Timing income and expenses
Why pay tax now when you can pay tomorrow? Deferring tax is a traditional cornerstone of good tax planning. Generally this means you want to accelerate deductions into the current year and defer income into next year. So it’s important to review your income and deductible expenses well before Dec. 31. You need to take action before the new year to affect your 2009 return.
However, deferring income and accelerating deductions may not always make sense. If you are going to be subject to the alternative minimum tax (AMT) in one year and not another, it can affect your timing strategy. (See more on coping with the AMT). More importantly, if you believe that tax rates are going up, you may feel it is beneficial to do the opposite. In that case, you want to realize more income now when rates are low and save your deductions for later when rates are higher.
Timing your income and expenses properly can clearly reduce your tax liability. Currently, many tax benefits are scheduled to remain in place and even improve from 2009 to 2010, but then disappear in 2011. Taxpayers may want to consider deferring tax into 2010 and then accelerating income ahead of a potential tax increase in 2011.
But be cautious. Legislative action is likely to make a big difference in this area, as will your personal situation. Income acceleration can be a powerful strategy, but it should only be employed if you are comfortable with your own political analysis and are prepared to accept the consequences if you are wrong.
There are many reasons to believe that existing tax benefits scheduled to expire in 2011 will be extended, at least for taxpayers with incomes below $250,000 (for a married couple filing a joint return). President Obama has proposed an extension of current tax benefits for these taxpayers, and Republican leaders have indicated they support an even broader extension. Legislation addressing this issue may not be considered until 2010. So call Grant Thornton to discuss the latest legislative developments and to find out how you, personally, may want to approach timing.
Whether it eventually makes more sense for you to defer or accelerate your taxes, there are many items with which you may be able to control timing:
Income
- Bonuses
- Consulting income
- Other self-employment income
- Real estate sales
- Other property sales
- Retirement plan distributions
Expenses
- State and local income taxes
- Real estate taxes
- Mortgage interest
- Margin interest
- Charitable contributions
It’s important to remember that prepaid expenses can be deducted only in the year they apply. So you can prepay 2009 state income taxes to receive a 2009 deduction even if the taxes aren’t due until 2010. But you can’t prepay state taxes on your 2010 income and deduct the payment on your 2009 return.
But don’t forget the AMT. If you are going to be subject to the AMT in both 2009 and 2010, it won’t matter when you pay your state income tax, because it will not reduce your AMT liability in either year.
Timing deductions can make a big difference
Timing can often have the biggest impact on your itemized deductions. How and when you take these deductions is important because many itemized deductions have AGI floors. For instance, miscellaneous expenses are deductible only to the extent they exceed two percent of your AGI, and medical expenses are only deductible to the extent they exceed 7.5 percent of your AGI. Bunching these deductions into a single year may allow you to exceed these floors and save more. (See Tax planning opportunity 2 to find out how to make this strategy work.)
Keep in mind that medical expenses aren’t deductible if they are reimbursable through insurance or paid through a pretax Health Savings Account or Flexible Spending Account. The AMT can also complicate this strategy. For AMT purposes, only medical expenses in excess of 10 percent of your AGI are deductible.
You also want to take full advantage of above-the-line deductions to the extent possible. They are not subject to the AGI floors that hamper many itemized deductions. They even reduce AGI, which provides a number of tax benefits. (See Tax planning opportunity 3.)
