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Happy Almost New Year
Tax and Financial News
November 2001
Happy Almost New Year
Last month, we spent a fair amount of time talking about a return to normalcy. This month, we continue that theme by talking about perhaps the most common of all American pursuits - trying to save on taxes. We know the thought of taxes is not something to make any of us smile, but the thought of the changes in taxes for the current and coming year should make you grin a little.
November and December are generally mad scramble months for those of us who help people reduce their taxes. This is when we start looking at the effect of all those tax planning strategies we've already implemented and start looking for a few more to reduce tax burdens even more. The only time it's really too late to try to save on taxes is next year, and even then there' a few exceptions. Let's take a look at a several things you should be thinking about for this year-end.
First, it's important to realize that most tax planning strategies don't necessarily prevent you from recognizing taxable income. Many just engineer (legally) the timing of that income and, thus, the overall amount of tax you will pay. There are primarily four ways to engineer your income. You can 1) defer recognition of income to 2002 or later, 2) accelerate income to 2001, 3) accelerate deductions to 2001 or 4) defer deductions to 2002 or later.
Deferring recognition of income.
By now, most readers will have a fairly good idea of what their income will look like for 2001. How much and what type of income you have will dictate how well this tax planning technique will work for you.
If you're an employee, you may or may not be able to defer compensation. However, if it looks like you may be in line for a bonus in the current year, you may wish to discuss with your boss deferring payment of that income. Some employers, particularly those whose books are set up on an accrual basis, might be receptive to holding your money a little longer.
If you're self-employed and report your income on a cash basis, one very effective technique is to hold off billing in December. By waiting to send your bills out late enough to guarantee you won't receive the cash until 2002, you can achieve substantial tax savings, particularly if you used the same technique last year.
How is your portfolio looking this year? Is it possible that you may have a few loss stocks? Did you perhaps sell some stock this year at a gain? If so, you may wish to sell some losers and take the loss this year to reduce capital gains. This technique is not limited to offsetting stock losses just against stock capital gains. Any capital gains can be reduced by capital losses. Just don't be too zealous and dump all your losers to the extent your losses exceed your gains. If that happens, the most you can deduct against ordinary income is $3,000.
If you happen to control a corporation that pays taxable dividends in addition to regular salary income, you can declare and pay dividends after year-end.
You don't have the same luxury with interest income. Since interest income is a tax-deductible expense to your closely held corporation, interest is only deductible when you pick it up in income (this assumes you own more than 50% of the corporation). The same goes for bonus payments. Still, if it's a choice between paying yourself a salary to minimize corporate taxes or paying yourself interest - pay the interest. Interest income is not subject to employment taxes.
If you sell property this year but want to minimize your tax bite, consider an installment sale if it doesn't jeopardize collection of the purchase price. In an installment sale, you sell the asset and collect enough of the sales price to pay any taxes resulting from recaptured depreciation plus whatever else you determine is a fair down payment. The rest of the purchase price is deferred until the next and/or succeeding years. Just make sure to adequately assure yourself that you will indeed collect the full sales price.
If you have interest earning deposits which are not particularly needed, you may wish to park the funds in a Treasury Bill or certificate of deposit due after December 31, 2001. This will prevent receipt of additional interest on the funds until a later year. The result will be tax savings.
All of the techniques above assume you'll be in a lower tax bracket in succeeding years. Given the reduction in income tax rates with the new law, along with the indexing of rate brackets for inflation, you stand a good chance of being in such a situation. The changes in the law allowing for greater deferrals of income to qualified retirement plans will also help reduce the effect of increased income in 2002 and beyond. The only way to know for sure is to run the numbers.
Why accelerate income?
In some situations, it may be advisable to accelerate income. If it looks like you'll be in a lower bracket in 2001 than in 2002 or later years, accelerating income into 2001 can reduce income tax. You can do this by reversing the advice we gave regarding income deferral.
How do you accelerate expenses?
The simple answer to how you accelerate expenses/deductions is you pay them before December 31. The more complex answer is: It depends.
From a personal income tax perspective, you're probably a cash basis taxpayer. This means you deduct expenses only when they're paid. As you near year-end, it would be helpful to discuss early billing from your vendors. The sooner they bill and you can pay, the sooner you get the deduction.
