It is that time of year again to do some year end tax planning. I know, you are all starting to yawn. However, bear in mind that looking at your tax position after the year end when you prepare your tax return will often be too late.
This year in particular there are several beneficial tax provisions expiring on December 31, 2011 so you need to take action before they expire.
Spending a little time with your tax advisor now may well be beneficial to you.
In this first article we will look at what planning you can do for the income you receive.
The first thing you need to do is get together your income and deductions for the year to date and an estimate of what you think they will be for the whole year. If you are an employee you can use your latest paycheck to get the income and tax withheld. If you run a business now is a good time to get your books up to date to get an estimated profit figure. If you use QuickBooks® having a tune-up done would make sense at this time.
Once you have your estimate for the year your tax advisor can work out your estimated tax position for the current year, what refund you can expect or how much tax is due. This will also show your marginal tax rate which is important to know when deciding whether to implement a tax planning idea.
So, what can you do about your income that may save you tax?
Here are some ideas to consider:-
- Defer Income– If you can delay receiving income until after December 31 that will defer the tax due on that income until the next tax year. However, you need to estimate what your marginal tax rate will be in the following tax year to see if this will be beneficial. If your marginal rate is 10% this year but will be 25% next year then it wouldn’t make sense to defer income in to the later year. Some income items that might be deferred include:-
- Wage bonus
- Exercising an employee stock option
- Delaying invoicing sales
- Delay selling capital assets until next year
- Don’t take an IRA distribution until next year
- Advance Income– This may seem counter intuitive but receiving income early may save you tax in some situations. If you expect your marginal tax rate to be much higher next year then receiving income in the current year will save tax. Examples of income that might be advanced include:-
- Realizing gains on capital assets like company stock.
- If you are a cash basis business, chasing up accounts receivable to get cash in before the year end
- Start taking an IRA distribution this year
These give you a flavor of what can be done as part of your year end tax planning. One big caveat to bear in mind with any tax planning is don’t let the tax tail wag the dog. In other words if a tax planning idea does not make commercial sense then being commercial should take priority over the tax planning.
Disclaimer – This article does not constitute personal tax advice to the reader and is only offering general information. You should seek professional advice for your own situation as the most appropriate tax planning depends on your personal and unique circumstances.