We're on a roll now... let's look at a few more year-end tax-planning tips.
Income Planning
A time-honored aspect of tax planning is to estimate both your adjusted gross income (AGI) for this year and next year. It might be difficult, but in many cases it can save some tax dollars in the long run.
Why? Because, if you anticipate being in a higher bracket next year, you might benefit from accelerating income into this year and paying taxes on that income at a lower rate. If you believe that you'll be in a lower tax bracket next year, you can reverse the strategy and attempt to defer income into next year.
Just remember that any time you mess with your AGI you are also indirectly messin' with other tax items. Deductible IRA contributions, Roth IRA contributions, Roth conversions, medical expense deductions, miscellaneous itemized deductions, taxation of Social Security benefits, and the threshold for various tax credits are just a few of the items that can be affected when your AGI is increased or decreased. So, be aware of how other items on your tax return will be impacted by your decision to "tinker" with it.
If you'll be in a higher tax bracket next year, ways to accelerate income into this year include:
Year-End Bonuses -- If your employer generally pays bonuses early next year, you might try to negotiate to have your bonus paid to you before the end of this year.
Retirement Plan Distribution -- If you are taking money from a retirement plan, consider taking your withdrawals before the end of this year, rather than waiting until next year. Even if you have no immediate use for the money, paying tax this year and simply putting the money in the bank (or other investments) could be a smarter way to go.
Accounts Receivable Collection/Billing -- If you are self-employed and report your income and expenses on a cash basis, issue year-end bills early to hopefully receive payment by the end of the year. You'll also want to attempt collection on any current or overdue accounts prior to the end of the year. Remember that many of your customers might also be in "tax-planning" mode and might want to pay their bills (and take their deductions) prior to the end of the year. They might be happy to pay for January's goods or services in advance.
Roth IRA Conversion -- As you should know, if you convert a regular IRA to a Roth IRA, you'll be required to report taxable income in the year of the conversion. So you might want to increase your income this year by making a Roth IRA conversion prior to the end of the year.
Investments -- Review your portfolio now. Try to determine your gains and losses for the year. See if there are stocks, bonds, or mutual funds you might want to sell. You might want to take some additional short-term stock gains this year. Your investment portfolio is the one area in which you have direct control. Don't overlook it.
If you expect your AGI to be higher next year than this year, you'll benefit by deferring income into next year. You can accomplish this by:
Investments -- Review your short-term gains and see what you might be able to defer into next year. Additionally, be careful of year-end mutual fund purchases. As we discussed in Part I of this series, mutual funds can throw off income at the end of the year... most of it in the form of ordinary income -- so plan any mutual fund purchases carefully.
Other Issues -- Basically, as you can imagine, other techniques would simply "reverse" the items that we noted above. If you're self-employed, you might want to delay your billing and collection of your bills into next year. Don't make a taxable Roth IRA conversion until early next year. Take your retirement plan distributions next year rather than this year. See if you can talk your employer into delaying your year-end bonus until early next year rather than paying it late this year. I'm sure that you can see how it all works. It all depends on which side of the fence you find yourself.
Deduction Planning This goes hand-in-glove with income planning. If you believe that your marginal tax rate will be greater this year than it will be next year, you'll want to accelerate deductions into this year's tax return. If you believe that the opposite is true, then you'll want to defer deductions into next year.
Deduction planning is difficult, because many deductions are affected by your Adjusted Gross Income (AGI). Deduction planning is also difficult because of the standard deduction. If your itemized deductions don't exceed your standard deduction, they do you absolutely no good. So, make sure that you've got a firm foundation on deduction planning before you attempt this gambit.
If deduction planning works for you, and you are a cash-basis taxpayer (which virtually all of us are), please remember these important deduction tips:
An expense is only deductible in the year in which it is actually paid. (This is especially important for people trying to "bunch" their deductions into any one specific tax year. Remember that you can't bunch expenses paid in different years.
If you use a credit card to pay expenses (such as last-minute charitable contributions, medical expenses, business expenses, etc.), the IRS considers the expense deductible in the year that the charge is incurred... not in the year that the credit card bill is paid. So consider using your credit card for those last-minute deductible purchases, services, and charitable contributions.
If you make a payment by check, make sure that it is dated and mailed before the end of the year. It's not important whether the check actually clears the bank by the end of the year... just that you made the payment before the end of the year.
Remember that a mere promise to pay (making a pledge for a charitable contribution, for example) doesn't constitute an actual payment and is, therefore, not deductible until the year actually paid.
If you have a business, don't forget the impact of the Section 179 election relative to various assets purchased. That election allows you to expense (i.e., deduct currently) purchases of business assets and property that you would otherwise be required to depreciate and deduct over a number of years. The total cost of Section 179 property that you can deduct increases periodically. For 2000, the maximum deduction was $20,000. For 2001 and 2002, it's $24,000. After 2002, it's $25,000.
This forum and the information provided here should not be relied on as a substitute for independent research to original sources of authority. The Motley Fool does not render legal, accounting, tax, or other professional advice. If legal, tax, or other expert assistance is required, the services of a competent professional should be sought. In other words, if you get audited, don't blame us.
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