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How Do I Time Income and Expenses at the End of the Tax Year?

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Question: How Do I Time Income and Expenses at the End of the Tax Year?
Answer:

Income and Expenses at Year End Many businesses have found that they can minimize business taxes year-to-year by considering carefully when to make payments and create income at the end of the tax year. For example, if you want to lower your business tax bill this year, pre-pay insurances, mortgages, and loans to increase your expenses. End of the tax year expense and income timing applies in several financial areas, including payroll taxes, gifts and donations, and credit card payments.

The principle of "constructive receipt" applies to payments and income that cross over the end of the year. According to the IRS, constructive receipt means that income is constructively received when an amount is credited to your account or made available to you without "substantial restriction or limitation," even if you don't have possession of it. For example, it might be held by an agent or in your bank account through direct deposit.

Employee Pay and W-2 Income
Employee wages at year-end are sometimes tricky, because of constructive receipt. Employee wages must be recorded in the correct year, and the date of the paycheck is controlling. If a paycheck is dated in December, that is the year the employee is considered to have received the pay, even if the paycheck hasn't been picked up yet. Sometimes, paychecks reflect income from two years; the last week in December and the first week in January, for example. If the paycheck is dated in January, all of the income is considered to have been received in the second year, because the employee did not have receipt of the money in the first year.

But, if employee had access to the wages in the first year "without substantial limitation or restriction" (remember constructive receipt), even if the check was dated in the second year, all of the money is considered to have been received in the first year. This might be the case if the money is deposited using direct deposit in December, for a pay period ending in January.

This issue affects amounts on employee W-2 forms. Check with your tax advisor if you aren't sure how to allocate employee pay across two years.

Payments at End of Year

  • Gifts and donations If you want to get credit for making a charitable donation, make sure the check is deposited this year. Use a certified check or electronic funds transfer rather than sending a regular check in the mail. Read more about business tax deductions for charitable gifts, to be sure the gift or donation is deductible.
  • Expense payments. Use the same principle as described for gifts and donations, and remember constructive receipt, to make sure the recipient takes receipt of the payment. For example, if you are pre-paying your business insurance or loan, send the payment electronically or walk the check to the recipient. Your December bank statement can be used to substantiate the receipt of the payment.
  • Buying assets. The IRS considers an asset to be owned by a business when it is "put into service," that is, when it starts being used. So even if you buy the asset this year, if you don't start using it until next year, you can't take a depreciation (bonus depreciation, for example).

Using a Credit Card
It's certainly appropriate to use a credit card to make those end-of-year payments. You don't have to pay off the balance now, but the expense can be recorded this year. For example, if you buy computers for your business before the end of the year, using your business credit card, you can get the depreciation deduction this year and pay off the credit card next year.

1099 Reporting for Independent Contractors
An independent contractor that performed work for your company may have received a payment in early January, but you might have mailed (and recorded) the payment in December and recorded the payment as part of the contractor's Form 1099-MISC for this year. The independent contractor should include the payment as it is reported on this year's Form 1099-MISC, but subtract the payment and attach an explanation with the return. The independent contractor must then include the payment on next year's return, even though no 1099 will be issued for next year.

Accounting Method and Income/Expenses
The accounting method you use for your business (cash or accrual) makes a difference in timing of payments and income and in the determination of constructive receipt. In cash accounting, you recognize the income when it is received and the expense when the bill is sent. In accrual accounting, you recognize the income or expense when it is established (that is, when the bill is sent or received). Read more about the differences between cash and accrual accounting before you attempt to time income and expenses between tax years.

DisclaimerAs mentioned above, end of the tax year timing is tricky. Discuss timing issues with your tax advisor before you commit to them.

Read more about how to save on business taxes with these end of the tax year tips.

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