Joe Kristan is a CPA at Roth & Company P.C.
While April 15 gets all the glamor, tax-savvy folks know that December 31 is where the real action is. While you add up the score in April, December is when you run the two-minute drill.
You can't run a good two-minute offense if you don't know the rules of the game (to continue the sports theme at least one paragraph too far). It doesn't help that with last-minute legislative tax law changes, year-end planning this year is like running a two-minute drill in a game of Calvinball. Yet we have to plan with the tax law we have, not the one we would prefer, so here are some notes you can write on your wrist as you call your year-end tax plays.
Figure out where you are on the field. The quarterback running a two-minute drill will call different plays on one ten-yard line than he will on the other. You need to pencil out your taxable income to-date for any year-end planning moves to succeed other than by accident. When you run the numbers, you may find that your deductions will end up being more valuable next year.
If you are planning for your business, figure out whether you are a cash-basis or an accrual-basis taxpayer. The rules to get a deduction are different.
Cash-basis businesses record their income when they receive the check. The tax law says you can't defer income by letting uncashed checks accumulate; if you can deposit a check, you've earned it, as far as the IRS is concerned.
Cash basis taxpayers generally deduct an expense when it is "paid." When does that happen?
- If the item is paid for with a credit card, it is "paid" when it is charged to the card, even if the card balance isn't paid until a later year.
- If the item is paid with a check, it is "paid" when the check is mailed (postmarked), even if the check isn't cashed until a later year.
There are limits on cash-basis deductions. For example, you can't prepay items for more than a year at a time, and there are other rules that can apply to deal with taxpayers that try to do too much of a good thing.
Accrual basis taxpayers pick up income when they have earned the income, even if they haven't been paid yet. For example, a wholesaler will normally record income when it ships the goods, even on credit. Accrual taxpayers generally get their deductions when they meet the "all events" test: all events have occurred to fix the liability, and it can be determined with reasonable accuracy.
The tax law applies some special limits to expense accruals. For example, the tax law has an "economic performance" requirement that limits accruals until "economic performance" of the activity giving rise to the deduction take place.
You can't just accrue an expense and never pay it if you want to deduct it. Accrued compansation has to be paid within 2 1/2 months of year-end to be deductible. Most other expenses need to be paid no later than 8 1/2 months after year-end.
The related party rules are the biggest practical limit on accrual-method deductions. An accrual basis taxpayer can't deduct an amount accrued to a cash-basis "related party" -- such as a bonus accrued to an owner -- until the related party has to include the payment in income. Whether you are "related" depends a lot on what entity you use to run your business. For example, a person owning 10 percent of a corporation would not be related to a corporation taxed as a C corporation, but would be related if the same corporation were an S corporation. You might even be related to an entity that you don't own at all if a relative is an owner.
Of course, being cash-basis or accrual-basis does nothing to help you deduct an expense that isn't deductible in the first place. Not everything your business can write a check for gets you an immediate deduction, or a deduction at all. Payments for salary have to be "reasonable," so writing a "salary" check to Grandma in Florida whose service to the business consists of monitoring her bingo card isn't going to work. If you buy a car for the business, you face annual deduction limits for vehicles. Owner life insurance premiums are rarely deductible. You get the idea.
With the likely re-enactment of the $500,000 Section 179 expense and 50 percent bonus depreciation for 2014, many owners are tempted to buy a new depreciable asset by year-end to get a big deduction. Be careful. It's not enough to pay for a fixed asset by year end; it has to be "placed in service" by then to be deductible this year. That means the asset has to be on-site and set up and ready to operate. A new machine in a crate on the loading dock at year-end isn't "in service" and won't give you a deduction.
And be sure to consult your tax professional. Even the best quarterback needs a good coach. Every taxpayer is different, and a move that might score for Jill might be a distance and loss-of-down penalty for Jane.