In years in which tax rates remain the same, it is generally recommended that income be deferred and deductions be accelerated – why pay tax today when you can put it off until tomorrow? However, if tax rates increase next year, it may be wise to reverse this strategy. Paying tax now at a lower rate may save you taxes in the long run. Generally this means you want to accelerate income into the current year and defer deductions into next year. There are plenty of income items and expenses you may be able to control. Consider accelerating bonuses, consulting income or self-employment income. On the deduction side, you may be able to defer state and local income taxes, interest payments and real estate taxes. But beware of the alternative minimum tax (AMT), which can affect timing strategies.
2. Bunch itemized deductions.
Many expenses can be deducted only if they exceed a certain%age of your adjusted gross income (AGI). Bunching itemized deductible expenses into one year can help you get over these AGI floors. Consider scheduling your non-urgent medical procedures all in one year to get over the 7.5% AGI floor for medical expenses. To get over the 2% AGI floor for miscellaneous expenses, bunch professional fees such as legal advice and tax planning, and unreimbursed business expenses such as travel and vehicle costs. If you can defer bunching these itemized deductions until next year, you may get a bigger bang for your buck!
3. Maximize “above-the-line” deductions.
Above-the-line deductions are especially valuable because they reduce your AGI. Many valuable tax benefits are limited based on your AGI. Common above-the-line deductions include traditional Individual Retirement Account (IRA) and Health Savings Account (HSA) contributions, moving expenses, self-employed health insurance costs, alimony payments and any bank penalties you may have had to pay for early account withdrawals.
4. Consider charitable contributions carefully.
Think about giving appreciated property to charity so you can deduct the full value without paying capital gains taxes. But don’t donate depreciated property. Sell it first and give the proceeds to charity so you can take the capital loss and a charitable deduction. As always, double-check the limits and substantiation rules before making any contributions. And don’t forget to consider whether an increase in taxes next year would make your contributions and deductions more valuable then.
5. Make up a tax shortfall with increased withholding.
Don’t forget that taxes are due throughout the year. Check your withholding and estimated tax payments now while you have time to fix a problem. If you’re in danger of an underpayment penalty, try to make up the shortfall through increased withholding on your salary or bonuses. A bigger estimated tax payment can still leave you exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year. Also, now would be a good time to consider how the expiration of the Bush tax cuts might affect your tax liability and, thus, your tax estimated payment for 2011. To avoid any penalties, the best action plan would be to make sure you pay estimated taxes equal to 110% of your estimated tax liability.
6. Leverage retirement account tax savings.
It’s not too late to maximize contributions to a retirement account. Traditional retirement accounts like 401(k)s and IRAs still offer some of the best tax savings in the Internal Revenue Code. Contributions reduce taxable income at the time you make them, and you don’t pay taxes until you take the money out at retirement. The 2010 contribution limits are $16,500 for a 401(k) and $5,000 for an IRA (not including catch-up contributions for those 50 and older). Remember that contributions to your IRA can be made as late as April 15, 2011. Regardless of whether tax rates go up, it almost always makes sense to put as much money into tax-favored retirement vehicles as you can.
7. Roll over into a Roth account.