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How To Do End-of-Year Tax Planning
The general rule of thumb is that you want to accelerate (record as much as you can) your expenses and decelerate (record less of, deferring to next year) your income.
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Business New Haven
11/22/1999
By: Susan Banfield
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We aren't even to Thanksgiving, and the end of the year may seem remote. However, now is the time to begin your end-of-year tax planning. Planning in November or at least by early December allows you time to think through your financial situation carefully, and to execute any transactions or make any adjustments in the way you do business the last weeks of the year.
The general rule of thumb is that you want to accelerate (record as much as you can) your expenses and decelerate (record less of, deferring to next year) your income. The rationale is obvious: most expenses are deductible, and the more deductions you have, the less tax you pay; also, the less recorded income you have, the less tax you pay.
To accelerate your expenses, simply pay all bills you can before the end of the year, even if they are not due until late January. Decelerating your income is a little more difficult, since you have no control over when people pay you. However, if you send out your December bills December 15, instead of on December 1, and give customers the standard 30 days to pay, most will not pay you until the new year.
Unfortunately, there are many situations in which this convenient rule of thumb is of little use. One example is that of a person who is in a lower tax bracket this year, but who knows she will be in a higher bracket next year. That person may actually want to defer deductions until next year and record as much income as she can this year. This reversal of the usual strategy will mean she will have more of his income taxed this year at a lower rate, and less next year at the higher rate.
Another situation in which the normal rules don't apply is that of the person who is paying alternative minimum tax (AMT). Review your financial picture for the year to determine if you will be subject to alternative minimum tax. If you are, you may want to make plans either to reduce it, or to take advantage of it.
To reduce it, employ such strategies as delaying exercising incentive stock options, which can add to your AMT liability, or eliminating municipal bond investments, the interest on which is subject to AMT. There are, however, ways to take advantage of owing AMT. As with the person in the preceding situation, you may want to accelerate your income for this year, as it will be taxed at the lower AMT rates of 26 or 28 percent.
Also, while those paying regular income tax may look to accelerate their property-tax payments, those paying AMT should not do so, as they will derive no benefit.
Losses are a tricky subject when it comes to taxes. With respect to portfolio management, in general you want to follow the principle of accelerating your losses. However, another important principle here is that of creating losses to offset gains - and, sometimes, vice-versa.
If you know that you will owe a large amount of capital gains tax because of lucrative stock sales, you may want to examine your portfolio with an eye to stocks that would sell at a loss now, and unload some of these. You can use this recorded loss to offset your gains and reduce your tax.
Also, since there is a limit on the amount of losses you can deduct, if you have incurred a loss that far surpasses the limit, you may want to offset the undeductible portion of it with a gain. In other words, you may want to sell at a profit some stock you had been contemplating selling anyway, since it will not affect the amount you can deduct for your loss, and at the same time will avoid capital-gains tax.
Other kinds of losses can also pose interesting twists to standard tax-saving logic. If you have a large loss on an investment in a partnership or a subchapter S corporation, you may also not be able to deduct the entire amount. The IRS allows you to deduct it only up to an amount equaling 100 percent of your investment. As with a large loss in the market, you might do best to offset part of it. You can do so by increasing your investment.
In addition to your adjustments to income and expenses, gains and losses, there are other financial moves you may want to make before year's end because of the happy tax consequences they can entail. One is to set up a profit-sharing plan at your company. The advantage is that you can take a deduction now for the money the company puts into the plan, but do not have to actually put it in until the date next year by which you must file your return.
Another IRS “break” to take advantage of, where appropriate, is the opportunity you have to gift up to $10,000 in a calendar year to any individual tax-free to the donor. You are allowed to do this once a year to as many persons as you want. However, if you do not make a particular gift this year, the opportunity is lost forever.
For more specific help with your particular tax situation, obviously, see your accountant.
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