It’s never too late to save money, even if you’re in the final hour of the tax year. There are things that an individual taxpayer can do at the last minute that have the potential of saving money, namely:
Deferrals of income into the following tax year results in lower taxable income in the current tax year. Consequently, this means the taxpayer owes less income tax in the current year. The theory is that the smaller amount of taxable income in the current year is taxed at an assumed to be lower effective tax rate in the future -- assuming, of course, that the current tax rate is larger than it is in the following tax year.
Acceleration of expenditures occurs when expenditures that would have otherwise been made in the following tax year, or in the future, are instead made in the current tax year. One of the theories behind accelerating expenditures is that the expenditure is “more valuable” in today’s money than it is a year from now thanks to the time value of money. In other words, there is a bigger bang for the buck.
Of course, money savings as a result of income deferrals is less when deferring income out of a low effective tax rate year into a high effective tax rate year. Similarly, the savings realized from expenditure acceleration becomes less advantageous if you are moving deductions out of a high effective tax rate year into a lower effective tax rate year.
Thus, the effectiveness of a last minute deferral and acceleration strategy depends largely on effective tax planning. Among items to consider during planning are:
Projected effective tax rates
Projected levels of taxable income (earnings and other)
In some cases, projected Schedule A deductions
Note that itemized deductions for taxpayers with adjusted gross incomes above $305,050 (in 2014) may be reduced, which could offset some of the tax savings afforded by accelerating expenditures reported on Schedule A.
Bonus Income Deferral Example
A popular application of the income deferral approach is the scenario in which the taxpayer accumulates an annual bonus earned throughout the tax year. Instead of the employer actually paying out the bonus on, or before, December 31, XXXX the employer and employee mutually agree that the bonus get paid after December 31. In this example the taxpayer ends up buying almost a year’s worth of time to decide what to do with the bonus and how to pay the income taxes associated with the bonus!
Schedule A Deductions Eligible for Acceleration into Current Year
Mortgage Interest Component of January’s mortgage payment
Property Taxes including Real Estate Taxes
State and Local Taxes
Professional Dues and Subscriptions
Miscellaneous employee expenses
You may want to reconsider this strategy, however, if you expect to be in a higher tax bracket in 2016. In that case, the deductions will be more valuable to you next year.
Furthermore, be on the lookout for any changes to deduction ceilings. If itemized deductions for taxpayers with adjusted gross incomes above $305,050 (in 2014) are reduced, it could negate some of the tax savings afforded by accelerating the foregoing expenditures reported on Schedule A, as noted at Time.com.
Income Deferral / Accelerated Deductions - Schedule C Self-Employed
If you are a self-employed cash basis taxpayer, you can save money by arranging with a customer(s) to wait until after December 31, XXXX, to be paid for outstanding receivables that would have otherwise been paid to you on, or before, December 31, XXXX. This deferral will be especially more advantageous when the effective tax rate for the year you are deferring to is less than the effective tax rate for the year you are deferring from. A significant tax savings for self-employed (“SE”) tax would be recognized as a result of the lower Schedule C profit.
Furthermore, a meaningful reduction of Schedule C income (and consequential income tax and SE tax) is possible by accelerating the acquisition of depreciable assets into the current year that are otherwise planned for after December 31, XXXX. Assuming that the purchase of depreciable assets is accelerated into the current year you can then take advantage of IRS Section 179, which enables tax payers to write off as an expense qualifying depreciable assets. As in the case of deferred Schedule C income previously discussed, a significant tax savings for income tax and self-employed (“SE”) tax would be recognized as a result of the lower Schedule C profit.
Accelerated Funding - College Savings Plans
If you’re saving for school in a 529 college savings plan, that money grows tax-free, and withdrawals are tax-free as long as the money goes toward higher education.
You can’t deduct those contributions on your federal return. However, you may qualify for at least a partial deduction or a credit on your state tax return, as long as you fund the account by Dec. 31. Look up your state’s rules at savingforcollege.com, as mentioned in this article from Time.com.
Accelerate Recognition of Capital Losses
If an investor’s portfolio contains a combination of investments that have recognized capital gains and unrecognized capital losses, the investor may be able to save money by accelerating the recognition of the capital losses and offsetting the losses against the capital gains. Remember that losses and gains are recognized when the underlying investment (stocks, bonds, etc.) is actually sold.
When the investment(s) are sold, two things happen:
First, the capital losses go to reduce some or all of the capital gains, thereby reducing the amount of tax owed on the capital gains.
Second, if the amount of capital losses exceeds the capital gains, up to $3,000 of the excess capital losses can be used to offset ordinary income in the current year, thereby further reducing adjusted gross income. Any “unused excess” capital loss can be rolled forward to subsequent tax years.
It is possible, however, that the losses could have more value at a later time because of the effective tax rate that comes into play. In this case, some tax planning concerning the matter is imperative.
In addition, to make use of this acceleration strategy, the sale of capital loss investments can happen at any time during the tax year, either on or before December 31.