How to Switch From Cash to Accrual Accounting: Form 3115 Steps

To switch from cash to accrual accounting, you file Form 3115 with the IRS, calculate a Section 481(a) adjustment that reconciles the two methods, and begin recording income when earned and expenses when incurred starting on the first day of the year of change. Most businesses qualify for automatic consent, which carries no user fee and requires no ruling letter before you file. The change takes effect on the first day of the tax year you designate, and any positive adjustment on a voluntary change spreads over four tax years rather than hitting a single return.

Is the Switch Required or Optional

Federal law prohibits three types of entities from using the cash method: C corporations, partnerships that have a C corporation as a partner, and tax shelters.¹ Businesses in the first two categories can still use cash accounting if they pass the gross receipts test. Tax shelters must use accrual regardless of revenue.

The gross receipts test looks at your average annual gross receipts over the three tax years before the current one. For tax years beginning in 2026, the threshold is $32 million.² Stay at or below that average and you can keep using cash. Cross the line and the law requires you to switch. The $25 million base written into the statute is adjusted for inflation each year, so verify the current figure before deciding.¹

Businesses below the threshold can still switch voluntarily. Companies seeking outside investment, planning to go public, or wanting financial statements that reflect actual economic activity often make the change before they have to. The mechanics that follow apply either way, but the Designated Change Number and some procedural details differ depending on whether the switch is voluntary or triggered by exceeding the threshold.

Gather the Financial Data First

Before filling out Form 3115, identify every item that was treated differently under cash accounting than it would be under accrual. These figures feed directly into your Section 481(a) adjustment. Work through each category using your billing software, bank statements, and vendor records.

Accounts Receivable

Pull every unpaid customer invoice for goods delivered or services performed before year-end. Cash accounting ignored this income because payment had not arrived. Accrual treats it as income in the period it was earned. This total increases your Section 481(a) adjustment.

Accounts Payable

Gather every unpaid vendor bill for expenses already incurred before year-end. These costs were invisible on your cash-basis return but are deductible in the year the obligation arose under accrual rules. This total reduces the adjustment.

Inventory

If you sell physical goods, get the value of inventory on hand at year-end. Cash accounting may have let you deduct the cost of goods when purchased. Accrual requires capitalizing those costs as an asset until the items sell. A physical count or a detailed report from your point-of-sale system gives you the figure.

Prepaid Expenses

Look through bank statements for large payments covering future periods. If you paid a $12,000 annual insurance premium in October, cash accounting deducted the full amount at payment. Accrual expenses only the portion covering the current tax year; the remaining coverage becomes an asset expensed as time passes.

Accrued Expenses

Identify costs you incurred but have not been billed for. Wages earned in the last days of December but paid in early January are the standard example. Under accrual, you report income when earned and deduct expenses when incurred, regardless of when payment happens.³ Compute the daily payroll rate and multiply by days worked before year-end. Utilities and loan interest spanning the year-end boundary often qualify too. Accrued amounts reduce the adjustment.

Calculate the Section 481(a) Adjustment

Federal law requires the accounting method on your tax return to match what you consistently use on your books,⁴ and when you change methods the code requires an adjustment so no income is taxed twice and none escapes tax.⁵ That figure is the Section 481(a) adjustment.

To calculate it, add your accounts receivable and inventory balances, then subtract accounts payable and accrued expenses. Include any prepaid expense adjustments as well. The result runs one of two ways:

A positive adjustment means unreported income: revenue earned but never taxed under cash. On a voluntary change, a positive adjustment spreads equally over four tax years (the year of change plus the next three).⁶
A negative adjustment means unreported deductions: expenses incurred but never claimed. A negative adjustment is taken entirely in the year of change.⁶

For most businesses making this switch, the adjustment is positive because receivables tend to outweigh payables. The four-year spread softens the tax hit by absorbing the additional income gradually.

File Form 3115

You cannot simply start using accrual on your next return. The IRS requires consent, and Form 3115 is how you request it. Most cash-to-accrual switches qualify for automatic consent, which the IRS approves when you file correctly. No user fee. No ruling letter. Filing under automatic consent also generally protects you from the IRS reopening prior years to challenge your old method.⁷

If your specific change is not on the IRS’s annual list of automatic changes,⁸ you must request non-automatic consent. That means filing Form 3115 with the IRS National Office during the year of change, paying a user fee, and waiting for a ruling letter before implementing the change on your return.⁹ The non-automatic user fee is $13,225 for 2026.¹⁰

What Goes on the Form

Form 3115 is available on the IRS website.¹¹ The form has several parts, and Schedule A applies if you are changing your overall method of accounting rather than the treatment of a single item.

