Question

Mary Lou, a cash-basis taxpayer, signs a 12-month lease for $36,000 which starts on May 1, 2020.

a. Assume that she paid the entire $36,000 on the date she signed the lease as required to obtain this rate.  Show the calculation for her 2020 deduction. b. Let's say that prepaying the lease was not required and she paid only the monthly amount the first of each month. Show the calculation of her 2020 deduction. c. Refer back to the original scenario in part a, and $36,000 was required to be paid up front when the lease commences on 5/1/20. But now the lease is for 24 months instead of 12 months. Show the calculation of Mary Lou's 2020 deduction?

Answer 1

1. In cash basis accounting the deductions are calculated on the basis of actual payments made. Even if these payments pertains to future months or future accounting year, they are allowable as deductions as Mary Lou is a cash-basis taxpayer.

A. Mary lou has signed a lease of 12 month for $36000 which starts on May 1, 2020.

12 months from May 1, 2020 will run upto April 1, 2021. However since mary lou has paid the entire amount of 12 months i.e. $36000 on May 1, 2020 itself, the whole amount will be available for deduction since Mary Lou has opted for "Cash Basis"

Therefore Answer is $36000.

B. In this question Mary Lou has opted to pay the lease amount on Monthly basis and that too on the first of each month.

Calculation of Monthy Lease Amount.

Total Lease Amount/ No. of Months .i,e. $36000/12 = $3000 Per month.

Now the payments made by Mary Lou are:

MONTH	AMOUNT
May 1, 2020	$3000
June 1, 2020	$3000
July 1, 2020	$3000
Aug 1, 2020	$3000
Sep 1, 2020	$3000
Oct 1, 2020	$3000
Nov 1,2020	$3000
Dec 1, 2020	$3000
TOTAL	$24000

These are the actual payments made by Mary Lou on cash basis instead of paying the whole amount.

As in cash basis method the actual payment is allowable as deduction.

Therefore the answer is $24000.

C. In this case the total lease amount is $36000 which is for 24 month of lease and it is paid upfront.

The per month lease amount is Total Lease AMount/ No of Months

i.e. $36000/24 = $1500 per month.

Now Mary Lou pays the whole $36000 upfront on May 1, 2020 for lease of 24 months. Therefore the lease is valid till April 1, 2022.

There is a rule called "12 month Rule " which is very important in this case. This rule specifies that the benefit of deduction in any prepaid/advance payment can be availed only if

1. That benefit extends no longer than 12 months

2. That benefit extends no longer than end of the next tax year i.e. 2021 in our case.

In our case the benefit of upfront payment of $36000 extends to 24 months and also til the year 2022. Therefore the above 12 month rule is not applicable to us. Therefore the benefit of the whole amount of "$36000" will not be allowed as deduction.

The amount allowable to deduction will be equal to the months available in each year i.e:

YEAR	MONTHS	NO OF MONTHS	AMOUNT PER MONTH	DEDCUTION
2020	MAY 2020 TO DECEMBER 2020	8	$1500	$ 12000
2021	JAN 2021 TO DECEMBER 2021	12	$1500	$ 18000
2022	JAN 2022 TO APRIL 2022	4	$1500	$ 6000
TOTAL		24		$ 36000

Therefore the answer for year 2020 deduction is $12000.

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