Year-End Review: Firm Finances
Last month we discussed reviewing and updating your firm’s policies and procedures. In keeping with the year-end review theme, this month we will focus on important Firm Resolutions and a few other financial to-dos to tackle before the new year.The timing of year-end income and expenses may have varying tax implications depending on which accounting method you use: cash or accrual. Just to brush up on basic accounting, the accrual method recognizes income when it is earned and expenses when they are incurred, regardless of when they are collected or paid. If you use the cash method, income is constructively received when it is credited to your account and expenses are deducted when they are paid out from your account. Many small businesses use the cash method of accounting because it is simpler to maintain records. For those who have recently opened a practice, “[y]ou choose an accounting method when you file your first tax return. If you later want to change your accounting method, you must get IRS approval” (www.irs.gov). See Form 3115, Application for Change in Accounting Method. Regardless of your firm’s accounting method, you want to make sure that you review your finances, close your books, and welcome the new year on the right foot.
- TALK TO YOUR CPA
- Complete your monthly reconciliations
- Send out client invoices through December 31
- Pay Bills
[Y]ou may not be able to deduct an expense paid in advance. Instead, you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules.
Expense paid in advance. An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule.
Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following.
-12 months after the right or benefit begins, or
-The end of the tax year after the tax year in which payment is made.
If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must obtain approval from the IRS before using the general rule and/or the 12-month rule.
You are a calendar year taxpayer and pay $3,000 in 2016 for a business insurance policy that is effective for three years (36 months), beginning on July 1, 2016. The general rule that an expense paid in advance is deductible only in the year to which it applies is applicable to this payment because the payment does not qualify for the 12-month rule. Therefore, only $500 (6/36 x $3,000) is deductible in 2016, $1,000 (12/36 x $3,000) is deductible in 2017, $1,000 (12/36 x $3,000) is deductible in 2018, and the remaining $500 is deductible in 2019.
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.(www.irs.gov)
- SEE #1 ABOVE!
- LexisNexis® Year End Resources
- With 2018 Fast Approaching, It’s Time for Some Year-End Tax Planning Tips
- Cosmolex 2017 Year-End Accounting Checklist for Law Firms
- ABA Legal Technology Resource Center
- Cosmolex Video: 2017 Year-End Accounting Checklist & Tips
- The Role Legal Finance Can Play In Firm Year-End Collections
- ABA’s Practice/Case Management Software Comparison Chart for Solo/Small Firm