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Timing Your IncomeIncome
is generally taxable to individual taxpayers in the year in which it is received. In
general, a taxpayer may defer payment of tax by deferring receipt of the income. However,
you cannot defer taxation by merely delaying receipt of the income if the funds are
available to you and the time of payment is subject to your unrestricted discretion. Chapter 6 discusses the deferral of compensation through the use of
various retirement plans and deferred compensation arrangements. If you operate a business
or collect rental income and report that income on the cash receipts and disbursements
method, you have the opportunity to delay or accelerate the billing to your customers or
tenants and determine the timing of the related income.
Timing Your Deductions
Opportunities for reducing taxable income may be available by controlling the payment
of deductible expenses. You may deduct certain expenses that are due for payment next year
on your 1999 return if you pay them by December 31. This strategy helps you the most when
you expect your marginal tax rate to be higher in the current year than in the next,
because the rate differential makes the deduction worth more in the current year.
However, even if you expect your tax rate to be the same in 1999 and 2000, it may still
be worth paying some expenses a few months early in order to gain the tax benefit a full
year sooner. There may also be an advantage to reducing your 1999 tax because, if you pay
2000 estimated taxes based on your 1999 tax liability, this amount will also be reduced.
For example, if you pay a deductible expense in December 1999, instead of April 2000
when it is due, you will reduce your 1999 tax instead of your 2000 tax, but you will also
lose the use of your money for three or four months. Generally, this will be to your
advantage, unless you have an alternative use for the funds that will produce a very high
return in that three- or four-month period. You need to decide whether the cash used to
pay the expense early is needed for anything more urgent or more valuable than the
accelerated tax benefit.
- State Taxes. If accelerating deductions makes sense for you, you may
consider prepaying and deducting 1999 state income and property taxes that would otherwise
be due in the first three or four months of 2000. Paying the balance of your estimated
state tax liability in December 1999 secures that deduction on your 1999 tax return, even
though the payment might not be required by the state until January 15, 2000, or April 15,
2000.
| AMT
-- Caution. If you’re likely to have to pay alternative minimum
tax, you may not want to accelerate your deductions for state and local income and
property taxes. State and local taxes are not deductible in computing alternative minimum
taxable income and, therefore, these deductions yield no benefit for you if you are
subject to AMT. |
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- Prepaid Interest. Although a cash-basis taxpayer generally may deduct expenses
only in the year they are actually paid, there is an exception for prepaid interest
expense. A cash-basis taxpayer may not deduct prepaid interest before the tax year to
which the interest relates. However, there is a small amount of flexibility in the ability
to prepay year-end interest that is due early in the following year. For example, if a
mortgage payment is due on January 10, a taxpayer can accelerate the deduction of the
portion of the interest relating to the period up to January 1 by mailing the check by
December 31.
The most significant interest deductions currently available are for home mortgage
interest, including interest on up to $100,000 of home equity loans, and investment
interest expense to the extent of current-year investment income. (Note that interest paid
in relation to investments that earn a tax-free return is not deductible.)
- Medical Expenses. If the timing of certain of your medical and dental
expenditures is flexible and if your overall medical expenses are high in the current
year, you may want to accelerate payment of these expenses. Because medical expenses are
only deductible to the extent that they exceed 7.5 percent of adjusted gross income, it is
best from a tax standpoint to incur expenses, such as replacement eyeglasses or contact
lenses, elective surgery, dental work, and routine physical examinations, in a year in
which you have already gone over (or the added expenses would take you over) the 7.5
percent threshold.
- Miscellaneous Itemized Deductions. Miscellaneous itemized deductions are a
defined group of deductions that you can deduct only to the extent that they exceed two
percent of your adjusted gross income. The potential advantage of accelerating
miscellaneous deductions is the possibility that you’ll be able to go over the
two-percent threshold. Therefore, you may want to bunch as many of these deductions as you
can into one year, if as a result your deductions exceed the two-percent threshold.
| AMT
-- Caution. As with state and local taxes, miscellaneous itemized
deductions are not deductible in computing alternative minimum taxable income. Thus, the
acceleration of itemized deductions must be planned with alternative minimum tax
consequences in mind. |
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- Tax Credits. Tax credits provide another means to reduce your
overall tax liability. As you consider the strategies discussed above, you should take
into account the effect, if any, that the strategies may have on any credits available to
you.
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Tax Guide
