In crop talk there is thread on paying year end bills, and tax effects thereof......…

This is a topic that always presents a lot of different "techniques", many of which are "required by my CPA".  Typically an interesting read.

Good source that summarizes prepaid expenses, and timing of bill payments is article by Andy Biebl, Clifton Larson, Sept 18, 2014 "Year-end Prepaid Expenses".  Just do a google.

Biebl is as good as they get when talking about tax gurus.

IRS Ruling document is revenue ruling 80-335.  Google it. two pages of easy reading, and talks about prepaid expenses, and when expenses are deemed to be paid by cash basis taxpayer.

IRS Code Section 461 is the heart of the matter.

Keep in mind that there are two kinds of expenses--------- operating, or period, expenses, AND capital expenses.

Period expenses are those deductible in the current tax period.

Capital expenses are those which must be capitalized, and typically depreciated.  Capital expenses are given special treatment under Sections 179 and 168(k) for expensing faster than IRS regular guidelines.

461 and rev rul 80-335 deal with period expenses.

1.  payments are deductible when timely made, and when actually PAID. 

Timely refers to being able to prove that payment was made before 01.01.xx.

Postmark is pretty good.…….but not absolute...…..and the payee typically receives the envelope.  The burden is on the payor to prove timely payment.  Having the check clear the bank takes away all doubt...…..but that seldom occurs.

If the payment is significant enough, and other documents---such as paid receipts--- are not available, then merely get some kind of delivery receipt...…..certified mail to show when given to post office, fed ex receipt, affidavit from the office girl that she mailed or delivered timely, etc.

In events where the payor wants the deduction NOW, but the payee wants the income in the next year, then certified mail works great since it shows date of delivery to post office (ie the release date by payor) AND the receipt date by payee, which would be in next tax year.

One CPA even told me that he advised clients to send empty envelopes by certified mail when the clients did not have funds in the bank, thereby documenting the aforesaid, but not having to put up the funds immediately....…...nasty...…..not legal...……

2.  payments actually paid.

Revenue Ruling 80-335 indicates "....the taxpayer is entitled to alloable deductions therefor on the day the checks are placed in the mail, provided the checks are subsequently paid by the bank."  (Estate of Witt v Fahs......etc.)

So, funds do not have to be on deposit at the bank at the time the checks are released...….just when the checks clear.

Note that Rev Rul 80-335 was written in 1980...…….so that has been law for many years.

We typically put a statement in the return that says that the taxpayer has an agreement with local bank to clear checks in the event of an overdraft, by placing funds in the account and charging a fee for the service, or turning the overdraft into a note...…….thereby covering any potential for a whoops.

Of course, that agreement has to exist.

3.  Effect when recipient holds check.

If the recipient holds the check...…..WITHOUT BEING SO INSTRUCTED BY PAYOR......that is on the recipient's neck...…...not the payor's.

However, it is obvious that if the recipient holds the check, the payor has additional burden to prove that funds were available to clear the check, and that the payment was released/delivered timely.

Hard to beat certified mail.

4.  Transactions with relatives.

Code Section 267 has provisions to curb monkeying around among family members.

In general it says that the payor is NOT allowed to take a deduction until the year the payee takes the item into his taxable income.

The family members are specified.

For example...…...rent payments by son mailed to father...…...with son wanting the deduction this year, and father wanting income next year...…..kills the deduction until the father picks up the income.

I don't remember about brothers/sisters, or nephews/uncles...…..but such is there.

5.  Cash basis rules require recognition of income at point of receipt.

If the 1099 is issued---- properly--- as of the date the check is mailed, then cash basis is REQUIRED to recognize the income as of the date such is received.

REcipient merely needs to include statement showing the circumstances.

The old wives' tale of "recipient must recognize income in conformity with 1099" is just that.....old wives' tale.

I have never heard of IRS reversing a recipient of included the income in year of 1099-------but strict adherence to the law would allow them to kick it into the next tax year.

(One defense against them kicking it fut is if recipient/taxpayer has enough history to show the basis for an adoption of an accounting method.)

6.  Funds obtained from vendor.

Payor has to be careful from where period funds are borrowed, if immediate deduction is desired.

If payor wants an immediate deduction, and payor borrows the funds used to make the payment, then those funds have to be "third-party" funds...…...cannot come from vendor.

That is why a credit card works ok-------- when a credit card is used, the funds for the payee come from the credit card company, NOT the vendor.

If a taxpayer walks into his local hardware store, and charges a bunch of items on his open account at that store, those purchases are not deductible until that account is paid.

Revenue Ruling 78-38 and 39.

Read Biebl's summary--------- excellent.