Deferring tax by deferring income or accelerating expenses is generally a cornerstone of good tax planning. However, in recent years there have been tax rate increases which made this a bad idea since it would push income from a lower tax bracket year into a higher bracket as the rates went up the next year, negating the benefit of paying tax later. The rate increases of recent years appear to be over for now, so you should once again be looking to defer tax. This means you should look to accelerate deductions into the current year and defer income into the next year. There are many items for which you may be able to control timing:
- Consulting income
- Other self-employment income
- Real estate sales
- Gain on stock sales
- Other property sales
- Retirement plan distributions
- State and local income taxes
- Losses on stock sales
- Real estate taxes
- Mortgage interest
- Margin interest
- Charitable contributions
As with all tax planning, the general rule does not always work. For example, you may want to delay an itemized deduction to bunch it with future itemized deductions allowing you to exceed the “AGI floor” amounts attached to some itemized deductions as discussed below. Also, your tax planning may be affected by the Alternative Minimum Tax (AMT).
You should also remember that prepaid expenses can be deducted only in the year they apply. So you can prepay 2014 state income taxes to receive a 2014 deduction even if the taxes aren’t due until 2015. But you can’t prepay state taxes on your 2015 income and deduct the payment on your 2014 return.
Bunch itemized deductions
Timing significantly affects your itemized deductions, because many of those deductions have adjusted gross income (AGI) floors. For instance, miscellaneous expenses are deductible only to the extent they exceed 2% of your AGI, and medical expenses are deductible only to the extent they exceed 10% of your AGI (7.5% for taxpayers age 65 and older). Bunching these deductions into a single year may allow you to exceed these floors and save. Miscellaneous expenses you may be able to accelerate and pay now include:
- Deductible investment expenses such as investment advisory fees, custodial fees, safe deposit box rentals and investment publications.
- Professional fees such as tax planning and preparation, accounting and certain legal fees.
- Unreimbursed employee business expenses such as travel, meals, entertainment, vehicle costs and publications.
Bunching medical expenses is often easier than bunching miscellaneous itemized deductions. Consider scheduling your non-urgent medical procedures and other controllable expenses in one year to take advantage of the deductions. Deductible medical expenses include:
- Health insurance premiums
- Prescription drugs
- Medical and dental costs and services, including elective surgical procedures that are not purely cosmetic.
Given the complexity of these rules in the current tax environment all taxpayers will likely benefit from multiyear tax planning. Please feel free to contact Rich Bloomfield, Dave Lemke or any of the Bloomfield CFO team to help with this.