Being slow to invoice isn't usually a good business practice, but in December it can actually be a smart move.
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As it turns out, not invoicing clients at the start of the month in December is one of the best things you can do to lower small businesses taxes.
Lowering Taxes By Lowering Revenues
Deferring your December invoices until the last day of December or even into early January ensures that you'll be paid next year instead of this year.
Assuming you are taxed on a cash basis, that means you won't pay tax on the income until next year.
As a result your tax payment stays in your bank for a full year and you can earn interest on it.
So is it always a smart idea to delay invoicing near the end of the year?
Not necessarily. If delayed billing decreases your chances of getting paid, you probably want to invoice sooner rather than later.
You also need to think about what tax bracket you are going to be in next year. If you think you will be in a much higher tax bracket, it may make sense to try to collect on those invoices this year. To make the right decision, you need to compare the time value of money you get from paying the taxes a year later versus the incremental amount you might pay because you've moved to a higher tax bracket.
Finally, if you've already accumulated a loss for the year and you'll still be in a loss situation if you get those revenues, you may want to take the income this year. By getting the money this year, all you'll do is decrease your loss for the year. You'll still pay no taxes but getting the money this year lowers your taxes for next year. In fact, if you have a big loss on the books for this year, you may even want to prebill clients for January and try to collect in December!
But, if you've got positive income year to date this year and think you'll be in the same or lower tax bracket next year, it's wise to defer 2007 revenues into 2008 if you can do it. You'll also want to defer income if collecting the money now would put you into a higher tax bracket this year.
Mind you, you cannot defer revenue by simply not depositing a check you receive.
Here's what the IRS has to say on that topic:
A valid check that you received or that was made available to you before the end of the tax year is considered income constructively received in that year, even if you do not cash the check or deposit it to your account until the next year. For example, if the postal service tries to deliver a check to you on the last day of the tax year but you are not at home to receive it, you must include the amount in your income for that tax year. If the check was mailed so that it could not possibly reach you until after the end of the tax year, and you could not otherwise get the funds before the end of the year, you include the amount in your income for the next year.
Long story short, a check you receive becomes taxable income when received, not when deposited. So, you can't just sit on a check and deposit it in January.
Similarly, amounts received before services have been provided or goods have been delivered are reportable. Even if a third-party receives the check, you have to report it.
One final thought on lowering revenues to manage taxes. Everybody out there is playing the same game. So, while you're delaying invoicing your customers, your suppliers may be doing the same thing to you.
That means your expenses won't be as high as your forecasts project, which is going to raise your tax burden. As such, if you don't delay invoicing and everybody else does, you're going to end up paying higher taxes…just because you decided not to play the game.
Remember, delaying invoicing to lower revenues is only one thing you can do to lower small business taxes. This article is part of a series of articles on Year End Tax Tips for Small Business Owners and we recommend you read all the articles in the series.
Now, that you've learned how to manage revenues to minimize taxes, it's time to learn how to accelerate deductible expenditures into this year – another excellent technique for lowering your small business taxes.