Should You Prepay Expenses Before Year-End?

Short Answer: Yes—If You’re on the Cash Basis and It Makes Strategic Sense

If your business uses the cash basis method of accounting, prepaying certain deductible expenses before December 31 can lower your taxable income for the current year. But not every prepayment qualifies, and done incorrectly, it may trigger red flags with the IRS.

Why Prepaying Expenses Before Year-End Matters

Many small businesses are cash basis taxpayers. That means income is recorded when received, and expenses are deducted when paid. If you’ve had a profitable year, prepaying next year’s expenses before December 31 might be a simple and legal way to reduce your tax liability.

But if you overdo it or prepay the wrong kinds of expenses before year-end, the deduction might be denied — or worse, raise audit risk.

Related Questions Small Business Owners Ask

• What types of expenses can I prepay? Rent, insurance, subscriptions, and services that provide benefit within the next 12 months are often eligible.

• Can I prepay for multiple years at once? No. Only prepayments covering a 12-month period or less that don’t extend beyond the end of the following tax year may qualify under the IRS’s 12-month rule.

• Does this strategy work for accrual-based businesses? Not usually. Accrual basis taxpayers deduct expenses when incurred, not when paid.

• Is there a limit on how much I can prepay? There's no dollar limit, but excessive prepayments can appear suspicious and may not be deductible if they don’t meet the criteria in IRS Publication 535.

  
  

Actionable Tips

✅ Know your accounting method. This strategy only works for cash basis taxpayers. If you’re not sure which method you use, check with your accountant.

✅ Focus on 12-month-or-less expenses. Prepay things like:

• Rent (for January or Q1)

• Software subscriptions

• Insurance premiums

• Marketing retainers or annual memberships

✅ Avoid capital expenditures. Prepaying for inventory or fixed assets like equipment usually doesn’t count — those items may be capitalized, not deducted.

✅ Don’t overdo it. The IRS watches for manipulation. Prepay only what makes business sense and is used within the coming year.

✅ Document everything. Keep clear payment records and agreements showing what the expense covers and the period it applies to.

Common Pitfalls

❌ Prepaying for a multi-year contract — Only the first year is deductible under the 12-month rule.

❌ Prepaying expenses without a clear invoice or service period — This can result in disallowed deductions.

❌ Prepaying unrelated personal expenses — These are never deductible.

Final Takeaway

Prepaying expenses is a simple cash basis strategy to reduce taxable income — if done right. Make sure your prepayments fall under IRS rules and only cover qualified expenses for the upcoming year.

Need help applying this strategy or optimizing your year-end tax plan? Talk to our Tax Advising team at Development Theory.