When you can deduct an expense depends on your accounting method. An accounting method is a set of rules used to determine when and how income and expenses are reported. The two basic methods are the cash method and the accrual method. Whichever method you choose must clearly reflect income.
For more information on accounting methods, see Publication 538.taxmap/pubs/p535-003.htm#en_us_publink1000208635
Under the cash method of accounting, you generally deduct business expenses in the tax year you pay them. taxmap/pubs/p535-003.htm#en_us_publink1000208636
Under an accrual method of accounting, you generally deduct business expenses when both of the following apply.
- The all-events test has been met. The test is met when:
- All events have occurred that fix the fact of liability, and
- The liability can be determined with reasonable accuracy.
- Economic performance has occurred.
You generally cannot deduct or capitalize a business expense until economic performance occurs. If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided, or the property is used. If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. taxmap/pubs/p535-003.htm#en_us_publink1000208638
Your tax year is the calendar year. In December 2009, the Field Plumbing Company did some repair work at your place of business and sent you a bill for $600. You paid it by check in January 2010. If you use the accrual method of accounting, deduct the $600 on your tax return for 2009 because all events have occurred to "fix" the fact of liability (in this case the work was completed), the liability can be determined, and economic performance occurred in that year.
If you use the cash method of accounting, deduct the expense on your 2010 return.taxmap/pubs/p535-003.htm#en_us_publink1000208639
You generally cannot deduct expenses in advance, even if you pay them in advance. This rule applies to both the cash and accrual methods. It applies to prepaid interest, prepaid insurance premiums, and any other expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. taxmap/pubs/p535-003.htm#en_us_publink1000208640
In 2009, you sign a 10-year lease and immediately pay your rent for the first 3 years. Even though you paid the rent for 2009, 2010, and 2011, you can only deduct the rent for 2009 on your 2009 tax return. You can deduct the rent for 2010 and 2011 on your tax returns for those years.taxmap/pubs/p535-003.htm#en_us_publink1000208641
Under the cash method, you can deduct a contested liability only in the year you pay the liability. Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U.S. possession income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. However, to take the deduction in the year of payment or transfer, you must meet certain conditions. See Contested Liability in Publication 538 for more information. taxmap/pubs/p535-003.htm#en_us_publink1000208642
Under an accrual method of accounting, you generally deduct expenses when you incur them, even if you have not yet paid them. However, if you and the person you owe are related and that person uses the cash method of accounting, you must pay the expense before you can deduct it. Your deduction is allowed when the amount is includible in income by the related cash method payee. See Related Persons in Publication 538.