Final answer:
Jaxon can deduct only the interest that applies to the current tax period under both cash and accrual accounting methods, which is $750 if it represents two months of prepaid interest. Prepaid interest is not fully deductible in the year it is paid due to IRS rules.
Step-by-step explanation:
In regards to whether Jaxon can deduct only $750 of interest under either the cash or accrual method of accounting, it is generally true that prepaid interest is not immediately deductible. Under the accrual method, expenses are recognized when incurred, not necessarily when paid. However, there are Internal Revenue Service (IRS) rules that limit the deductibility of prepaid expenses including prepaid interest, requiring that they be deducted over the period to which they apply. Consequently, if Jaxon pays a full year's interest in advance, he can only deduct the portion that applies to the current tax year. If two months of interest equates to $750, then under both cash and accrual methods, only that amount may be deductible in the current year, assuming it aligns with the period the expense applies to.
The scenario provided with the credit card debt and savings account illustrates the concept of mental accounting. A person paying 15% yearly interest on credit card debt and receiving 2% interest on savings would logically be economically better off using the savings to pay off the credit card debt. Yet, people often keep such compartments in their finances separate due to personal value judgments and psychological comfort, even if it is not financially optimal.