Want to cut your tax bill, legally? Pre-pay agency expenses!

Written by: Karl Sakas

In business school, our business law professor asked the class, “How many legal deductions are you permitted to take?” Answer: “All of them.”

Are you worried about a big year-end tax bill? I’ve got good news.

If you have extra money in the bank—and you do accounting on a Cash basis—you can likely cut your tax bill by pre-paying next year’s expenses.

Let’s look at some U.S.-oriented examples. Disclaimer: Ask your accountant to confirm that this applies to your situation.

Things You Might Pre-Pay

Here are some examples of things you can pre-pay this year to potentially cut your next tax bill:

  1. Rent
  2. Insurance premiums
  3. Accounting fees
  4. Consulting fees
  5. Office supplies (stock up!)

You can also potentially take a deduction this year for new computers, phones, etc.—but double-check with your accountant first, since you may need to deduct capital equipment over time.

Caveats

This is based on U.S. tax law—things will vary if you’re outside the United States. Here are some additional caveats:

  1. If you do accounting on an Accrual basis, this tip likely won’t apply. More on that here.
  2. Don’t dip into your cash reserves to pre-pay expenses. You need the cash more than the deduction.
  3. Don’t spend money for the sake of spending money—spend it on things you need. And be realistic—buy 1-2 toner cartridges, not 20.
  4. Don’t pre-pay more than 12 months of expenses. This can trigger the “12-month rule” that reduces deductibility.
  5. This doesn’t erase your tax liability next year—but it lets you defer taxes to a year from now.

Schedule a Meeting with Your Accountant

Ask your accountant about your specific situation—you should be meeting with them before year-end anyway.

If they confirm you can use pre-paid expenses to cut this year’s tax bill, ask them for a projected estimate of your taxes to help you decide how much to pre-pay. Based on that number, you can decide what to pre-pay.

You’ll need to make some prioritization decisions; just because you can pre-pay doesn’t mean you should. You’ll still want a healthy cash reserve, and you shouldn’t use potential tax savings to pre-pay for things you don’t actually need. (When I pre-pay, I focus on things I know I’ll be using next year.)

Question: What might you do today to cut your tax bill in the future?

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