Discussion:Cash basis adjustments

Thank you for your answer.

This is mainly an accounting question. The correct way to report payroll taxes is to record the following entries on the date the wages are paid. I also just dug out my old Accounting Principles textbook (12th Edition) and found that the authors, Niswonger and Fess, agree with me. Actually, they taught me this back in 1970.

(1) debit FICA Expense, FUTA Expense, and SUTA Expense (2) credit FICA Payable, FUTA Payable, and SUTA Payable

I'll try to find more on the web, possibly after the Pistons game.

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Besides the FICA Tax and Federal Income Tax deducted from the employees’ earnings discussed above, the employer must also pay FICA Tax equal to the amount paid by the employee, Federal Unemployment Insurance Tax (FUTA), and State Unemployment Insurance Tax (SUTA). These three taxes on salaries paid by the employer are considered operating expenses. The journal entry results in a debit to Payroll Tax Expense and credits to FICA Tax Payable, FUTA Payable, and SUTA Payable.

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>>>>>>> See Publication 535, page 23, Employment Taxes, be sure to read the example, third paragraph down from the "Employment Taxes" title. This is so simple that the IRS didn't think it was necessary to state that this applies in December, when the payroll taxes will be paid in January.

I'm done for now with this subject. I've been doing it this way for 26 years. I suspect that most accountants do it this way. I'm not sure how some CPAs' clerks handle it, though.

Regarding FUTA, when the SUTA tax is paid late, the IRS will bill the taxpayer for the additional FUTA owed. I would then expense the additional FUTA in the year it was paid. But this was not the question in this discussion, and neither are the following: whether or not Tax Mama is right or wrong on sales taxes, whether unpaid interest can be deducted on an auto loan, distinctions between personal and business credit cards, and how FICA and FUTA can be paid. None of these topics have anything to do with the original question.

See Reg. 1.461-1(a)(1) which talks about the cash basis of accounting and when an expense can be deducted. We are not talking about the combined (hybrid) method which combines both the cash and accrual method. If you were than I would agree with you but the original question concerned cash basis. I have not yet read anything above that has been authoritative to the contrary.

In the end we may very well agree to disagree but to issue f/s on the cash basis method and deduct er p/r taxes before they are paid is incorrect. This would be a M-1 adjustment as I see it if you were to take this unpaid expense on your tax return. A sole properitor does not have an M-1 on their Schedule C but that does not change the theory. There is also the issue of materiality where the IRS is concerned and also consistency in how items are reported but for now, I am not changing my position. I look forward to additional discussion on this topic.

Death & Taxes Inc has a 940 tax due of $127: 2 employees at $56 and one at $15. It will appear on the Other Current Liabilites line 18. Last year it was $129.

Dennis - You might be correct, but I didn't notice anything on that page that said it is discussing Examination of Returns for only "full accrual basis" taxpayers.

My point is that the IRS allows cash basis taxpayers to deduct payroll taxes in the year accrued, instead of deducting them in the year paid, as long as the taxpayer is consistent in the method he chooses when the payroll is started. The IRS also allows deductions for cash basis taxpayers for SEP contributions and credit card purchases when accrued and not when actually paid.

JD, Michael, and Dennis - So, can I assume that you record SEP contributions in 2007, when paid in 2007 by cash basis employers for 2006?

This same corporation contributes to the two owners' SEP plans. I make entries to deduct those SEP contibutions in the prior year, even when the contributions will be paid between January and March 15th.

Next....!

I will limit my discussion to the employer p/r taxes as in my mind that was what the original discussion was all about.

Deback, you are correct - reg 1.461-1(a)(1) does not specifically discuss employer p/r taxes. What it discusses it the timing of when deductions are allowed for a cash basis t/p.

Also, your site of pub 535 (page 23) it talks about the deduction of unemployment fund taxes and that the t/p can deduct these payments. This part is not in question - it is an operating expense and certainly a deductible expense - what is in question is the timing of that deduction which we do appear to have a difference of opinion.

From a theoritical stand point, to match income with expenses within the same period makes perfect sence. Unfortunately, the internal revenue code can limit this matching concept when it may hurt a t/p most.

D&T - The trust fund portion (which is not even able to be obsolved in bankruptcy as we all know) of the employee p/r taxes would be shown as a current liability on the cash basis f/s (and I tend to use income tax basis of accounting for f/s reporting with no notes) that I would issue and it would be those same f/s that would and do get reviewed in the peer review which I have always passed with flying colors.

Deback - if the IRS preferred for cash basis t/p's to deduct er p/r taxes before they were actually paid - I very much doubt it would be one of those best kept secrets and the CPA community would certainly know about it. During our years of training by the "partners" they would not have had to write so many silly review comments over and over on this very issue.

