Prepaid insurance premiums are deductible when paid as long as they don't apply to a period extending more than 12 months after the end of the taxable year when the payments were made. If the insurance contract runs for a longer period, you need to take the deduction over time.
The 12-Month Rule
So the general rule is that all prepaid expenses must be capitalized. There is an exception to that, however, in certain circumstances. Under Reg. Section 1-263(a)-4(f), taxpayers are not required to capitalize prepaid expenditures for “any right or benefit for the taxpayer that does not extend beyond the earlier of—
12 months after the first date on which the taxpayer realizes the right or benefit; or
The end of the taxable year following the taxable year in which the payment is made.”
Example: Grayson Corporation purchased an insurance policy on October 31, 2015 covering November 1, 2015 to October 31, 2016. The general rule says that must be capitalized and expensed as it is utilized. However, the 12 month rule can apply here because the policy does not cover a period beyond 12 months after the date on which the taxpayer realized the benefit (November 1, 2015). Therefore the entire amount of the policy could be expensed in 2015.
Cash Basis Taxpayers:
In general, the rules for cash basis taxpayers are fairly straightforward. When revenue is received it is income. When expenses are paid they are deducted. However, because of the general rule regarding prepaid expenses, simply prepaying an expense does not make it immediately deductible (barring an exception due to the 12-month rule).
Say for example that on November 1, 2015, Drake Corp purchased a computer maintenance service program that covered from November 1, 2015 to October 31, 2017. This prepayment must be capitalized because it does not meet the 12-month rule and therefore it is expensed as the benefit is received, even for cash basis taxpayers.
@JaLaMooNo, I'm no expert, but based on my understanding of the earlier reply: - If you operate on a cash basis, then you could have deducted the entire 1-year subscription paid in 2016 on your _2016_, not 2017, tax return. The rule appears to be, for expenses paid in advance for:
- anything lasting 12 months or less and ending before the end of the _next_ tax year (2017 in your case) can be deducted in full in the year in which you pay them (2016).
- anything lasting more than 12 months or extending past the end of the _next_ tax year would have to be deducted in pro-rated pieces: one piece for each tax year that your payment is paying for. So I guess if you paid for a 2-year subscription in November 2016, I think you would deduct 1/2 (12 months) in 2016. For the other half, I'm less sure; maybe deduct the other half in 2017.
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