When do I get to deduct the expense?

For many businesses, cash is tight right now.  But there still is taxable income, and you'd sure like some more deductions this year.  As I mentioned, cash is tight.  Can you deduct something this year even if you pay it next year?

Sometimes.

In general, if you are a cash-basis taxpayer, you have to pay your business expenses by the last day of the year to deduct them. If you are an accrual-basis taxpayer, you have to clear the "all-events test." That is, all events to determine the liability must have taken place by year-end, and the liability must be determinable with reasonable accuracy.

But that would be so simple. For example, even cash-basis taxpayers may deduct contributions made after year-end to qualified retirement plans that are set up by year-end, as long as the contributions are made by the due date of the tax return (including extensions).

Most of the time, though, the tax law looks to limit your ability to deduct expenses paid after year-end. For example, even accrual-basis taxpayers can't deduct expenses accrued to "related" cash-basis taxpayers. Such expenses are deductible to the accrual-basis taxpayer only when the related cash-basis taxpayer has to record the income. Even when unrelated parties are involved, the expense is deductible only if "economic performance" has occurred. That exception to the "all-events" test itself has an exception; the "recurring item exception."

Accrued compensation is normally deductible for accrual-method payers if the expense is actually paid within 2 1/2 months of year-end. When the recipient is a related party, though, the expense is deductible only in the year paid.

Finally, even expenses paid before year-end normally are non-deductible if they purchase a benefit that goes out beyond one year. If, for example, you prepay your tax fees for five years (an idea that I would always encourage for my own selfish reasons), you would only get to deduct the amount for the next 12 months. The remaining prepayment would be capitalized and deducted in the year to which it applies.

So for your year-end planning, this means:

- You have to pay related cash-basis taxpayers by year-end to get the deduction this year.
- You have to have your qualified plan set up by year-end to deduct contributions for this year, but you have until the return due-date to make the contributions.
- Don't overdo prepayments (except perhaps to your friendly tax preparer). If you prepay beyond one year, such prepayments aren't currently deductible.

If you think a taxpayer might be a related party, contact your tax advisor to get more information.