Can you believe that we are in November already? It is time to have a discussion on what to do with income for 2013. I am starting a six week series on Tax Avoidance. This week we are going to talk about the deferral of income. Today we are going to discuss cash basis and accrual basis income shifting strategies.
First some background on cash vs. accrual. The cash method of accounting dictates that you recognize income as you receive it. That is logical. So our customers pay us, and now we have income. The accrual method of accounting states that we recognize income when we incur income. That is a fancy way of saying that when we bill our customer or client, we have to claim the income. So whether or not we receive the money is immaterial under the accrual method of accounting. It is income when we bill it. You choose whether you are a cash method taxpayer or an accrual method taxpayer on your first business tax return. This is an important choice that your tax professional should make. This really isn’t a do it yourself thing. There are different reasons to do different things.
Under the cash method of accounting I can only defer my income by just not CONSTRUCTIVELY receiving it. Constructive receipt is what is important. The definition of constructive receipt come from IRS Reg. §1.451-2(a) which basically states that , income is constructively received by a cash-basis taxpayer when it is credited to his account, set apart for him, or otherwise made available to him. So, once an item is credited to the account of the taxpayer upon which he may draw at any time, or once it is set off against a debt owed by him, it is constructively received. So even if you get a check on December 31st that you don’t deposit until January, you still constructively received it in December. Under the accrual method of accounting it is pretty simple to defer income. You simply just don’t bill for your services until the following year. These are the rules that we have to operate under. Remember it is always important to understand the rules first.
Under the cash method of accounting you slow down income by just telling your customers not to send you checks until the following year. But esthetically, who wants to do that? Hey customer you owe me money, but don’t send me a check until January. They want to send the money to you, because, guess what? They want to count that expense on their return. They may need it. Plus who turns down money? Not me. Under the accrual method of accounting, you just wait to bill for your services. That is pretty simple right there. Just wait and bill.
Believe it or not there are a lot of situations where you would want to accelerate your income. That’s right. You want to increase your income and pay taxes now rather than later. I am sure I just lost a client or two by saying that. Just stay with me for a second. Let’s say that in 2013, you are in the 25 percent tax bracket. But it is November and you just signed this big contract that is going to pay you $480,000 guaranteed in 2014. In 2014 you will be in the 39.6 percent tax bracket. So you save a lot of money in 2013 if you would just bill for your services, or call those customers and ask them to pay you before yearend. See there was a method to my madness.
I have stressed this so many times in my articles, it is times like this that you have to just pay some good money for an accountant or tax person to TELL YOU to do this. You are too busy running your business. Now you are going to have to pay a little bit of money for a tax accountant that knows his stuff. Paying professionals should never go to the lowest bidder. Just throwing that out there.
So, in conclusion, talk to your tax advisor. Get with them before year end. If you wait until tax time, it will be too late.
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If you have any questions you can email Craig W. Smalley E.A., C.E.P.®, C.T.R.S.®
Admitted to Practice Before the Internal Revenue Service
Certified Estate Planner®
Certified Tax Resolution Specialist®
Author of the books:
- It Starts With an Idea – Tax Tips for Small Businesses
- The Ultimate Real Estate Investor Tax Guide
- The Complete Guide to the New Tax Law – American Taxpayer Relief Act of 2012
- Everything You Wanted to Know about the IRS – Audits, Appeals and Collections
- Tax Avoidance is Legal! The Complete Guide to Individual Income Tax
- The Complete Guide to the Affordable Care Act’s Tax Provisions
- The Complete Guide to Retirement Plans for Small Businesses
- The Complete Guide to Estate, Gift and Trust Taxation
- The Complete Guide to Hiring an Accountant
- The Complete Guide to Subchapter S-Corporations,
- Free Money
All available exclusively on Kindle