As the end of the year approaches, it is a good time to think of planning moves that will help lower your tax bill for this year and possibly the next. While many strategies exist, and tax planning should be highly customized to your individual situation, let’s broach one particular strategy: shifting expenses as a cash-basis taxpayer.
Before all else, who can operate on the cash-method? Under the gross receipts test, taxpayers with average annual gross receipts that do not exceed a dollar amount for the three prior tax years may use the cash method. For 2020, the gross receipts test is satisfied if, during the three-year testing period, average annual gross receipts do not exceed $26 million.
If you are a cash-basis taxpayer, a common goal at year-end is to delay the receipt of cash from customers and to accelerate business expenses. By reducing your cash on hand at year-end, it results in lower taxable income. If you operate in the restaurant industry, it’s nonsensical to delay receipt of cash from customers. The focus will need to be put on the acceleration of business expenses. If a taxpayer is permitted to, and does, keep their tax records on a cash basis, their business expenses are deductible when paid. Thus, the taxpayer can accelerate 2021 expenses into 2020 by doing the following:
(1) Pay in 2020 all bills already received for expenses rather than deferring payment until 2021.
(2) Choose to incur and pay in 2020 expenses that would normally be incurred and paid in 2021. For instance, the taxpayer might have repair and maintenance work performed before the end of 2020 instead of waiting until early 2021. Or make a subscription payment due in Jan. 2021 in Dec. 2020.
(3) Prepay expenses where feasible. Some prepaid expenses such as insurance, dues and service contracts can be deducted by a cash method taxpayer in the year of payment. Certain other prepayments made by cash method taxpayers, such as prepaid compensation must be prorated over the period to which they apply. Discuss this strategy with your tax advisor before moving forward. Certain rules must be met, and you may have to notify the IRS if you were not deducting prepaid expenses in the past.
Also remember you can use credit card charges to accelerate deductible expenses. Even as a cash-basis taxpayer, the credit card bill does not need to be paid before year-end to get the deduction.
If you expect to be in a higher tax bracket next year or Congress and the White House are expected to raise rates for 2021, you’ll want to flip your thinking. Saving the cash now and paying the tax this year may be a better approach.
Please contact your Henry+Horne advisor with any questions.
Scott W. Clouse, CPA