Fall has officially begun and along with the season come some very special events.
Let’s see, football season is now in full swing, so all you football fans are cheering and you football haters are jeering. Everyone who has been suffering from this year’s sweltering summer heat is happy for the cooler weather, and those of us who like to sleep know the clock rollback for an extra hour’s sleep is soon to be. Fall leaves will soon be changing colors and falling off the trees. Columbus Day, Thanksgiving, Christmas, Kwanza and Hanukkah are not far off. And it’s time again for the accountants’ favorite time of year.
No, it’s not tax return time yet, but if that’s what you were thinking, you weren’t far off. Our really favorite time of year is whenever we can spend time with you and help you prepare for tax time. This is the time of year we start gently reminding you to review your tax strategies before December 31. That way, you can fix any strategies that are broken before they are beyond repair.
Elsewhere in our newsletter, we have some planning points for you to consider. Many of these date back to our 1999 suggestions and will be updated soon. The major changes you need to consider have not changed from 1999, and the rates, personal exemption amounts and similar fixed- number items are not as important as how you plan to get to the magical “taxable income” number for the year.
Maybe this article will jog your memory on items we have touched on in the past, such as:
Just as many people want to have their cake and eat it too, most of us would like to have as much income as possible without having to pay tax on it. Unfortunately it doesn’t work this way. There are, however, legitimate ways to plan your income to reduce your tax burden.
Business owners who report income on a cash basis can bill more slowly near year-end to prevent customers from paying the bill before early January. Of course, you need to consider your cash flow needs before slowing your year-end billing and collecting activities. However, we have found that most clients can survive a slow collection month in December if that translates into substantial tax savings. You should also consider that if you take this idea and run with it, you will need to continue the practice from year to year to avoid a big jump in income by putting 13 months of collections into one year.
What about accrual basis taxpayers? Planning income can be a bit trickier in this case, but it is still possible. Delaying completion of a project and, therefore, the billing for the project is one way of reducing income. Delaying shipment of merchandise is another way to reduce the income you must recognize in the current year.
This is all great for business owners, but what about employees? What can they do to reduce income? The answer may be nothing. On the other hand, an employer who files taxes on an accrual basis may wish to consider paying the December 31 payroll on January 1. Unless you are a greater than 50 percent owner, payments to you as an employee can generally be deducted in the year they are earned, but paid in a subsequent year. This is another of those things that once started, can’t be stopped without the employee being hit with more than a year’s income in the year the practice stops. The savings to employees can be substantial if your employer decides to use this technique.
If the employer is inclined to accommodate the employees in this way, be sure all employees are treated in the same manner. One of the main doctrines in income tax law is the “constructive receipt” doctrine. This basically says that if you had the right and the ability to receive income, but didn’t take it, you will still be taxed when you had the right to receive it. Therefore, reducing income because the employer puts off paying the year-end payroll by a day must be the employer’s decision and outside the control of the employee.
What we just said is all designed to reduce income because you want to minimize this year’s tax. However, you may be in a position where you know next year’s income will be much less, and it will behoove you to reduce it even further to put you in a lower tax bracket. In that case, you may wish to accelerate income. This may sound strange, but consider what would happen if you knew that this year’s income is going to be in the 31 percent bracket but next year’s income will be high enough to push you into the 36 percent bracket. If you could shift enough income to get you out of the 36 percent bracket in both years, wouldn’t it make sense to accelerate income to this year?
If you have stocks that have capital gains in them, consider your options carefully. If you sell this year, will your income put you in the 20 percent tax bracket for capital gains or the 10 percent tax bracket? Do you need to sell your stock? If you do sell your stock, do you have stocks with losses that you should sell to reduce the overall tax bite? Before you sell anything, take a look at what it will do to your taxes and also what the prospects for the stock are. It may be that selling in 2000 is not a wise move.
For more information on capital gains for 2000, see our June 2000 Tax and Financial Accounting News article “Forget About 2000! Think About 2001!”
You can also plan your income by planning interest and dividend payments. In some cases, an interest-bearing investment (certificate of deposit) will offer alternative ways to receive interest. Many times, you can have the interest paid upon the maturity of the CD. If you have a CD maturing before year-end and don’t need the interest between now and next year, consider renewing the CD to mature after December 31, 2000 with interest payable when the CD matures.
The other side of the taxable income equation is expenses. Expenses can be planned just like income.
Cash basis taxpayers will want to pay every bill they can think of by December 31. This is a relatively simple matter for the bills you already have before year-end, but what about things like utilities expenses, or accountant fees, or similar items that generally aren’t invoiced until the month after you incur them? You may wish to check with your vendors and service providers to see if you can get a bill early. Even if they can’t bill you early, you may wish to make a prepayment based on the prior month’s bill. Rent is another item that is generally paid at the beginning of a month, but can be paid on December 31.
Accrual basis taxpayers will be able to take a tax deduction only when the expense is incurred. This is generally advantageous because it doesn’t require you to use your cash or ask your vendors or service providers to do anything special. However, since the controlling factor is when the expense is incurred, you might want to “encourage” your service providers and suppliers to complete any projects or ship products before year-end.
Finally, if you haven’t spent $20,000 on equipment this year, but plan to purchase new equipment early in 2001, consider accelerating your purchases into the current year. The only thing you lose is the taxes you save.
All of this “pay sooner” stuff is great, but what if you don’t have the cash? If you have a credit card, the IRS recognizes payments to creditors via credit cards as being essentially equivalent to cash payments. Don’t let the lack of cash prevent you from paying an otherwise deductible expense if you have credit cards available to make the payments. Of course, don’t put yourself in a position where you incur debt you won’t later be able to repay.
For many taxpayers, planning itemized deductions has become an art.
The same rules that apply to cash basis taxpayers for business expenses apply to payments of itemized deductions. Therefore, you should determine what your deductions are likely to be this year and next year. Sometimes it is better to “bunch” deductions by delaying payment of state income taxes, real estate taxes and other itemized deductions until the following year. “Bunching” itemized deductions means delaying or accelerating the payment of the deductions to exceed the standard deduction in one of the years. This can be useful if your deductions this year and next are expected to be less than the standard deduction.
The major itemized deductions are as follows:
1. Medical expenses, including smoking cessation programs and prescriptions for drugs to break nicotine addiction, are deductible to the extent they exceed 7.5 percent of adjusted gross income (AGI)
2. Taxes, including state income taxes, real estate taxes and personal property taxes
3. Interest and points, paid for home mortgages. This includes interest paid for a mortgage on your personal residence and a second home. Points paid on an initial mortgage are immediately deductible, while points paid for a refinancing are deductible over the life of the new loan. There are some restrictions that affect persons with very large (over $1 million) mortgages
4. Investment interest, paid on loans to purchase investments, to the extent they don’t exceed investment income
5. Charitable donations
6. Casualty losses, to the extent they are greater than $100 and exceed 10 percent of AGI
7. Dues, education, investment, employee business and other expenses, to the extent they exceed 2 percent of AGI
Just as with business expenses, don’t forget you can charge an itemized deduction on your credit card and take it in the year you make the charge.
This may seem to be the time of year to relax and enjoy the scenery, the holidays and the many other benefits of fall and winter, but don’t be fooled. Saving taxes takes planning – before December 31. Now is the time to take stock of where you are from a tax perspective and where you want to be. Give us a call and schedule a time to discuss your current situation. Together, we can work out a plan to minimize your tax bill for 2000. You might even find it a little fun finding ways to reduce what you pay Uncle Sam.