Amy borrowed $25,000 for her business from a local bank two years ago.To increase her deductions for 2017,she pays December interest of $400 and prepays January and February interest totaling $800 on December 30,2017.The maturity date of the note is November 30,2018.How much of the interest that she paid in December is deductible in 2017?
I.If she is a cash-basis taxpayer,Amy's interest deduction is $1,200.
II.If she is an accrual-basis taxpayer,Amy's interest deduction is $400.

Question

Amy borrowed $25,000 for her business from a local bank two years ago.To increase her deductions for 2017,she pays December interest of $400 and prepays January and February interest totaling $800 on December 30,2017.The maturity date of the note is November 30,2018.How much of the interest that she paid in December is deductible in 2017?
I.If she is a cash-basis taxpayer,Amy's interest deduction is $1,200.
II.If she is an accrual-basis taxpayer,Amy's interest deduction is $400.
​

Quizplus · Accepted Answer

If Amy is an accrual-basis taxpayer, she is only allowed to deduct the interest in the year in which it accrues, which is the year for which it is earned, regardless of when it is paid. Since she prepaid for January and February 2018, the $800 is not deductible in 2017. Only the $400 December interest is deductible in 2017. Therefore, statement II is correct, but statement I is incorrect as it assumes Amy can deduct all $1,200 in 2017.

Amy Borrowed $25,000 for Her Business from a Local Bank