When looking at business expenses, there are a few things you should know. The only expenses this rule applies to are deductible ones. Early payment of club dues and other nondeductible items will be of little use. On the other hand, business supplies, a month's rent and similar items are all fair game. If you need equipment, now is the time to buy it if you haven't exceeded the amount of equipment that is immediately deductible. For 2001, you can expense up to $24,000 in equipment purchases instead of deducting them. This is not true of luxury automobiles, so be careful what you buy. Just be certain the assets purchased are received and placed in service prior to December 31.
What does it mean to pay your expenses before year-end? The IRS defines payment as being either a cash or check payment, borrowing money from a third party to pay an expense or capital asset purchase and payment using credit cards. Purchasing equipment or supplies and paying the vendor in the following year won't meet those criteria.
The same general principles apply for purposes of personal deductions as apply to business expenses. You must incur and pay the expense by December 31 and the amounts must be deductible. Deductible items include medical expenses to the extent they exceed 7.5% of your adjusted gross income, income and property taxes, contributions to charitable causes (qualifying charities), home interest and points and miscellaneous itemized deductions to the extent they exceed 2% of your itemized deductions. Be careful to take into account the effect of the phase-out of itemized deductions when your adjusted gross income exceeds a specified level.
If you don't have the cash to give away, don't forget you still are able to deduct the fair market value of property given away. If you have property that has appreciated in value, consider giving it to your favorite charity rather than selling it and gifting the proceeds. Either way you'll be able to deduct the amount of the gain, but if you sell first, you pay taxes.
Why defer expenses?
Are you light on income this year but expecting business to boom in 2002? Defer expenses. By deferring expenses and deducting them when you're in a higher bracket, you'll save taxes. This is true regardless of whether those expenses are business or itemized deductions.
Conclusion
The tax planning opportunities available to you depend on your income sources. One thing is true though; we could literally write a book on tax savings opportunities and still only scratch the surface. For example, we haven't discussed what type of retirement plan you should have or current year estate planning opportunities.
Regardless of your situation, now is the time to start working on your year-end planning. Give us a call today and schedule a time to sit down and plan your tax saving strategies. In the meantime, have a great November and enjoy the Thanksgiving holiday season.
November and December are generally mad scramble months for those of us who help people reduce their taxes. This is when we start looking at the effect of all those tax planning strategies we've already implemented and start looking for a few more to reduce tax burdens even more. The only time it's really too late to try to save on taxes is next year, and even then there' a few exceptions. Let's take a look at a several things you should be thinking about for this year-end.
First, it's important to realize that most tax planning strategies don't necessarily prevent you from recognizing taxable income. Many just engineer (legally) the timing of that income and, thus, the overall amount of tax you will pay. There are primarily four ways to engineer your income. You can 1) defer recognition of income to 2002 or later, 2) accelerate income to 2001, 3) accelerate deductions to 2001 or 4) defer deductions to 2002 or later.
Deferring recognition of income.
By now, most readers will have a fairly good idea of what their income will look like for 2001. How much and what type of income you have will dictate how well this tax planning technique will work for you.
If you're an employee, you may or may not be able to defer compensation. However, if it looks like you may be in line for a bonus in the current year, you may wish to discuss with your boss deferring payment of that income. Some employers, particularly those whose books are set up on an accrual basis, might be receptive to holding your money a little longer.
If you're self-employed and report your income on a cash basis, one very effective technique is to hold off billing in December. By waiting to send your bills out late enough to guarantee you won't receive the cash until 2002, you can achieve substantial tax savings, particularly if you used the same technique last year.
How is your portfolio looking this year? Is it possible that you may have a few loss stocks? Did you perhaps sell some stock this year at a gain? If so, you may wish to sell some losers and take the loss this year to reduce capital gains. This technique is not limited to offsetting stock losses just against stock capital gains. Any capital gains can be reduced by capital losses. Just don't be too zealous and dump all your losers to the extent your losses exceed your gains. If that happens, the most you can deduct against ordinary income is $3,000.
If you happen to control a corporation that pays taxable dividends in addition to regular salary income, you can declare and pay dividends after year-end.
