Amy borrowed $25,000 for her business from a local bank two years ago. To increase her deductions for 2018, she pays December interest of $400 and prepays January and February interest totaling $800 on December 30, 2018. The maturity date of the note is November 30, 2019. How much of the interest that she paid in December is deductible in 2018?
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 2018, she pays December interest of $400 and prepays January and February interest totaling $800 on December 30, 2018. The maturity date of the note is November 30, 2019. How much of the interest that she paid in December is deductible in 2018?
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.
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Quizplus · Accepted Answer

If Amy is an accrual-basis taxpayer, she can only deduct the interest expense in the year it is due, which is December 2018. Therefore, only the $400 interest payment made in December 2018 is deductible for 2018. The prepayment of January and February interest ($800) cannot be deducted until those months are reached in 2019. Hence, statement II is correct. Statement I is incorrect because if Amy is a cash-basis taxpayer, she could deduct the full $1,200 in 2018.

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