By Amy Smith

As we approach the end of the year, it becomes increasingly more critical to focus on tax planning. Cash basis taxpayers are in a unique position because there are numerous tax planning strategies that can be put into effect with relative ease. Many of these strategies can be summed up in one simple phrase – control cash. As the amount of taxable income a cash basis taxpayer reports will primarily be a function of cash inflows and outflows, it stands to reason that a cash basis taxpayer can control taxable income by controlling the inflow and outflow of cash from the business. A cash basis taxpayer may want to consider the following suggestions for 2002 year-end tax planning.

One area a taxpayer may have some flexibility with is the receipt of cash. Cash received for services in 2002 will be taxed in 2002. However, if the taxpayer doesn't receive that income until 2003, then that income would not be taxed until 2003. Therefore, if the taxpayer wants to reduce the amount of income taxed in 2002, she would want to control the amount of cash received in 2002. One strategy for controlling cash receipts is to defer billing your customers. If a taxpayer defers some billings that would normally be sent in mid-December until the end of December, then the customer may not have sufficient time to make payment prior to year-end. Therefore, the taxpayer would likely receive the cash in 2003, and thus, the income would be taxed in 2003. Please note, however, that deferral of a cash receipt may not be possible in all situations. The billing relationship the taxpayer has with her customer may not provide the flexibility to defer billings. Many government contractors are expected to bill certain government agencies at specific intervals and should not deviate from that time frame.

Given the restrictions that may be placed on controlling receipts, cash basis taxpayers often look to controlling their cash disbursements in order to control their taxable income. As with cash receipts, the year when the cash disbursement is made controls the year in which the deduction is permissible (for expense items only). Therefore, if the taxpayer wanted to accelerate a deduction to the 2002 tax year, that expense should be paid in the 2002 tax year. If the taxpayer wanted to defer a deduction into the 2003 tax year, she would refrain from making the payment in 2002 and make the payment in 2003. The following summarizes some strategies a cash basis taxpayer may want to employ in controlling cash disbursements.

One of the strategies a cash basis taxpayer may employ if she wanted to accelerate deductions into the 2002 tax year is to prepay expenses. This means that the taxpayer would pay an expense in advance of when it is actually incurred. For example, assume that the company rents office space for $2,000 a month. As of December 15, 2002, it has paid all of its rent payments through the end of 2002. The company may want to consider paying its rent expense for the month of January prior to the end of 2002 in order to secure an additional $2,000 deduction in 2002. There are some limitations, however, on the extent you can prepay your expenses. Generally, the prepaid expense must be an expense that you would normally pay within the next year and there must be a business purpose for prepaying the expense, not just to avoid taxes.

A second strategy that a cash basis taxpayer may want to employ to reduce 2002 taxable income is to pay down any accounts payable and accrued expenses that are outstanding. For example, if a taxpayer has $25,000 of deductible accounts payable in December 2002, she may want to consider paying these payables prior to year-end to receive a deduction in 2002. If the payments are not made until January, then the deduction for these items will not be received until 2003. Other items a taxpayer may want to consider paying before year-end include accrued salary items, such as bonuses, vacation and payroll. If these items are paid prior to December 31, 2002, the deduction will be received in 2002.

There is one notable exception to the cash disbursement rule. To the extent that you will make a retirement plan contribution for the 2002 tax year, you will obtain a deduction in the 2002 tax year as long as payment is made prior to the due date of the tax return (for some types of plans, this will include extensions). Depending on the type of account that is set up and the type of taxpayer (individual/partnership versus corporation), this could allow a taxpayer to take a current deduction for a cash disbursement you will not make until up to nine and a half months after year-end. This is a great strategy for companies or individuals that do not have the cash available at year-end to implement some of the other strategies.

In addition to the cash basis strategies above, here are a few additional tax-planning strategies to consider.

• First, the IRS allows taxpayers to elect to expense certain qualified fixed asset additions up to $24,000 for 2002. Therefore, if a taxpayer has not already purchased $24,000 of qualified additions in 2002 and plans on making some purchases in early 2003, she may want to consider making those purchases prior to year-end to accelerate the deduction to 2002.
• Further, taxpayers should note that some fixed assets may be allowed a 30 percent bonus depreciation in 2002. The taxpayer may elect out of the 30 percent bonus depreciation if it does not meet her objectives for the 2002/2003 tax years.

As you can see, there are numerous strategies that can be implemented to control a cash basis taxpayer's 2002 taxable income. Some of these strategies require some advance planning and will require continual monitoring as year-end approaches. However, with effective implementation, these strategies can result in positive tax savings for you and your business.

Amy Smoth, CPA, has over nine years of diversified experience in many industries – particularly real estate and services industries. She joined AWR in 2000 after working as the Senior Tax Analyst at NVR, Inc., where she was responsible for managing the corporate compliance requirements for consolidated income tax, sales and use tax, property tax and business licenses. She was also responsible for the coordination of various sales and use tax and income tax audits and research of planning opportunities in the homebuilding/construction and mortgage banking industries. Upon graduation from college, she joined Arthur Andersen and has worked in their Rochester, New York and Jacksonville, Florida offices. During her five years with Arthur Andersen, she provided tax compliance and consulting services to various manufacturing, distribution and service companies, individuals and international executives.