You don't have the same luxury with interest income. Since interest income is a tax-deductible expense to your closely held corporation, interest is only deductible when you pick it up in income (this assumes you own more than 50% of the corporation). The same goes for bonus payments. Still, if it's a choice between paying yourself a salary to minimize corporate taxes or paying yourself interest - pay the interest. Interest income is not subject to employment taxes.
If you sell property this year but want to minimize your tax bite, consider an installment sale if it doesn't jeopardize collection of the purchase price. In an installment sale, you sell the asset and collect enough of the sales price to pay any taxes resulting from recaptured depreciation plus whatever else you determine is a fair down payment. The rest of the purchase price is deferred until the next and/or succeeding years. Just make sure to adequately assure yourself that you will indeed collect the full sales price.
If you have interest earning deposits which are not particularly needed, you may wish to park the funds in a Treasury Bill or certificate of deposit due after December 31, 2001. This will prevent receipt of additional interest on the funds until a later year. The result will be tax savings.
All of the techniques above assume you'll be in a lower tax bracket in succeeding years. Given the reduction in income tax rates with the new law, along with the indexing of rate brackets for inflation, you stand a good chance of being in such a situation. The changes in the law allowing for greater deferrals of income to qualified retirement plans will also help reduce the effect of increased income in 2002 and beyond. The only way to know for sure is to run the numbers.
Why accelerate income?
In some situations, it may be advisable to accelerate income. If it looks like you'll be in a lower bracket in 2001 than in 2002 or later years, accelerating income into 2001 can reduce income tax. You can do this by reversing the advice we gave regarding income deferral.
How do you accelerate expenses?
The simple answer to how you accelerate expenses/deductions is you pay them before December 31. The more complex answer is: It depends.
From a personal income tax perspective, you're probably a cash basis taxpayer. This means you deduct expenses only when they're paid. As you near year-end, it would be helpful to discuss early billing from your vendors. The sooner they bill and you can pay, the sooner you get the deduction.
When looking at business expenses, there are a few things you should know. The only expenses this rule applies to are deductible ones. Early payment of club dues and other nondeductible items will be of little use. On the other hand, business supplies, a month's rent and similar items are all fair game. If you need equipment, now is the time to buy it if you haven't exceeded the amount of equipment that is immediately deductible. For 2001, you can expense up to $24,000 in equipment purchases instead of deducting them. This is not true of luxury automobiles, so be careful what you buy. Just be certain the assets purchased are received and placed in service prior to December 31.
What does it mean to pay your expenses before year-end? The IRS defines payment as being either a cash or check payment, borrowing money from a third party to pay an expense or capital asset purchase and payment using credit cards. Purchasing equipment or supplies and paying the vendor in the following year won't meet those criteria.
The same general principles apply for purposes of personal deductions as apply to business expenses. You must incur and pay the expense by December 31 and the amounts must be deductible. Deductible items include medical expenses to the extent they exceed 7.5% of your adjusted gross income, income and property taxes, contributions to charitable causes (qualifying charities), home interest and points and miscellaneous itemized deductions to the extent they exceed 2% of your itemized deductions. Be careful to take into account the effect of the phase-out of itemized deductions when your adjusted gross income exceeds a specified level.
If you don't have the cash to give away, don't forget you still are able to deduct the fair market value of property given away. If you have property that has appreciated in value, consider giving it to your favorite charity rather than selling it and gifting the proceeds. Either way you'll be able to deduct the amount of the gain, but if you sell first, you pay taxes.
Why defer expenses?
Are you light on income this year but expecting business to boom in 2002? Defer expenses. By deferring expenses and deducting them when you're in a higher bracket, you'll save taxes. This is true regardless of whether those expenses are business or itemized deductions.
Conclusion
The tax planning opportunities available to you depend on your income sources. One thing is true though; we could literally write a book on tax savings opportunities and still only scratch the surface. For example, we haven't discussed what type of retirement plan you should have or current year estate planning opportunities.
Regardless of your situation, now is the time to start working on your year-end planning. Give us a call today and schedule a time to sit down and plan your tax saving strategies. In the meantime, have a great November and enjoy the Thanksgiving holiday season.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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