Part I asks for the Designated Change Number (DCN) that matches your change.¹² Use DCN 122 for a voluntary switch from cash to accrual. Use DCN 257 if the switch is required because your business first exceeded the Section 448 gross receipts threshold.¹³ Enter only one DCN unless IRS guidance says otherwise. Part I also asks whether any eligibility rules prevent you from using the automatic procedures.

Part II collects your business name, EIN, and the beginning and ending dates of the tax year the change takes effect. The year of change is the first tax year you use accrual, even if no items are affected that year.

Part IV, line 26, is where you enter the Section 481(a) adjustment and mark whether it increases or decreases income. Attach a summary showing how you calculated the amount and explaining the methodology. If you are changing your overall method, Schedule A walks you through combining receivables, payables, inventory, and accrued expenses into the net figure that flows into Part IV.

Where to Send It

For automatic consent, you file in two places:

Attach the original Form 3115 to your timely filed federal income tax return for the year of change, including extensions.
Mail a signed duplicate copy to the Internal Revenue Service, Ogden, UT 84201, M/S 6111. Send this copy no earlier than the first day of the year of change and no later than the date you file the original with your return.⁷

The IRS does not typically send an approval letter for automatic changes. The change is treated as approved once both copies are timely filed. If there is an error, the IRS may contact you.

Update Your Books for the New Method

Your accounting software needs to reflect accrual starting on the first day of the year of change. Enter opening balance adjustments for accounts receivable, accounts payable, accrued expenses, prepaid expenses, and any inventory reclassifications from the conversion work. These journal entries align your books with the accrual figures on your return.

From that point forward, record income when earned and expenses when incurred, regardless of cash movement. If you were not tracking receivables and payables before, set up the processes to do so. The IRS expects you to apply the new method consistently in all later periods unless you obtain approval for another change.

Hold on to the documents supporting your Form 3115 figures: unpaid invoices, vendor bills, inventory counts, payroll records, and the Section 481(a) worksheet. The IRS generally requires records supporting any return item until the statute of limitations expires, typically three years after filing but six years if more than 25 percent of gross income is omitted.¹⁴ Because a positive 481(a) adjustment spreads over four years, keep your conversion records for at least seven years.

What Happens If You Switch Without Filing

Changing methods without filing Form 3115 can go badly. If the IRS finds the unauthorized change during an audit, it can impose the change on its own terms, and those terms are worse. When the IRS forces a change, the entire positive Section 481(a) adjustment lands in a single year rather than spreading over four.⁹ That concentrates the extra income into one return, potentially pushing you into a higher bracket and generating a large tax bill at once.

On top of that, the IRS can apply a 20 percent accuracy-related penalty on the resulting underpayment for disregarding tax rules and regulations.¹⁵ Interest accrues from the original due date of the return until you pay. You also lose the audit protection that comes with a voluntary filing, so the IRS can reexamine your accounting method for all open prior years.

Check Your State’s Rules Separately

Some states automatically follow the federal method change once you file Form 3115 with the IRS. Others require a separate state filing or apply different rules to the Section 481(a) adjustment. Some may also use gross receipts thresholds that differ from the federal $32 million figure. Confirm the rules with your state tax agency before assuming the federal approval carries over.

1
Office of the Law Revision Counsel. 26 USC 448 – Limitation on Use of Cash Method of Accounting
2
Internal Revenue Service. Rev. Proc. 2025-32
3
Internal Revenue Service. Publication 538 (01/2022), Accounting Periods and Methods
4
Office of the Law Revision Counsel. 26 USC 446 – General Rule for Methods of Accounting
5
Office of the Law Revision Counsel. 26 USC 481 – Adjustments Required by Changes in Method of Accounting
6
Internal Revenue Service. 4.11.6 Changes in Accounting Methods – Section: 4.11.6.5.3
7
Internal Revenue Service. Instructions for Form 3115 (Rev. December 2022)
8
Internal Revenue Service. Rev. Proc. 2024-23
9
Internal Revenue Service. 4.11.6 Changes in Accounting Methods
10
Internal Revenue Service. Internal Revenue Bulletin 2026-01
11
Internal Revenue Service. About Form 3115, Application for Change in Accounting Method
12
Internal Revenue Service. Form 3115 (Rev. December 2022)
13
Internal Revenue Service. Instructions for Form 3115 (12/2022)
14
Internal Revenue Service. Publication 583 Starting a Business and Keeping Records
15
Internal Revenue Service. Return Related Penalties