Question

Describe the 12-month rule for determining whether and to what extent businesses should capitalize or immediately deduct prepaid expenses such as insurance or security contracts.

Answer 1

In case expenditure or liability relates to a business expense , business expenditure or business liability may be immediately deducted (rather than capitalizing). Where,

1. The contract period does not last more than a year

2. It does not extend beyond the end of the taxable year following the tax year in which taxpayer makes payment

This rule is an attempt to simplify the deductions for expenditures and would not likely result in material differences in taxable income should the expenditure be capitalized across both periods.