Most New Jersey contractors never choose their accounting method—they simply default to whatever their bookkeeper or accountant sets up. This passive decision costs profitable contractors $10,000 to $40,000 annually in unnecessary taxes and creates financial statement distortions that lead to poor business decisions.
The IRS allows you to choose between cash and accrual accounting methods (with some restrictions), and that choice dramatically impacts when you recognize income and expenses for tax purposes. For contractors in Red Bank, Long Branch, and across Monmouth County, understanding the strategic implications of each method is critical to both tax savings and business growth.
This guide explains both methods, identifies who must use which method, and demonstrates how to leverage accounting method choice for maximum tax benefit while maintaining accurate financial reporting.
Under cash method accounting, you recognize income when money hits your bank account and deduct expenses when you actually pay them. It's straightforward: if you received $150,000 in December from customer payments, you report $150,000 in December income—regardless of when you invoiced or performed the work.
Income recognition:
Expense recognition:
Simplicity: Cash method tracks naturally with your bank account. Money in = income. Money out = expense. This makes DIY bookkeeping more accessible for smaller contractors.
Tax deferral opportunities: You control timing of income and expenses. Need to reduce December income? Delay invoicing until January 2nd. Want to maximize deductions? Prepay January expenses in December.
Cash flow alignment: Cash method naturally aligns with actual cash position, making it easier to understand true liquidity.
Lower accounting costs: Cash method requires less technical accounting knowledge, reducing professional bookkeeping costs.
Distorted profitability: Cash method creates terrible profit reporting for job-based businesses. You might show huge December income (customers paying invoices) with minimal December expenses (you haven't paid subcontractors yet), creating phantom profits.
Difficult job costing: Matching revenue to related job costs becomes impossible. A project might generate revenue in Month 1 when the customer pays, but show expenses in Months 2-3 when you pay suppliers and subs. This destroys accurate project profitability analysis.
Banking limitations: Banks and bonding companies prefer accrual financial statements because they provide more accurate financial position. Cash method understates assets (no accounts receivable) and liabilities (no accounts payable).
Strategic limitations: Advanced tax strategies like completed contract method (for long-term contracts) and percentage-of-completion method require accrual basis.
Accrual accounting recognizes income when earned (invoiced) and expenses when incurred—regardless of cash movement. This "matching principle" creates more accurate financial statements but requires more sophisticated bookkeeping.
Income recognition:
Expense recognition:
Accurate profitability: Revenue and related expenses are matched in the same period, showing true project and period profitability.
Better financial statements: Banks, bonding companies, and investors prefer accrual statements because they show complete financial position including receivables and payables.
Job costing accuracy: Accrual method allows accurate real-time job profitability tracking—essential for contractors managing multiple simultaneous projects.
Required for growth: Once you exceed IRS size thresholds (explained below), you must use accrual method. Starting there from day one avoids painful method-change adjustments later.
Advanced tax strategies: Long-term contract accounting methods (completed contract, percentage-of-completion) require accrual basis and can provide significant tax deferral opportunities.
Complexity: Requires understanding of revenue recognition principles, deferred revenue, accrued expenses, and other accounting concepts.
Higher accounting costs: Professional bookkeeping becomes essential. DIY accrual bookkeeping typically creates errors requiring expensive cleanup.
Cash flow confusion: Showing $100,000 profit doesn't mean you have $100,000 cash—some might be tied up in receivables. Contractors must track both accrual P&L and cash flow.
Less tax control: You can't simply "delay invoicing" to push income to next year—once work is complete, income must be recognized regardless of invoicing timing.
The IRS doesn't let everyone choose their accounting method freely. Size and structure matter.
C-Corporations with average annual gross receipts over $30 million (3-year average):
Businesses required to maintain inventory:
Tax shelters:
Small businesses with average annual gross receipts under $30 million (3-year lookback):
This covers 99%+ of New Jersey contractors. Unless you're generating over $30 million annually (3-year average), the IRS allows you to choose cash or accrual method.
The test uses a three-year rolling average of gross receipts:
Example: New Brunswick contractor gross receipts:
Three-year average: ($24M + $28M + $35M) / 3 = $29 million
Result: Still eligible for cash method in 2025. If 2026 exceeds $33 million, the new three-year average would exceed $30 million, requiring a switch to accrual for 2026.
Your accounting method choice creates significant tax planning opportunities—or limitations.
Year-end income deferral:
A roofing contractor in Middletown completes $180,000 in work during December. Under cash method, delaying invoicing until January 2nd pushes that income to the following tax year.
Before optimization (invoicing in December):
After optimization (invoicing in January):
This isn't tax evasion—it's strategic timing using IRS-permitted cash method rules. The income is still reported and taxed, just one year later.
Critical requirements:
Year-end expense acceleration:
The same contractor has $85,000 in material purchases and subcontractor payments planned for early January. Paying these in December instead creates immediate deductions.
Before optimization:
After optimization:
Combined strategy: Delay $180,000 income to 2026, accelerate $85,000 expenses to 2025Total swing: $265,000 reduction in 2025 taxable incomeTax savings: $92,750
Important limitations:
Accrual method offers different but equally powerful tax strategies, particularly for contractors with long-duration projects.
Completed contract method (available only on accrual basis):
For contracts expected to be completed within two years, contractors can defer ALL income and expenses until the project is substantially complete.
Example: Commercial HVAC contractor in Edison signs a $2.4 million contract in March 2025 for a 16-month project.
