Need Some Deductions for 2011?

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10 Oddball Tax Deductions

11 Most Overlooked Tax Deductions

Updated for 2011

Accounting Methods

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Prepaying Expenses Under the Cash Method

There are two rules that govern how you deduct advance payments (prepaid expenses).

The General Rule
The 12-Month Rule

1) The General Rule:

Under the general rule you may not deduct the full amount of an advance payment covering more than 12 months.

You must deduct a portion of the payment in the year to which it applies.

Example:

The General Rule.

You're a cash method taxpayer on a calendar year.
On October 1, 2011 you pay $3,600 in advance for business insurance covering three years.
Coverage begins October 1, 2011.
Coverage ends September 30, 2014.

Result:

The general rule applies.
The advance payment covers more than 12 months (36 months).

A portion of the $3,600 must be deducted ratably over the three-year period.

To find the portion of the $3,600 you can deduct each tax year:

First, divide the $3,600 by 36 (months) to find the monthly premium amount.
Then, multiply the number of months remaining in each tax year by the monthly premium.
2011: deduct $300 ($3,600/36 x 3).
2012: deduct $1,200: ($3,600/36 x 12).
2013: deduct $1,200 ($3,600/36 x 12).
2014: deduct $900 ($3,600/36 x 9).

2) The 12-Month Rule:

This rule says that you may deduct the full amount of an advance payment in the year the payment is made if it creates rights or benefits for the taxpayer that do not extend beyond the earlier of:

12 months after the right or benefit begins, or
The end of the tax year after the tax year in which payment is made.

Example #1:

The 12-Month Rule.

You're a cash method taxpayer on a calendar year.
On September 30, 2011 you pay $2,000 for business insurance covering one year.
The policy begins October 1, 2011 and ends September 30, 2012.

Result:

The 12-month rule applies.
Deduct the full $2,000 in 2011.

The benefit does not extend beyond 12 months after the right to receive the benefit begins-October 1, 2011.

Example #2:

The 12-Month Rule.

You're a cash method taxpayer on a calendar year.
On September 1, 2011 you pay $1,000 for business insurance covering the first six months of 2012 (January 1, 2012 through June 30, 2012).

Result:

The 12-month rule applies.
Deduct the full $1,000 in 2011 when the payment was made.

Although the benefit begins January 1, 2012, it does not extend beyond the end of 2012 (the year following the year of payment, which was 2011).

Accounting Methods-Cash Method: The Accrual Method Exception Under Revenue Procedure 2002-28

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Accounting Methods

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Prepaying Expenses Under the Cash Method

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