Dear Clients and Friends:
Does it make sense to pay taxes on money you haven’t collected? Probably not! Under current tax laws businesses generally have two methods by which they must report income and expenses, cash and accrual.
There are certain drawbacks to filing under the accrual method of accounting such as:
- You might find it is more difficult to manage the timing of taxable income and deductions.
- You must report income in the tax year your right to income has occurred and the amount can be determined.
- You must also report deductions when the liability and amount has been established.
- Example – a company reports income when it has invoiced the client/customer. What this means is that you may be paying tax on income you haven’t even collected.
The cash method of accounting might be a better option for your business as follows:
- You must report income in the tax year revenue is constructively received (example – when receivables are collected). Deductions are reported in the tax year actually paid.
- You can defer the receipt of income and accelerate payment of expenses to lower taxable income all the way up until the end of the tax year.
- If you want to report more income in the year, such as with tax rates increasing the following year or if you have expiring loss carry forwards, you may accelerate income and defer paying expenses.
Not all businesses can use the cash method of accounting. The businesses that may benefit are:
- Existing service providers such as engineers, architects, attorneys, doctors and consultants.
- Existing businesses that do not carry inventory (carrying supplies may be allowable).
- New businesses that have not established an accounting method for tax purposes.
This is just a brief introduction to the many tax advantages that relate to the use of the cash method for tax purposes. If you wish to discuss your specific needs in greater detail, please give us a call.
Very truly yours,
WRIGHT FORD YOUNG & CO.
Certified Public Accountants and Consultants, Inc.
Please note that any tax laws or regulations discussed in this memo may not necessarily be effective after the date of drafting this article.
To ensure compliance with the requirements imposed by the Treasury Department Regulations (Internal Revenue Service), Wright Ford Young & Co. is required to inform you that any tax advice in this written or electronic communication was not intended or written to be used, and it cannot be used, by a client or any other person or entity for the purpose of avoiding penalties that may be imposed on any taxpayer.