What Tax-savvy Business Owners do as the Year-end Approaches

As the year draws to a close, tax-savvy business owners using the cash basis method of accounting face a unique opportunity to manage their tax liabilities effectively. By carefully timing expenses and income, these business owners can reduce their taxable income for the current year and improve cash flow for the next. This post explains why advancing expenses before year-end and deferring income until after the New Year can be a smart strategy, especially when considering deductions for cash basis taxpayers.

© 2025 Cedarmill Financial

Understanding Cash Basis Accounting and Its Impact on Taxes

Cash basis accounting records income when it is received and expenses when they are paid. This method contrasts with accrual accounting, which records income and expenses when they are earned or incurred, regardless of cash flow. Most small businesses prefer cash basis accounting because it is simpler and aligns tax reporting with actual cash movement.

For cash basis taxpayers, deductions for cash basis taxpayers depend on when payments are made, not when bills are received. This timing creates opportunities to reduce taxable income by accelerating expenses or delaying income.

Why Advance Expenses Before Year-end?

Advancing expenses means paying for costs before December 31, even if the service or benefit will be received in the following year. This approach allows business owners to claim deductions in the current tax year, lowering taxable income.

Examples of Expenses to Advance

• Office supplies and equipment: Purchase needed items before year-end rather than waiting.

• Prepay rent or utilities: If your landlord or utility company allows prepayment, consider paying early.

• Professional services: Pay invoices for accounting, legal, or consulting services before December 31.

• Employee bonuses: Issue bonuses before year-end to claim deductions in the current year.

  
  

Benefits of Advancing Expenses

• Lower taxable income: Reducing taxable income can decrease your tax bill.

• Improved cash flow planning: Paying expenses early can help smooth out cash flow in the new year.

• Maximize deductions for cash basis taxpayers: Since deductions depend on payment timing, advancing expenses ensures you don’t miss out on deductions you are entitled to.

  
  

Why Defer Income Until After the New Year?

Deferring income means delaying receipt of payments until January or later. For cash basis taxpayers, income is taxable only when received, so postponing income can push tax liability into the next year.

Practical Ways to Defer Income

• Delay invoicing: Send invoices after December 31 for work completed in December.

• Postpone delivery: If possible, delay delivering products or services until January.

• Hold off on year-end sales: Encourage customers to make purchases in the new year.

• Delay year-end bonuses or commissions: If you pay yourself or employees bonuses based on income, consider timing payments after year-end.

  
  

Advantages of Deferring Income

• Reduce current year tax liability: By pushing income into the next year, you lower taxable income for the current year.

• Manage tax brackets: Deferring income may keep you in a lower tax bracket this year.

• Better cash flow management: Receiving income in the new year can help balance cash flow.

  
  

Important Considerations and Limits

While advancing expenses and deferring income can be effective, there are rules and practical limits to keep in mind.

• Economic substance: Transactions must be genuine. Prepaying expenses without intent to use the goods or services soon can raise red flags.

• IRS rules on prepaid expenses: Some prepaid expenses must be capitalized and deducted over time rather than immediately.

• Customer relationships: Delaying income should not harm customer satisfaction or business reputation.

• Cash flow impact: Ensure you have enough cash to pay expenses early without straining operations.

  
  

Real-life Example

Imagine a small consulting firm using cash basis accounting. In December, the owner pays $10,000 for software licenses that will be used throughout the next year. This payment counts as a deduction for the current year, reducing taxable income.

At the same time, the owner delays invoicing a client for a $15,000 project until January. This defers the income to the next tax year, lowering the current year’s taxable income by that amount.

Together, these moves reduce the firm’s taxable income by $25,000 for the current year, potentially saving thousands in taxes.

How to Plan Your Year-end Tax Moves

• Review your financials early: Start planning at least a month before year-end.

• Consult your accountant: A tax professional can help identify which expenses to advance and income to defer.

• Keep detailed records: Document payments and income timing carefully to support your tax filings.

• Balance tax savings with business needs: Don’t sacrifice operational efficiency or customer relationships for tax benefits.