2009 Tax Strategy XIII – Deducting Prepaid Business Expenses

A question that often arises is whether prepaid business expenses can be deducted in the year it is paid. Unfortunately, they cannot. Generally, where an expense relates to a period covering more than 12 months, the IRS and most courts agree that the deduction must be spread over the period to which the expense applies.

For example, you purchase a three-year maintenance plan for your office photocopy machines. The service company offers you a discount to prepay the contract, which you end up doing. In this case, the expense must be amortized (ratably deducted) over the three-year period and not all at once in the year paid. If you had only prepaid three months of the contract, that amount would have been deductible in the year paid. This rule precludes business owners from prepaying expenses as a means to reducing their profits for a particular year.