Tax Court OKs Disallowance of Accrued Expenses

Why It Matters

Improper accrual accounting can lead to massive tax adjustments and audit exposure, affecting cash flow and profitability. The decision reinforces strict compliance requirements for businesses choosing accrual reporting.

Key Takeaways

• Tax Court upheld IRS disallowance of $450K deductions for accrual errors
• Accrual method requires accurate timing of income and expense recognition
• C corporations with >$30M receipts cannot use cash accounting under TCJA
• Inaccurate journal entries can trigger audits and significant tax liabilities

Pulse Analysis

Cash versus accrual accounting remains a pivotal choice for small and midsize firms. The cash method offers simplicity—income is reported when received and expenses when paid—allowing businesses to defer tax on earnings while capturing immediate deductions. However, the Tax Cuts and Jobs Act permanently barred C corporations with average annual receipts above $30 million (indexed from $25 million) from using cash accounting, nudging larger entities toward accrual reporting, which demands precise timing of revenue and expense recognition.

The recent Tax Court case, Garibyan (TC Memo 2025‑106), illustrates the pitfalls of lax accrual practices. A California hospice‑care C corporation, run by two brothers, recorded income and expenses inconsistently, leading the IRS to uncover over $200,000 of understated gross income and to disallow more than $450,000 in deductions for 2015‑2016. The court cited suspicious journal entries, uncategorized deductions, and erroneous accounts receivable/payable entries as decisive evidence. By upholding the IRS’s findings, the ruling sends a clear message that the burden of proof lies with taxpayers to maintain accurate, contemporaneous records.

For accountants and business owners, the case reinforces the necessity of rigorous bookkeeping discipline. Implementing robust internal controls, regularly reconciling ledgers, and ensuring that every expense is matched to the period it was incurred can mitigate audit risk. Moreover, firms should reassess their accounting method eligibility under the TCJA and consider professional guidance when transitioning between cash and accrual systems. Accurate accrual accounting not only safeguards against costly tax adjustments but also provides a clearer financial picture for strategic decision‑making.