Businesses must have a reliable means of maintaining their accounting records to manage their operations and determine tax liabilities. The two methods of accounting that businesses can use for this purpose are respectively known as cash and accrual basis of accounting. Under cash basis accounting, revenue and expenses generally are recognized and recorded when cash is actually paid or received. Under accrual basis accounting, revenue is recorded when it is earned and expenses are reported when they are incurred, regardless of when payments are actually made or received. Although the cash basis method is simpler and perhaps less administratively burdensome, it may result in a less accurate measure of economic income and allow for a deferral of tax liability. The Joint Committee on Taxation (JCT) considers cash accounting a departure from "normal income tax law." Thus, the ability to use cash accounting for the purposes of determining tax liability is considered a tax expenditure by the JCT . The JCT estimates the five-year revenue loss associated with cash basis accounting to be $10.9 billion between FY2014 and FY2018. Legislation has been proposed that would change the tax accounting requirements for businesses. The changes would affect federal tax revenues and the businesses' tax liabilities. Similar discussions on cash and accrual accounting were held prior to the enactment of the Tax Reform Act of 1986 (TRA86; P.L. 99-514 ). This report provides a brief explanation of cash and accrual accounting, and it reviews relevant legislative history surrounding TRA86. The report then explores the effects of the tax policy if cash basis of accounting is expanded for certain businesses and limited for others. Accounting is the process by which businesses, nonprofits, and government entities record and report their financial transactions. Properly accounting for the timing of income and expenses allows for more accurate predictions of cash flows and better business and investor decisions. Accurate accounting also allows taxpayers and tax authorities to correctly determine a taxpayer's income tax liability. Financial regulators employ certain accounting standards as well to help gauge the financial health of firms. Although a discussion of financial accounting standards and policy considerations is beyond the scope of this report, it is worthwhile mentioning that financial accounting or "accounting per books" may differ in various ways from accounting for tax purposes. Businesses generally use one of two accounting methods for calculating their federal tax liabilities. Under the cash basis method of accounting, income and expenses generally are recorded only when payments are actually received or paid. In contrast, under the accrual method of accounting, income and expenses are recorded when a transaction occurs, regardless of when payments are actually received or paid. An example may assist in better understanding the difference between cash and accrual accounting. Consider a nail supply company that sells $1,000 worth of nails to a roofing company in August, but the roofing company does not make payment until January of the following tax year. Using the cash accounting method, the nail supply company would record $0 in revenue for that sale in August of Year 1 and $1,000 in revenues in January of Year 2, when the payment is actually received. Alternatively, if the nail supply company used the accrual method of accounting, it would record $1,000 in revenue in August of Year 1 and no revenue for that sale in January of Year 2. The nail supply company would treat any business expenses in the same manner as revenues depending on the accounting method used. The accrual method more accurately measures a business's income during a given accounting period. The reason is that the accrual method captures all revenues actually earned during a given period, even if the cash has not actually been received. Similarly, the accrual method also captures all expenses generated in the production of revenue in a given period. The accrual method thus most accurately measures a firm's economic income in the sense that all profits or losses are accounted for when an economic event occurs, regardless of whether they are actually realized. It is this feature of the accrual method of accounting that leads it to be the baseline accounting method underlying the "normal income structure" used by the JCT. Departures from the accrual method in computing tax liability, such as the cash basis method, are therefore considered tax expenditures by the JCT. On the one hand, the cash method of accounting is simpler. Allowing small business taxpayers to file taxes using cash accounting reduces the cost of record keeping for these businesses. In addition, some businesses, particularly smaller ones, may find the cash method beneficial when they are cash or credit constrained and would have trouble meeting their tax obligations under the accrual method. For example, a company may be waiting to receive payment for goods or services provided to a customer. Even if the payment is not expected to arrive until the following year, under the accrual method, the company would be required to incorporate it in its taxable income calculation for the current year. This, in turn, could result in a tax liability that the company may not yet have the cash resources to pay (because they are