- Cash basis (most individuals fall under this type as well as some businesses)
- Accrual basis (typically a business is this type)
Cash basis can easily be defined as recognizing expenses when they are paid and income when it is received. Accrual basis recognizes expenses and income when events occur.
Examples:
- The recognition of income occurs when invoices are cut, not when money is received. If a business ships product and sends an invoice to its customer, the income is earned when the items are shipped and the invoice is produced. Then, when the money is received, perhaps 30 days later, cash is recorded and the accounts receivable balance is reduced. Income was, however, recognized long before the money was provided by the customer.
- In the case of expenses, an easy example of this is utilities. Once a bill is received from a utility company, the event of the expense occurred. The expense has been incurred by the business even though it will not be paid until 20 or 30 days later.
For year-end strategies, the above distinctions are important:
As a cash basis taxpayer, one would want to pay expenses before year-end, and avoid receiving cash/income until the following year. Accrual taxpayers can postpone the recognition of income by delaying the issuance of invoices until next year. And, making purchases of office expenses, etc. yet delaying payment of these expenses until the following year if purchased from vendors offering credit terms.
Charitable contributions can be made with cash (if made by 12/31/15) or credit card and still be counted in 2015 (even though paid in 2016).
Equipment purchases at year-end can count as direct expenses if they qualify for Section 179 direct write-off deduction. So, if there are needs for equipment for one's business, consider making the purchases before year-end and take advantage of write-offs with this deduction.
And, always keep in mind, IRA contributions can be made up to 4/15/16 and still qualify for a potential 2015 tax deduction.
If you have more questions on tax-savings ides before year-end, contact the LFC office.
