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Gilt Company is a cash-basis calendar-year taxpayer. The company's president has decided to do some year-end tax planning. The company has $50,000 in excess cash, so he would like to prepay some expenses before year-end in order to reduce taxable income. The company could buy supplies, prepay interest expense, or prepay two years of insurance expense. He wants your advice about which item the company should pay. What advice I can give to Gilt?

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The solution assists with giving advice to what can be given to the Gilt Company.

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In general, if you are a cash-basis taxpayer who prepays interest on a loan, you are not permitted to deduct all the interest in the year of payment. Under the Internal Revenue Code, you are required to capitalize the prepaid interest and deduct it as if you are an accrual-basis taxpayer. In other words, you cannot take a deduction for interest other than in the year in which it is due. The prepaid interest is allocated to the tax year in which the interest actually represents the cost of using the borrowed money.

Generally, taxpayers who use the cash basis method of accounting are not permitted to deduct prepaid ...

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Sandeep Bardia, MBA
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  • MBA, Rochester Institute of Technology
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