accounting and tax professionals can aid the taxpayer in identifying how to make use of this approach to best advantage and ensure the tax returns and payments are in compliance with current regulations.