CLIENT KNOWLEDGE BASE

    Deferring Income and Accelerating Expenses as a Cash Basis Taxpayer: A Strategic Guide

    As the year-end approaches, cash basis taxpayers often consider strategies to manage taxable income effectively.
     
    Two of the most common methods are deferring income and accelerating expenses. At Anomaly, we believe these tactics can be particularly useful if you're experiencing an abnormally good or bad year and need to manage your tax liability. 

    Here’s how these strategies work and when they might be appropriate.

    1. 1

      Understanding the Cash Basis Taxpayer

      Don't know?  Ask you PM in soraban! You most likely ARE Cash Basis.

      Cash basis taxpayers recognize income when it is received and deduct expenses when they are paid. This is in contrast to accrual basis taxpayers, who recognize income when earned and expenses when incurred, regardless of when cash changes hands.

    2. 2

      Deferring Income to Next Year

      Deferring income involves delaying the receipt of taxable income until the next tax year. Common methods include:

      1. Postponing Invoicing:
        • If you’re a business owner, consider delaying invoicing for work completed late in the year. For instance, sending an invoice on January 1 instead of December 31 defers the income to the following tax year.

      When to Defer Income

      Deferring income is most beneficial if:

      • You’re having an abnormally good year: Delaying income can help keep your taxable income below certain thresholds to avoid higher tax rates, phaseouts of deductions, or additional taxes like the Net Investment Income Tax (NIIT) depending on your total income. 
      • You expect lower income next year: Deferring income into a year when you anticipate being in a lower tax bracket can result in significant tax savings.

      Caution

      While deferring income is a legitimate strategy, excessive deferrals might draw scrutiny from the IRS if it appears you're manipulating taxable income without a bona fide business purpose.
    3. 3

      Accelerating Expenses into THIS Year

      Accelerating expenses involves paying for deductible items before the year ends to lower your taxable income for the current year. Common methods include:
      1. Prepaying Business Expenses:
        • For businesses, consider prepaying rent, insurance, or utility bills for the first few months of the next year. 
      2. Purchasing Supplies or Equipment:
        • Stock up on office supplies, or consider purchasing equipment that qualifies for the Section 179 deduction or bonus depreciation (60% in 24, 40% in 25). 
      3. Accelerating Repairs and Maintenance:
        • Schedule repairs or maintenance expenses before year-end to claim them in the current year EVEN if you do not need that repair until Jan or Feb. 

      When to Accelerate Expenses

      Accelerating expenses is most beneficial if:
      • You’re having an abnormally good year: Reducing taxable income now can help offset a spike in earnings, potentially keeping you in a lower tax bracket.
    4. 4

      Balancing the Strategies in Abnormal Years

      Abnormally Good Year

      In a strong income year:
      • Primary Goal: Reduce taxable income to minimize tax liability and avoid additional taxes tied to high earnings.
      • Strategies: Focus on deferring income and accelerating deductions to offset higher earnings.

      Abnormally Bad Year

      In a low-income year:
      • Primary Goal: Increase taxable income or reduce deductions strategically to avoid wasting tax benefits like credits or losses.
      • Strategies:
        • Avoid deferring income: Instead, consider recognizing as much income as possible in the current year to use up available deductions and credits.
        • Postpone expenses: Delay expenses to next year if you anticipate higher income, allowing deductions to have a greater impact.
    5. 5

      Example Scenarios to Think About

      Scenario 1: Abnormally Good Year

      A consultant on the cash basis expects a net income of $500,000 in 2024, significantly higher than their usual $250,000. They could:
      • Defer $50,000 in invoiced payments into January 2025.
      • Prepay $10,000 in office rent for the first quarter of 2025.
      • Purchase a $30,000 piece of equipment qualifying for the Section 179 deduction.

      Result: Their taxable income decreases by $90,000, potentially saving $32,000 in taxes (assuming a 35% marginal rate).

      Scenario 2: Abnormally Bad Year

      A freelance designer on the cash basis expects only $50,000 in income in 2024, compared to $150,000 in prior years. They could:
      • Invoice all clients before December 31 to maximize income for the current year.
      • Delay purchasing new equipment until 2025 to use deductions when they’re in a higher tax bracket.

      Result: They maximize the tax value of income and deductions over both years.

      If you have questions, reach out in Sorbaban!
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