Podcast: Timing of Year-End Business Expenses

Year-End Business Expenses

Written by Jeff Dvorachek

December 23, 2021

Over the summer and fall, there has been a lot of talk about the tax legislation going through Congress. It’s called the Build Back Better Act. The legislation has gone through the House and now is in the Senate with some kind of passage expected by the end of the year. Last week, we talked about some income tax aspects of the plan. This week I want to look at some other potential changes.

What do you mean by “no matter how a company accounts for its normal expenses”?

  • There is essentially two ways that a company can account for its expenses – the cash method and the accrual method.
  • Under the cash method, a company gets to deduct an expense as soon as they pay the bill.
  • Under the accrual method, a company gets to deduct an expense as soon as they incur the cost. It does not matter when they pay it (within reason).
  • But there are some exceptions to these rules

Ok, let’s talk about those.

  • First is inventory. If you purchase something today that will not be sold until tomorrow, you don’t get to take the expense until it is sold. Now as there always is, there are some exceptions where the inventory is not a material part of your business. In this case the deduction can be taken earlier.
  • Second is buying a fixed asset, like a vehicle or equipment. These are items that generally last longer than one year. The rules here are you can start to deduct it in the year it is “placed in service”. In other words, when you start to use it. This is the same whether a business is using the cash or accrual basis. It does not generally matter when it is paid for.

That makes sense, but what about regular expenses like wages or rent?

  • That is a good question since it is treated differently whether the business is related to the person who is getting the payment or not.
  • For rent or wages to a related person, the payment must be made before the end of the year to be deductible. An accrual basis business essentially needs to treat these expenses like they were on the cash basis.
  • And it makes sense because if the person who is making the payment and receiving the payment is the same person, they have a direct effect on the timing.
  • They could set it up so that the company gets a deduction this year, but the related person does not need to pick it up as income until next year. This rule stops that from being done.

What about paying an expense to an unrelated person?

  • For a cash basis business, it is deductible when paid.
  • But for an accrual basis business, as long as the expense in incurred, they can pay it next year and still deduct it in the current year.
  • That being said, the expense still generally still needs to be paid within 2 ½ months after the year end or it may not be deductible.

Be sure to talk to a tax professional if you have any questions about Timing your Year-End Business Expenses.

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Jeff Dvorachek
I joined Hawkins Ash CPAs in 1998. I am the partner-in-charge of the Manitowoc, WI, office and tax director for the firm. I have thorough experience providing tax services to individuals, commercial businesses, nonprofit entities and estates and trusts. I also provide compilation and review services. I lead the Tax Committee and am a member of the Information Technology Advisory Committee.

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