I for one do not want to make this or any other subject on this board a CPA versus non CPA issue. We are all here to help each other and learn and assist those newer to the profession with answers to their questions. Heck, I have only been in public accounting 23 years so I still have lots to learn. We are all each others peers with sincere intentions and health opinions.

Unfortunately, at this point based on all that I know and have read - on a true cash basis method of accounting - employer p/r taxes are not a tax deduction until paid.

The employer becomes liable for ALL of them as of the date of the p/r! THESE ARE A CURRENT LIABILITY!

The employer becomes liable for BOTH the EE tax w/h and the ER tax due on the p/r.

Many computer programs and o/s p/r services compute them as of the p/r date. However, we may book them on a monthly or quarterly basis even though it is a current liability as of the p/r date.

Cash basis books must pick up the CURRENT LIABILITY and expense, even if it's not paid during the period.

Cash basis books would not however pick up a p/r that started 12/26 and paid 1/2 of the following year. That would be an accrual adj. That would be considered a Jan p/r for the cash basis.

This is not a discussion about cc purchases. However, the same idea is true. If you may purchases in Dec and the cc is not paid until Jan, the Dec purchases are considered a current liability. dr. expenses cr. cc payable It is the recording of a current liability, not an accrual. You become liable for the payment when the purchase is made.

"A cash basis employer deducts (as ordinary and necessary business expenses) taxes withheld from an employee's compensation in the taxable year in which the taxes are withheld. The fact that the taxes withheld (i.e., the taxes on the employees) are not actually paid to or deposited with IRS until the following tax year does not change this result.

However, Social Security and unemployment taxes imposed on the employer for compensation paid to employees are not deductible by a cash basis employer until actually paid to the government"

I can't find consenus on this question from other online posting boards among tax pros.

Looks like this is incorrect based on:

Rev. Rul. 80-164

INCOME TAX WITHHOLDING, FICA, AND FUTA; WHEN DEDUCTIBLE

                           Published: June 23, 1980

26 CFR 1.461-1: General rule for taxable year of deduction

(Also Section 162; 1.162-1.)

 Income tax withholding, FICA, and FUTA; when deductible. An employer who uses the cash receipts and disbursements method of accounting should deduct, under section 162 of the Code, as wages paid, federal taxes withheld from employees' wages in the year such taxes are withheld. FICA and FUTA taxes imposed on the employer are deductible in the year paid to the U.S.

Here's the link:

http://www.taxlinks.com/rulings/1980/revrul80-164.htm (link may no longer be active; try legalbitstream instead)

If this is the case, this would bring about a tax planning issue for clients to pre-pay their 12/31 payroll liabilities on 12/31 instead of depositing the following month for monthly depositors.

Any thoughts?

See James W. Tippin; 104 TC 518:

We now turn to the third issue, which concerns the deductibility of the FUTA taxes and of the employer's portion of the FICA taxes. Secs. 3301, 3111. Petitioner incurred liability for these taxes with respect to wages paid to the employees of his law practice. On Schedule C of their tax returns, petitioners deducted these taxes for the year in which the liability accrued (i.e., the year in which the wages were paid), even though petitioner did not pay the tax until a later year. Petitioners argue that this treatment was proper and was in compliance with section 1.461-1(a)(1) and (3), Income Tax Regs. We disagree. Section 1.461-1(a)(1), Income Tax Regs., provides deductions for depreciation, amortization, depletion, and losses under sections 167, 611, and 165. Nothing in section 1.461-1(a)(3), Income Tax Regs., allows a cash basis taxpayer to deduct a tax before the year of payment. See also Rev. Rul. 74-70, 1974-1 C.B. 116 (for cash basis taxpayers, FICA and FUTA taxes are deductible for the tax year in which they are paid). Accordingly, petitioners may not deduct either the FUTA taxes or petitioner's share of FICA taxes until the year in which he paid such taxes.

And I remember reading/hearing in a seminar(long long ago, in a galaxy far far away), that as long as the taxpayer is consistent in the approach, the IRS accepts the accrual of payroll taxes for cash basis taxpayers. Wish I had something more concrete.

Unless I'm halucinating...it's always a possibility during March.

And wouldn't be the first thing I've found on this forum that proved the prior way of doing it where I used to work was incorrect.

1 2

An accrual basis taxpayer may accrue and expense employer payroll taxes in the period incurred, if the recurring item exception is met under Reg Section 1.446-1(c)(1)(ii). A cash basis taxpayer may only deduct payroll excise taxes when paid as also confirmed in Revenue Ruling 80-164. A cash basis tax payer may only accrue a narrow listed of taxes, specifically enumerated by Section 164(a). A hybrid taxpayer, if in compliance with the hybrid accounting rules, can elect to treat the employers' payroll excise tax account as an accrual. Note, a hybrid taxpayer must treat all income accounted under the accrual method in order to enjoy the benefit of accruals in any expense account per Reg 1.446-1(c)(1)(1)(iv)(a) and held in Connors, Inc (1979) 71 TC 913. Also, see Howard Brunton (1982) 82 TC 166 for additional support.

