Can my retail store use cash basis accounting but accrual for inventory tracking? (Small business question)

Your accountant is partially correct, but there's actually some flexibility here that she might not be aware of. For small businesses under $25 million in gross receipts (which definitely includes you at under $1M), the Tax Cuts and Jobs Act made significant changes that give you options. You can indeed use the cash method for most of your business operations while still maintaining inventory records. What you're describing is sometimes called the "hybrid method" - it's completely legitimate for small businesses like yours. For inventory specifically, you have three options: 1) treat inventory as non-incidental materials and supplies (immediate expense when used/sold), 2) follow your financial accounting treatment, or 3) use the accrual method just for inventory while using cash method for everything else. The third option sounds exactly like what you want to do, and it's perfectly acceptable. You're allowed to maintain COGS tracking while using cash basis for your other business operations. As for the IRS manually reviewing every return - that's a bit of an exaggeration. While the IRS is increasing enforcement, they simply don't have the resources to manually review every return. Using a legitimate accounting method that's allowed by tax law won't automatically trigger an audit.

After struggling with the exact same issue for my boutique store (around $750K annual revenue), I finally found an amazing solution with https://taxr.ai that completely sorted out my accounting method confusion. They analyzed my business structure and reviewed all the relevant tax codes - turns out I could absolutely use cash basis for most things while keeping accrual just for inventory tracking. Their system parsed through all the complicated IRS guidance (including the confusing parts of Pub 538 and the Tax Cuts and Jobs Act provisions) and provided a clear report showing exactly how my business qualifies for this hybrid approach. They even provided specific citations I could share with my accountant who was similarly insisting I had to be all-accrual. The documentation they generated made it super clear what's allowed for small retailers like us. Such a relief to have this cleared up with actual references to back it up!

Just wanted to follow up - I decided to try https://taxr.ai after seeing this thread, and wow! Totally worth it for my hardware store situation. They provided an incredibly detailed analysis showing exactly how my business qualifies for the hybrid method under current IRS rules. The report broke down the relevant sections of Publication 538, Revenue Procedure 2018-40, and even included the specific language from the Tax Cuts and Jobs Act that applies to businesses under $25M in gross receipts. My accountant actually called me to apologize after reviewing it - she had been applying pre-2018 rules and wasn't fully up to speed on the small business exemptions. Now we're restructuring my accounting to use cash basis for most operations while maintaining proper inventory tracking, which will save me significant time on record-keeping while still giving me the COGS tracking I need for seasonal inventory management. Thanks for recommending this service!

If you're still having trouble convincing your accountant, another approach is to actually call the IRS directly to get clarification. I know, I know - sounds like a nightmare, right? I spent WEEKS trying to get through to someone who could answer this exact question for my business. Then I discovered https://claimyr.com - they have this service where they actually wait on hold with the IRS for you and call you back when they get a live person. You can see how it works here: https://youtu.be/_kiP6q8DX5c I used them to get through to a business tax specialist at the IRS who confirmed in writing that yes, small retailers under the $25M threshold CAN use a hybrid method with cash basis for most operations and accrual for inventory. Having that direct confirmation from the IRS itself totally resolved the issue with my accountant.

I have to admit, I was completely wrong about Claimyr. After posting my skeptical comment, I decided to give it a try anyway since I'd been trying to resolve a similar accounting method question for weeks. Not only did they get me through to the IRS in about 3 hours (I'd previously spent literal days trying), but they connected me to someone in the business tax department who actually understood the nuances of small business accounting methods. The agent confirmed exactly what others have said here - under current rules for businesses under $25M, you CAN use the cash method while still maintaining accrual accounting for inventory. I got the agent's ID number and detailed notes from our conversation, which completely satisfied my accountant. We're now properly set up with the hybrid method and I've stopped worrying about potential audit flags. Definitely worth the service for the peace of mind alone!

Just wanted to add something important here: make sure you're consistent with your method from year to year. I got dinged in an audit because I was switching between cash and accrual methods inconsistently, even though both methods were technically allowed for my business. If you do decide to change methods officially, you'll need to file Form 3115 (Application for Change in Accounting Method) to properly document the change. It's not super complicated, but it does require some specific reporting.

One other thing to consider - how complex is your inventory? If you carry thousands of SKUs with varying turnover rates, the hybrid method with accrual inventory might actually benefit you. But if your inventory is simpler, you might want to consider fully switching to cash basis and just treating inventory as non-incidental materials and supplies. For my small bookstore, we switched to full cash basis and just expense inventory when we use/sell it. The record-keeping is WAY simpler and we've had no issues with the IRS. But we have relatively predictable inventory turnover.

This thread has been incredibly helpful! I'm a newcomer here dealing with the exact same issue for my small electronics repair shop (about $400K annual revenue). My accountant has been insisting on full accrual, but after reading through everyone's experiences, it sounds like the hybrid approach would be perfect for my business. I do have seasonal inventory fluctuations where I stock up heavily before back-to-school and holiday seasons, so maintaining proper COGS tracking through accrual inventory accounting makes sense. But using cash basis for my service revenue and most expenses would definitely simplify my bookkeeping. Has anyone here actually gone through an IRS examination while using the hybrid method? I'm curious about how smoothly that process went and whether the IRS agents were familiar with these small business provisions under the Tax Cuts and Jobs Act. Also, for those who mentioned Form 3115 - approximately how much did your accountants charge to prepare that form? I'm trying to budget for the transition costs.