The accounting method you choose (cash or accrual) affects your year-end tax planning activities, and the timing of income and expenses. First, a brief review of these accounting methods, then a discussion of how they each affect year-end transactions.
Cash vs. Accrual Accounting
In cash accounting, income and expenses are recognized as transactions when money changes hands. If you receive a bill, it only counts as an expense when you actually pay it, and income is counted only when you actually receive the money.
In accrual accounting, the transaction must be counted when it is established. For example, if you send someone a bill for your services, you count the income from the date of the bill. In accrual accounting, you count an expense when you receive the bill.
Year-End Transactions, Taxes, and Accounting Method
The general rule for timing transactions is to first make a determination about which year will most likely have higher income, then to maximize deductible expenses in the year of higher income, and move income to the year of lower income.
- Timing income:
If you are using cash accounting, see if you can get customers to pay you in the year when you want to take the income (this year or next year).
If you are using accrual accounting, you can time income by sending out bills before the end of the current fiscal year or after the beginning of the next fiscal year, depending on when you want the income to be recorded.
- Timing expenses:
For cash accounting, pay bills in the year with the highest income, so you can increase your deductible expenses and minimize your taxes for that year.
For accrual accounting, you might ask vendors to bill you in the year you want to have the most expenses.
In all cases, work to minimize income in the year when you estimate your income will be highest, and maximize expenses in the year with the highest income. How you do this depends on the accounting method you use, as shown above.
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