What is postponing income/accelerating deductions?
Postponing income and accelerating deductions are two techniques commonly employed by taxpayers to minimize tax liability during the current year. These techniques are part of year-end tax planning. Your ability to utilize a deduction depends largely on when you incur the deductible expense. In many cases, you can control whether you incur an expense in the current tax year or in the next, thereby controlling the timing of your deduction. You may also have control over whether you receive some of your income in the current tax year or in the next tax year.
Deferring some of your income can affect your tax liability in two ways. First, if you lower your income sufficiently (so that you’re in a lower tax bracket), you will pay tax at a lower rate this year. Second, if your income is lower, it’s easier to meet the 7.5% floor required for deducting medical expenses. Medical expenses are allowed only to the extent that they exceed 7.5% of your adjusted gross income (AGI) when you total them.
Accelerating deductions into the present tax year also makes it easier to meet the 7.5% floor — you incur the expenses in the current tax year instead of incurring them in one or more future years.
Why might you wish to postpone income and accelerate deductions?
There are several reasons why you might wish to postpone your income and accelerate your deductions, not the least of which is to delay the payment of your tax liability for as long as possible. If you expect to be in a lower tax bracket next year (because of retirement, unemployment, an anticipated business reversal, or any other reason), you should consider postponing income this year and paying tax on it next year to lower your overall tax burden. If you’re in a higher tax bracket this year, you should also consider accelerating your deductions in order to use them this year. This may allow you to derive the greatest advantage from your deductions.
Social Security benefits
Do you receive Social Security benefits? If so, you might want to consider postponing some of your investment income and accelerating some of your deductions. This is because you will be taxed on a percentage of your Social Security benefits if your modified adjusted gross income (MAGI) plus 50% of your Social Security benefits exceeds a specified base amount. So, in some cases, timing income and deductions can affect how much of your Social Security benefits are subject to tax.
Change in marital status
You also may wish to postpone income and accelerate deductions if you expect to divorce. Your marital status for the entire year is determined as of December 31. If both you and your spouse have substantial income, you may potentially be subject to the so-called marriage penalty.
Additionally, if you expect to use head of household filing status in the following tax year instead of single, you may want to postpone income until next year (if possible) to take advantage of the lower tax rates that apply to head of household taxpayers.
How do you postpone income?
There are a number of ways to postpone or defer your receipt of income. These include the following.
Delay collections
Are you self-employed? If so, you can postpone income (assuming that, like most people, you’re a cash-basis taxpayer) by waiting to collect money owed to you. You can do this by sending out year-end bills late in December so that you won’t receive the payments until the following year.
Defer compensation
Are you employed by someone else? If you can hold off on receiving some of your pay for a while, it might be possible to have your employer wait until early the following year before paying you some of your year-end wages.
Defer year-end bonuses
Are you one of those lucky employees who actually gets a year-end bonus? If so, your employer may be willing to postpone the bonus until early the following year. Your employer will generally still be able to deduct it for the current year as long as you receive it within two and one-half months after the end of the tax year.
Hold your incentive stock options
Are you luckier still in that your employer grants you qualified incentive stock options (ISOs)? If so, remember that you generally do not recognize any taxable income until you exercise the options and sell the stock. You can postpone income tax and any capital gains tax by holding on to the options and/or the stock as long as permitted.
Remember interest income
Don’t forget about your interest income. The interest on bank certificates and Treasury bills isn’t includable in your income until you receive it at maturity (if the instruments have a term of one year or less). Transferring funds from other types of interest-bearing accounts to these types of certificates may delay tax on the interest.
Maximize retirement plan contributions
Don’t forget to add to your retirement savings. If you contribute the maximum amount allowable to certain retirement plans (such as 401(k) plans, IRAs, SEPs, and Keogh plans), you may be able to reduce your AGI if you meet all applicable requirements.
Use like-kind exchanges
Do you have business or investment property? Usually, you can defer recognition of capital gain or loss if you trade business or investment property for other business or investment property of a “like kind.” The gain will eventually be subject to income tax, but you can defer it for a while.
Ask for installment payments on sales
Are you planning to sell property any time soon? If you receive the payments in installments over the next few years instead of all at once, you may be able to defer recognition of some of the capital gain on the sale.