awaiting a customers' payment). The cash basis method allows the pending payment to be accounted for in the tax year in which it is received. On the other hand, the cash method of accounting might lead to mismatching of income and related expenses to maximize tax deferral and avoidance. Under the cash method, a business could maximize tax deferral by strategically timing when income and expenses are recorded. For example, during a tax period when expenses are lower, a firm could ask a customer to remit the payment the following tax period to reduce income and taxes on the profit in the current tax period. The converse is also possible; a firm could ask a customer to pay early if there were high expenses during the current tax period. By receiving the payment early, the firm is able to record higher income in the current period that is offset by the higher expenses, thus the firm is able to reduce the net tax liability in the subsequent tax period. Continuous management of income and expenses from one period to the next may not be as significant with small transactions but with larger transactions, it has the potential to significantly reduce tax liability. Mismatching of income and expenses is one of the many reasons the cash method of accounting is not considered in accordance with generally accepted accounting principles. Before TRA86, taxpayers were allowed to use any method of accounting that clearly reflected income for tax purposes and that was regularly used for bookkeeping purposes. Taxpayers were required to maintain records to reconcile differences between financial and taxable income. If the taxpayer used an accounting method that failed to clearly reflect income, the Secretary of the Treasury had authority to require the taxpayer to use a method that satisfied the statutory requirements. Accounting methods potentially available to taxpayers before TRA86 included the cash method, the accrual method, certain industry specific methods, and, with limitations, hybrid methods that combined several of these and other methods. TRA86 changed the tax accounting rules governing what types of businesses could use the cash method of accounting. Congress recognized that the simpler cash method is easier for record keeping, entails less paperwork, and requires less computation to file taxes. As a result, TRA86 allowed most businesses with three-year average gross receipts of $5 million or less to use the cash method of accounting. TRA86 also allowed certain businesses to continue to use the cash method of accounting regardless of whether their average gross receipts exceeded the $5 million threshold. These businesses included (1) Personal Service Corporations (PSCs), such as law firms, doctors' offices, and consulting companies; (2) Subchapter S corporations; and (3) farm corporations subject to corporate income tax if their average gross receipts were not greater than $1 million. In addition, partners of a partnership were taxed at the individual level on a cash basis. TRA86 also excluded certain businesses from using the cash method based on the legal structure of the business. As a general rule, the following businesses were prohibited from using the cash method: (1) Subchapter C corporations with average gross receipts over $5 million; (2) partnerships that had a subchapter C corporation with average gross receipts over $5 million as a partner; (3) tax shelters; and (4) businesses that had average gross receipts in excess of $1 million that carried inventory. In the year following enactment of TRA86, Congress passed the Omnibus Reconciliation Act of 1987 ( P.L. 100-203 ), which raised the average gross receipts test for family farm corporations from $1 million to $25 million. Family farm corporations with average gross receipts in excess of $25 million were required to use the accrual method of accounting. The proposals to change the method of accounting for tax purposes predate the 1986 tax reform and continue to be a policy consideration for Congress and the executive branch. For example, the 1984 Treasury report on tax reform contained proposals on changes to method of accounting. Since TRA86, there have been other proposals to modify the tax code as it relates to cash accounting. Over the last decade, at least three executive branch reports have addressed the allowable methods of accounting for tax purposes. In general, all three reports emphasized the ease of recordkeeping and lower costs of compliance for small businesses. The reports recommended expanding the use of cash accounting by small businesses when they file their taxes because cash accounting corresponds with how they pay their bills. Recent proposals to change the allowable methods of accounting have focused on three general options. The first would expand the use of cash accounting for small businesses. Several bills introduced in the 113 th Congress, including the Small Business Accounting and Tax Simplification Act ( H.R. 947 ), the Start-up Jobs and Innovation Act ( S. 1658 ), and the Small Business Tax Certainty and Growth Act ( S. 1085 ), would have expanded the use of cash basis accounting by raising the average gross receipts limit to $10 million from $5 million. Similar legislation was introduced in the 112 th Congress, the Small Business Tax Simplification Act ( H.R. 4643 ). The second option, from the 113 th Congress, the Tax Reform Act of 2014 ( H.R.