Authors: Jennifer Wallace, CPA and Jason A. Mendick
Tax planning can help you minimize your tax liability in both the current year and future year giving you, rather than the government, the use of your money for investment, business, or personal purposes. Timing the payment of deductible expenses or when income is received can permanently reduce your taxes or defer some of your tax to a future year.
To obtain the maximum benefit, you need to be able to project your tax situation for the current and subsequent years. Based on those results, you can decide what actions are needed before year-end. If you expect your current year tax rate to increase in the subsequent year, then you may want to consider deferring the payment of deductible expenses and accelerating income in the current year. Conversely, you may want to prepay deductible expenses and defer income in the current year if you anticipate a lower tax rate in the following year.
Prepay Deductible Expenses
You may be able to increase your tax benefit by prepaying the following deductible expenses by the end of the year:
- Fourth quarter state estimated tax payment due January 15, 2016
- State and local income taxes projected to be due when the tax returns are filed
- Real estate taxes due in 2016
- January 2016 mortgage payment if it consists of accrued interest for the month of December
- Charitable contributions
- Bunching miscellaneous itemized deductions into one tax year to exceed the 2% AGI threshold
Certain expenses are not deductible for Alternative Minimum Tax (AMT) purposes. If your projection indicates that you will be subject to AMT, then you may not need to pay the following expenses before the end of the year since they are not deductible in computing AMT and you will receive no tax benefit from the deduction:
- State and local income taxes
- Real estate taxes
- Miscellaneous itemized deductions such as investment expenses and employee business expenses
Accelerate or Defer Income
You may be able to control the timing of receipt for the following types of income in order to take advantage of having the income taxed in a year that you are in a lower tax bracket:
- Cash salaries or bonuses
- Consulting or other self-employment income
- Retirement plan distributions or Roth IRA conversions/recharacterizations
- Capital gains
- You can sell securities to recognize unrealized capital gains in 2015 if you expect your tax rate to be higher in a subsequent year.
- If you have recognized capital gains in 2015, then you may want to sell securities with unrealized capital losses before the end of the year to offset the gains.
- U.S. Treasury Bill income – If you have U.S. Treasury Bills maturing early in 2016, you may want to sell these bills to recognize income in 2015 if you expect to be in a lower tax bracket this year.
Retirement Plan Contributions
Contributing the maximum allowed to an employer-sponsored defined contribution plan such as a 401(k) or 403(b) is generally a wise financial decision. Typically such contributions are pre-tax and plan assets grow tax-deferred, meaning you pay no tax on that income until you take distributions. Some employers even match all or a portion of your contribution pre-tax. ROTH IRA contributions, while not pre-tax, will grow tax-free and qualified ROTH distributions are tax-free. Retirement plan contribution limits for 2015 are:
|Regular||Additional Catch-up (if age 50 or older)|
|IRAs||$ 5,500||$ 1,000|
|403(b), 401(k), 457, SARSEP||18,000||6,000|
Please remember that your maximum contribution could be less depending on your earned income and plan participation by either you or your spouse.
Consider increasing your payroll withholding and/or making an estimated tax payment before the end of the year in order to eliminate or minimize the underpayment penalty for failure to pay your 2015 tax liability on a timely basis. To avoid this penalty, estimated tax payments and withholding must equal the lesser of at least 90% of your tax liability for 2015 or 110% of your 2014 tax liability [100% if your 2014 Adjusted Gross Income (AGI) was $150,000 or less unless married filing separately in 2014 in which case with AGI $75,000 or less].
Timing of Income and Deductions
Cash-basis businesses can delay billing until January for services already performed if a higher tax rate is expected in the current year. Alternatively, if you expect to be in a higher tax bracket in the following year, you can accelerate billing and collections into the current year to take advantage of the lower tax rates.
Certain business expenses are discretionary and you can either prepay or defer paying these expenses so that the deduction coincides with the year that you expect to be subject to the higher tax rate.
Businesses should try to make as many of their expenses deductible rather than subject to capitalization and should take advantage of Code Section 179 to currently deduct expenditures on tangible property. Businesses should also try to take advantage of the tangible property regulations’ de minimis safe harbor election.
Other Business Concerns
Businesses should review the availability of deductions for bad debts, casualty and theft losses, and losses on the sale of business assets.
These are just some of the year-end tax planning steps that should be taken to reduce the tax liability on both your current and future tax returns.