and (2) the amount of the liability can be determined with reasonable accuracy.
Cash Method Taxpayers
A cash method taxpayer "pays" the expense when cash, check, property, or service is
transferred. Neither a promise to pay nor a note evidencing such promise is considered payment.
Consequently, when a cash method taxpayer buys on credit, no deduction is allowed until the deb
are paid. However, if the taxpayer borrows cash and then pays the expense, the expense is
deductible when paid.
Restrictions on Use of the Cash Method
Under the general rule, a cash method taxpayer deducts expenses when paid. Without
restrictions, however, aggressive taxpayers could liberally interpret this provision to authorize not
only deductions for routine items, but also deductions for capital expenditures and other expenses
that benefit future periods (e.g., supplies, prepaid insurance, prepaid rent, and prepaid interest). R
§1.446-1(a)(1) provides that any expenditure resulting "in the creation of an asset having a useful
life which extends substantially beyond the close of the taxable year may not be deductible when
made, or may be deductible only in part." In this regard, the courts agree that "substantially
beyond" means a useful life of more than one year. M.J. Zaninovich, 69 TC 605, Dec. 34,935
(1978), rev'd, CA-9, 80-1 USTC ¶ 9342, 616 F2d 429.
A cash method taxpayer's prepayments for rents or services may be deducted in the year paid
when two conditions are present: (1) the period for which the payment is made does not exceed o
year following the end of the current tax year, and (2) the taxpayer is contractually obligated to
prepay an amount for a period extending beyond the close of the year. M.J. Zaninovich, supra.
Prepayments of insurance premiums must be capitalized and prorated over the period actually
covered by the insurance policy.
Prepaid interest and other costs or fees incurred in obtaining a loan must be capitalized and
deducted ratably over the period of the loan. The sole exception is for "points" paid for a debt
incurred by the taxpayer to purchase his or her principal residence. Points paid on borrowing
money to refinance an existing mortgage must be capitalized and amortized over the life of the ne
Prepayments of other expenses normally should be deductible if the asset will be consumed
by the close of the following year, there is a business purpose for prepaying the expenditure, and
there is no material distortion of income.
Federal income taxes are not deductible on the federal income tax return since the return is
being prepared to compute the amount of federal income taxes due. Payroll taxes paid by an
employer are fully deductible, but taxes withheld from employee wages such as federal, state, and
local income taxes payable and F.I.C.A. taxes are not. The latter type of tax expense (withholdings
from employees' wages) is not incurred by the employer, but by the employee. Accordingly, the
employer is not allowed a deduction for these expenditures. Similarly, while property taxes are