Most individuals and many small businesses use the cash basis method of accounting. With this method you record income when money is received and you record expenses when money is paid out. Tax deductions are taken in the year they’re paid for.
The general rule is that you can’t prepay business expenses for a future year and deduct them from the current year’s taxes. This means that generally an expense you pay in advance can be deducted only in the year or years to which it applies. Such an expense must be prorated over time rather than deducted in full in the tax year in which it is paid.
However, there’s an important exception called the 12-month rule. It lets you deduct a prepaid future expense in the current year if the expense is for a right or benefit that extends no longer than the earlier of:
- 12 months after the right or benefit begins, or
- the end of the tax year after the tax year in which payment is made
An example the IRS provides in Publication 538 is:
“You are a calendar year taxpayer and pay $10,000 on July 1, 2016, for a business insurance policy that is effective for only one year beginning on July 1, 2016. The 12-month rule applies. Therefore, the full $10,000 is deductible in 2016.”
Therefore, you may be able to deduct those prepaid expenses sooner than later.