Publication 535 |
2001 Tax Year |
When Can I Deduct an Expense?
When you deduct an expense depends on your accounting method. An
accounting method is a set of rules used to determine when and how
income and expenses are reported. The two basic methods are the cash
method and an accrual method.
For more information on accounting methods, see Publication 538.
Cash method.
Under the cash method of accounting, you generally deduct business
expenses in the tax year you actually paid them, even if you incurred
them in an earlier year.
Accrual method.
Under an accrual method of accounting, you generally deduct
business expenses when both of the following apply.
- The all-events test has been met. The test is met when:
- All events have occurred that fix the fact of liability, and
- The liability can be determined with reasonable
accuracy.
- Economic performance has occurred.
Economic performance.
You generally cannot deduct or capitalize a business expense until
economic performance occurs. If your expense is for property or
services provided to you, or for your use of property, economic
performance occurs as the property or services are provided, or the
property is used. If your expense is for property or services you
provide to others, economic performance occurs as you provide the
property or services.
Example.
Your tax year is the calendar year. In December 2001, the Field
Plumbing Company did some repair work at your place of business and
sent you a bill for $150. You paid it by check in January 2002. If you
use an accrual method of accounting, deduct the $150 on your tax
return for 2001 because all events occurred to fix the fact of
liability and economic performance occurred in that year. If you use
the cash method of accounting, you can deduct the expense on your 2002
return.
Prepayment.
You generally cannot deduct expenses in advance, even if you pay
them in advance. This rule applies to both the cash and accrual
methods. It applies to prepaid interest, prepaid insurance premiums,
and any other expense paid far enough in advance to, in effect, create
an asset with a useful life extending substantially beyond the end of
the current tax year.
Example.
In 2001, you sign a 10-year lease and immediately pay your rent for
the first 3 years. Even though you paid the rent for 2001, 2002, and
2003, you can deduct only the rent for 2001 on your current tax
return. You can deduct on your 2002 and 2003 tax returns the rent for
those years.
Contested liability.
Under the cash method, you can deduct a contested liability only in
the year you pay the liability. Under an accrual method, you can
deduct contested liabilities, such as taxes (except foreign or U.S.
possession income, war profits, and excess profits taxes), in the tax
year you pay the liability (or transfer money or other property to
satisfy the obligation) or in the tax year you settle the contest.
However, to take the deduction in the year of payment or transfer, you
must meet certain conditions. See Contested Liability in
Publication 538
for more information.
Related person.
Under an accrual method of accounting, you generally deduct
expenses when you incur them, even if you have not paid them. However,
if you and the person you owe are related and the person uses the cash
method of accounting, you must pay the expense before you can deduct
it. The deduction by an accrual method payer is allowed when the
corresponding amount is includible in income by the related cash
method payee. See Related Persons in Publication 538.
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