II. Deductibility of Payroll Taxes Section 164(a) permits taxpayers to deduct specified taxes. Excise taxes--like Federal Unemployment Tax Act (FUTA) taxes and the employer’s share of Federal Insurance Contributions Act (FICA) taxes--are not enumerated on the list of specified taxes and are deductible only if they constitute ordinary and necessary business expenses. See secs. 162, 212; see also sec. 1.164-2(f), Income Tax Regs.3

III. Accounting Method A taxpayer is required to compute taxable income “under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.” Sec. 446(a).4 Similarly, a taxpayer must claim deductions in the proper tax year under that taxpayer’s method of accounting. Sec. 461(a). “The accounting methods most commonly used for income tax purposes are the cash receipts and disbursements method, and the accrual method.” Irby v. Commissioner, 30 T.C. 1166, 1174 (1958), affd. 274 F.2d 208 (5th Cir. 1960). The cash receipts and disbursements method is commonly referred to as the “cash method”. A cash method taxpayer must deduct expenditures for the tax year in which they are actually made. See sec. 1.446-1(c)(1)(i), Income Tax Regs. The standard is more complex for an accrual method taxpayer--“a liability is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.” Sec. 1.446-1(c)(1)(ii), Income Tax Regs.

Just think about the je to record the payroll.

Kindly, provide any citation by a controlling authority that is worthy of of avoiding the negligence penalty, that allows this journaled expense to be an allowable current period income tax expense.

Furthermore, in considering the journal entry: it is prima facia an accrual. The debit to payroll tax expense and credit to a payroll tax liability is indicative of its accrued nature. Later, a debit to the liability and credit to cash will clear that particular accrued liability. A cash journal entry would be a debit to payroll tax expense and a credit to cash.

Very respectfully,

Arman Barsamian

Using constructive receipt to claim cash expenses, however, is necessarily limited by regulation because arguably most expenses can be claim under this principle (ex. unpaid mortgage interest is constructively received if the mortgage lender has sufficient security in the collateral to guarantee the debt's ultimate payment; plus the fact that the lender starts earning income on it the moment it's added to the loan balance). All this is possible because, after all, cash basis accounting is a fictional concept in today's world - and accordingly GAAP insists that proper accounting be done on the accrual basis.

This all comes with caveats of course. Administratively speaking the IRS treats a taxpayer using these modifications and the other allowed exceptions as included under the umbrella of "cash basis" repoerting so long as they've been applied consistently. If not then you're going to have to file Form 3115 to report the tax implications of the change.

P.S. If you can cite a case supporting your position that hasn’t been overturned by a higher court such as Arman Barsamian’s Bascos Case then you’re golden in regards to any negligence penalty. They are, after all, the ultimate authority when it comes to taxes.

Scott B 21:29, 18 March 2010 (CDT)

Those words may not appear in the Code, but that is pretty clear law to me. Again, assuming cash basis all the way.

No one here is arguing that "cash basis" means "pay cash" to get a deduction every single time. There are plenty of examples, including the purchase of an asset with a non-recourse note, will get you a deduction "on the cash" cash when no "cash" was outlaid. And Lenny just gave another example, in the reverse, of sales tax collected.

What you are doing is arguing that since a grossed-up wage is allowable as a deduction, even though not fully paid, this gives free license to deduct any expense of a cash basis taxpayer, even when such expense is not paid. I think you'll find that everyone on this forum will disagree with your logic, if we can call it that.

Maybe you shouldn't post here and tell the forum readers to "Deduct it!" because MikeB, who knows nothing and who chooses to ignore the clear (and rather fair and logical authority) told you to.

Because he doesn't know what he's doing, obviously.

I have no problem with MikeB's lack of knowledge, but he really should keep it to himself.

He was obviously doing some research in this area and was second-guessing his 25-year policy of deducting accrued expenses for cash basis taxpayers. Why else would he be responding to a post that is nearly 3-years old?

Now that he has learned that (1) there is guidance on this issue and (2) such guidance is contrary to what he's been doing for 25-years...he can't just be a man and own up to all of his mistakes. Instead, he wants to throw insults all over the place, search our websites, and research US, to see what he's up against. And what he's up against are people that know far more than him; people that find it typical for the "know it all" mistaken practitioner to toss insults about.

Now you're changing your tune a bit. Before, you argued that it was unclear and if the IRS cares, they would have provided guidance.

Well, there is guidance.

And now that you know, you ignore it (again) and base your mistaken position on "it's a small thing, let's not worry about it."

Again, typical of the "know it all" mistaken practitioner.

Call us anal. We don't care.

Seems your the anal one. You see, we don't do anything with the accrued expenses of our cash basis clients. Seems that you are anal in that you go out and find them, accrue them up and spend time to book up these "bogus" deductions.