Set up individual/flexible spending accounts
If your employer allows you to set up an individual spending account (ISA) with pretax wages, you can pay in advance for eligible health-care and dependent care expenses. You are reimbursed from your account when you incur an eligible expense. It is up to you to decide how much money goes into the account (subject to certain limits). However, any money not used by the plan’s deadline (either the end of the plan year or up to 2½ months after the end of the plan year) is forfeited.
Defer bad debt cancellation or reduction
Do you owe anyone money? If you have a debt reduced or canceled, it is generally taxable income to you to the extent that the debt exceeds the amount for which it’s settled. Look into having it canceled or reduced next year instead. Special rules apply to bankrupt and insolvent debtors.
Shift or transfer income
By actually shifting (not postponing) income to someone in a lower tax bracket, you may be able to lower your tax bite. For example, you could shift income to a child under the Uniform Gifts to Minors Act. However, beware of the kiddie tax, which applies to certain investment income earned by children.
How do you accelerate deductions?
There are a number of ways to accelerate deductions. These include the following strategies.
Bunch deductions
When your itemized deductions are less than (but generally close to) your standard deduction, you usually lose the benefit of your itemized deductions. However, if you plan carefully, you don’t have to lose out by having to choose between the standard deduction and itemized deductions. Bunching allows you to adjust the timing of your expenses so they’re high in one year (when you itemize) and low in the next (when you take the standard deduction).
You can bunch deductions by taking the following steps:
- Prepay January interest in December
- Appropriately time nonemergency visits to your dentist and doctor
- Prepay property tax due the following year
- Time charitable gifts for maximum benefit
| Itemized Deductions | 2023 | 2024 |
|---|---|---|
| Mortgage interest | $4,000 | $4,000 |
| Medical (deductible portion) | $4,000 | $2,500 |
| State and local taxes | $3,500 | $3,000 |
| Charitable contributions | $3,000 | $2,500 |
| Total | $14,500 | $12,000 |
In this scenario, if your filing status is single, you should itemize in 2023. That is because your itemized deductions ($14,500) exceed your standard deduction for that year ($13,850). In 2024, you should take your standard deduction ($14,600) because it’s larger than the amount of your itemized deductions ($12,000).
| Filing Status | 2023 Standard Deduction | 2024 Standard Deduction |
|---|---|---|
| Single | $13,850 | $14,600 |
| Married filing jointly | $27,700 | $29,200 |
| Married filing separately | $13,850 | $14,600 |
| Head of household | $20,800 | $21,900 |
By accelerating deductions from 2024 to 2023, you may be able to take advantage of deductions that otherwise would have been lost.
Take the deduction the year you pay the expense
If you use the cash method of accounting, as most individuals do, you cannot claim a deduction until you pay the related expense. You should date your checks and mail them before January 1. Accrual method taxpayers may claim a deduction in the year in which they incur the obligation to pay.
Document your charitable contributions
A charitable pledge doesn’t suffice. You must actually give the money to a charity before you can deduct the contribution. Charitable gifts must be verifiable to be deductible. In such cases, the charity should give you written confirmation of your donation at the time you make the contribution. This confirmation must include a good faith estimate of the value of any goods or services you contributed.
If you donate appreciated property, you generally will receive a charitable contribution deduction for the full appreciated value of the property, and you will avoid paying capital gains tax.
Deduct bad debts
Does anyone owe you money? If you lent money to someone who isn’t planning to pay you back, you may deduct the bad debt in the year it became totally worthless. You must take steps to try to collect on the debt well before the year’s end, however. Your efforts are evidence of the debt’s worthlessness.
Deduct any mortgage points paid by the seller
Have you bought a home recently? If you bought a home and the seller paid the mortgage points for you, you may be able to deduct the points (in certain cases).
Rent your vacation home
Do you have a vacation home that’s empty much of the year? If you rent it out less than 15 days per year, the rental income you receive is tax free. In addition, you may deduct real estate taxes, mortgage interest, and casualty losses. You may not deduct expenses for maintenance and repairs.
If you rent the home for more than 14 days per year and meet certain other requirements, it may be possible for you to deduct more expenses, including those for maintenance and repair.
Prepay state and local income tax
When you prepay state and local income tax, you can generally accelerate deductions for these taxes.
Deduct investment interest
You may deduct interest on loans used for investment purposes only against net investment income. If you’ve passed this limit, you can absorb the excess deduction by selling appreciated property (discuss the tax consequences with a tax professional).
Prepared by Broadridge Advisor Solutions. © 2024 Broadridge Financial Services, Inc.
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