For taxable years beginning in 2026, a corporation or partnership meets the section 448(c) gross receipts test if its average annual gross receipts for the three taxable years ending with the year before the test year do not exceed $32,000,000. Rev. Proc. 2025-32, section 4.30, states that figure. The same test controls whether a business may keep using the cash method, skip the full inventory rules, skip uniform capitalization under section 263A, and avoid the percentage-of-completion method on short construction contracts. This article walks through how the test is built, the points that trip up engagements, and a computation a reviewer can follow.
Who must pass the test?
Section 448(a) prohibits the cash receipts and disbursements method for C corporations, partnerships that have a C corporation as a partner, and tax shelters. Three exceptions in section 448(b) release an entity from that ban:
- Any farming business.
- A qualified personal service corporation.
- Any corporation or partnership (or its predecessor) that meets the gross receipts test of section 448(c) for the year.
So a C corporation with a regular business and receipts under the threshold can use the cash method, while the same corporation above the threshold must compute income under an accrual method unless it is a farming business or a qualified personal service corporation. The tax shelter definition comes from section 461(i)(3), applied after paragraph (4) of that section. A tax shelter does not benefit from the gross receipts exception.
An entity such as an S corporation, or a partnership with no C corporation partner, is not within the section 448(a) ban unless it is a tax shelter. The gross receipts test still matters to those clients because sections 471(c), 263A(i) and 460(e) cross-reference it.
How is the threshold set and indexed?
Section 448(c)(1) sets the base amount at $25,000,000. For taxable years beginning after December 31, 2018, section 448(c)(4) increases that amount by the cost-of-living adjustment under section 1(f)(3), substituting calendar year 2017 for calendar year 2016 as the base year. The result is rounded to the nearest multiple of $1,000,000. The IRS publishes each year's number in its inflation-adjustment revenue procedure. For 2026 that number is $32,000,000.
What counts in the three-year average?
The rules in section 448(c) matter more than the headline number:
- Three-year window. Use the three taxable years ending with the year before the test year. For a calendar-year entity testing 2026, that is 2023, 2024 and 2025.
- Returns and allowances. Gross receipts for a year are reduced by returns and allowances made during the year.
- Short years. Gross receipts for a taxable year of less than 12 months are annualized.
- Short existence. If the entity was not in existence for the whole three-year period, the test uses the period it existed.
- Predecessors. A reference to the entity includes a predecessor.
- Aggregation. All persons treated as a single employer under section 52(a) or (b), or section 414(m) or (o), are treated as one person. A client with a controlled group, or with commonly owned entities under those rules, must add the receipts of the group.
Worked example: a calendar-year C corporation
A C corporation with no farming activity and no tax shelter status has these gross receipts, after returns and allowances: 2023, $30,500,000; 2024, $33,000,000; 2025, $34,000,000.
- Total: $30,500,000 + $33,000,000 + $34,000,000 = $97,500,000.
- Average: $97,500,000 divided by 3 = $32,500,000.
- Compare to the 2026 limit: $32,500,000 exceeds $32,000,000 by $500,000.
The corporation fails the test for 2026. It cannot use the cash method for 2026, and it also falls outside the small business rules for inventory and section 263A.
Now change the facts: 2023, $28,000,000; 2024, $31,000,000; 2025, $34,000,000. The total is $93,000,000 and the average is $31,000,000. That is under the limit, so the corporation passes even though 2025 alone was above $32,000,000. The test uses the average, not the current year.
Short-year annualization
A new entity formed July 1, 2025 has a first taxable year that ends December 31, 2025 with gross receipts of $15,000,000. Annualized, that year is $15,000,000 times 12 over 6, or $30,000,000. Because the entity did not exist for the whole three-year period, the test for 2026 uses only the period it existed, and the annualized amount is the figure in the window.
What else depends on the 448(c) test?
- Inventory (section 471(c)). A taxpayer that meets the test is not required to use the general inventory method of section 471(a). The inventory method is acceptable if it treats inventory as non-incidental materials and supplies, or conforms to the method reflected in an applicable financial statement. Without an applicable financial statement, the taxpayer's books and records govern.
- Uniform capitalization (section 263A(i)). A taxpayer that meets the test, other than a tax shelter barred from the cash method by section 448(a)(3), is exempt from section 263A for the year. Section 263A(i)(3) treats any resulting accounting method change as initiated by the taxpayer and made with the consent of the Secretary under section 481.
- Long-term contracts (section 460(e)). A construction contract is outside the percentage-of-completion rules if the taxpayer estimates at the start that it will be completed within two years and meets the test for the year the contract is entered into.
For taxpayers that are not corporations or partnerships, such as sole proprietors, these sections apply the test as if each trade or business were a corporation or partnership.
What should the engagement file show?
Keep a schedule for each test year with the three annual gross receipts figures, the returns and allowances taken out, any short-year annualization, and the entities included under the section 52 aggregation. Record the Rev. Proc. 2025-32 figure used and its section number. Where a client crosses the line in a given year, document the planned method change before filing. The guides on cash versus accrual accounting and converting cash books to accrual cover the conversion mechanics. For other 2026 amounts, see the Rev. Proc. 2025-32 summary, and for interest limits that use a related small-business test, see section 163(j) after the 2025 legislation.
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Sources
- Cornell Legal Information Institute, 26 U.S.C. 448, Limitation on use of cash method of accounting: https://www.law.cornell.edu/uscode/text/26/448
- Cornell Legal Information Institute, 26 U.S.C. 471, General rule for inventories: https://www.law.cornell.edu/uscode/text/26/471
- Cornell Legal Information Institute, 26 U.S.C. 263A, Capitalization and inclusion in inventory costs of certain expenses: https://www.law.cornell.edu/uscode/text/26/263A
- Cornell Legal Information Institute, 26 U.S.C. 460, Special rules for long-term contracts: https://www.law.cornell.edu/uscode/text/26/460
- IRS, Rev. Proc. 2025-32, section 4.30: https://www.irs.gov/pub/irs-drop/rp-25-32.pdf
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