Without completed contract method:
With completed contract method:
Advantage: The contractor defers $270,000 of taxable income from 2025 to 2026. If properly planned with other strategies (equipment purchases, retirement contributions), this deferral might save substantial taxes.
Percentage-of-completion method (required for contracts over two years):
For very long contracts (rare in residential/light commercial, common in major commercial/infrastructure), contractors must recognize income proportionally as work progresses.
This method is complex and requires careful tracking, but it provides the most accurate long-term financial reporting.
Business profile:
Cash method advantages:
Accrual method advantages:
Recommendation: Cash method. The business benefits from year-end income deferral opportunities, and simplicity matches business needs. No bank financing or bonding requirements necessitate accrual statements.
Annual tax savings from strategic timing: $15,000-$25,000 by deferring December income and accelerating January expenses.
Business profile:
Cash method disadvantages:
Accrual method advantages:
Recommendation: Accrual method. The business needs accurate job costing, and external financing requirements mandate better financial reporting. Completed contract method provides tax deferral for multi-month projects.
Annual benefit: Improved job costing identifies $80,000 in underpriced projects, allowing pricing adjustments. Completed contract method defers $120,000 taxable income strategically.
Business profile:
Optimal approach: Accrual method with strategic hybrid elements
Implementation:
Benefits:
You can change accounting methods, but it requires IRS permission and often triggers a "catch-up" adjustment.
Automatic consent changes:
Prior approval changes:
When switching methods, Section 481 adjustment prevents double-counting or omission of income/expenses.
Example: Plumbing contractor in Sayreville switches from cash to accrual.
December 31, 2025 (end of cash method):
Under cash method, none of this was recognized. Under accrual method, it all should have been recognized when earned/incurred.
Section 481 adjustment:
IRS allows spreading this adjustment over 4 years:
This prevents the entire $118,000 from hitting one year's tax return.
Best time to switch from cash to accrual: When receivables are low and payables are high (minimizes positive Section 481 adjustment).
Best time to switch from accrual to cash: When receivables are high and payables are low (maximizes favorable Section 481 adjustment).
New Jersey generally follows federal accounting method choice, but there are considerations:
New Jersey follows federal method: If you use accrual for federal, you use accrual for New Jersey.
Tax differences still matter: Even using the same method, federal and New Jersey might treat specific items differently (depreciation, certain deductions).
Strategic state planning: Some contractors benefit from entity structures that create different state vs. federal income allocations, but accounting method remains consistent.
Accounting method isn't isolated—it integrates with your entire tax reduction strategy:
Equipment depreciation: Cash vs. accrual affects timing of Section 179 and bonus depreciation benefit realization. Learn more about equipment depreciation strategies.
Estimated tax payments: Your accounting method impacts quarterly income projections, affecting estimated tax payment calculations.
Entity structure: S-Corporation reasonable compensation requirements interact with accounting method choice for profit determination.
Retirement contributions: Retirement plan contribution limits are based on taxable income, which accounting method affects.
You use cash method for income (recording when received) but accrual method for expenses (deducting when incurred).
Problem: IRS requires consistency. Mixing methods is prohibited and triggers audit adjustments.
Solution: Choose one method and apply it consistently to both income and expenses.
You complete work in December, customer mails check on December 29th, and it arrives January 3rd. You claim this is January income under cash method.
Problem: "Constructive receipt" doctrine says income is recognized when available to you—if check was mailed in December, IRS considers it December income even if deposited in January.
Solution: Be conservative with year-end income recognition. If payment is clearly in transit before year-end, recognize it in the earlier year.
You use cash method and try to evaluate project profitability by matching revenue to expenses for each job.
Problem: Cash method makes this impossible. Project expenses often span multiple months with revenue hitting when customer pays, destroying profitability accuracy.
Solution: Either switch to accrual method or implement separate job costing software that tracks accrual-basis job costs even while reporting taxes on cash basis.
Your contractor business hits $4 million revenue and you decide to switch from cash to accrual for better financial reporting—but you don't plan for the Section 481 adjustment.
Problem: Surprise $150,000 positive adjustment increases your taxable income unexpectedly, creating a massive tax bill.
Solution: Work with your CPA to model Section 481 impact before switching methods, and time the switch strategically to minimize adjustment.
You operate with cash method because "it's simpler," but you're pursuing bonding and need a bank line of credit. Both require accrual financial statements.
Problem: Banks and bonding companies either reject your application or require expensive third-party conversion of cash-basis statements to accrual.
Solution: Use accrual method from the start if you anticipate growth requiring external financing. The upfront complexity pays off in avoided hassles later.
Chart of accounts setup:
Software selection:
Monthly process:
Chart of accounts setup:
Software selection:
Monthly process:
Professional help: Accrual method strongly benefits from professional monthly bookkeeping services. DIY accrual bookkeeping typically creates problems requiring expensive accounting cleanup.
Choose cash method if:
Choose accrual method if:
Use hybrid approach (accrual for books, strategic elections for taxes) if:
Shore Financial Planning helps contractors throughout Central New Jersey choose and implement optimal accounting methods:
We specialize in all contractor trades:
Your accounting method choice affects taxes, financial reporting, business decisions, and growth opportunities. Most contractors never actively choose—they default to whatever their first bookkeeper set up, often the wrong choice.
If you're currently:
...it's time for a strategic review.
Schedule a complimentary strategy session with Shore Financial Planning. We'll analyze your revenue, project duration, financing needs, and growth plans to determine your optimal accounting method and implementation approach.
Contact Shore Financial Planning or call (732) 704-8982.
Our guarantee: If our tax planning doesn't identify savings greater than our fees, we refund your money.