- Accelerating or deferring income.
- Accelerating or deferring expenses that can be used for tax deduction or tax credits.
- Taking advantage of any tax provisions that are scheduled to expire at the end of 2012.
Finding the right year in which to incur additional income or deductions is made especially prominent in 2012 due to the large number of expiring tax provisions. Changes in store include higher tax rates and significantly altered parameters for many popular deductions and credits.
Normally, people would prefer to defer income and accelerate deductions. A year-end bonus or selling off investments can often be pushed out to the following year. If tax rates are the same in both years, the person has gained the advantage of time. If a person's overall tax rate will be lower in the following year, deferring income has the additional benefit of pushing the additional income into a year with a lower overall rate, thereby reducing tax. The same holds true for deductions, but in reverse. If a person's overall tax rate is the same in both years, accelerating deductions achieves tax savings this year rather than waiting for those tax savings to materialize next year. If a person's overall tax rate is higher in 2012 than it will be in 2013, accelerating deductions produces the additional benefit of yielding potentially larger tax savings this year rather than next year.
But what if a person's tax rate will be higher in 2013 than in 2012? Under current tax law, all the tax rates will change for 2013. Also, the two percentage point reduction in the Social Security tax is also scheduled to end. And for higher-income individuals, a new Medicare surtax will apply to wages, self-employment income and investment income. On the other hand, there are two legislative proposals in Congress to keep the tax rates the same or increase only the top two tax brackets. But so far those bills have not passed into law. Accordingly, people may want to plan out their 2012 and 2013 taxes with an eye towards the presumably higher tax rates that might go into effect in 2013. And this means that usual traditional tax planning techniques highlighted above may need to be reversed. When tax rates go up between two years, accelerating income has the benefit of locking in a lower tax rate now instead of a higher tax rate in 2013. By the same token, deferring tax deductions has the benefit of yielding potentially larger tax savings next year where the deductions can offset income taxed at higher rates, thereby squeezing extra tax dollars out of a deductible expense.
Income Deferral StrategiesA deferral strategy shifts income to a following year if tax rates in that subsequent year will be lower overall than in the current year. Common income deferral strategies include:
- Ask your employer to pay out any bonuses in January 2013 instead of in December 2012.
- Hold off on selling stocks and other investments with taxable gains until next year.
- Hold off on taking distributions from an IRA or other retirement account until January 2013.
Income Acceleration StrategiesAn acceleration strategy shifts income to the current year if tax rates in the current year will be lower than in a subsequent year. Most types of income are difficult to accelerate, but some types of income are easier to shift into different years. For example:
- Ask your employer to pay out bonuses in 2012 instead of next year.
- Sell off stocks and other investments with taxable gains in 2012 instead of next year to absorb capital loss carryovers or to lock-in gains at the 15% rate.
- Accelerate IRA distributions in 2012 to avoid potentially higher tax rates starting in 2013.
- Convert pre-tax retirement savings to a post-tax Roth account to lock-in a known tax liability.
Deduction Acceleration StrategiesAccelerating deductions functions just like deferring income: the tactic attempts to reduce taxes in the current year at a higher tax rate if the overall tax rate is expected to be lower in a subsequent year. Deductions can be accelerated by:
- Paying tax deductible expenses in 2012 instead of 2013, such as medical bills, charity donations and property tax.
- Selling off stocks and other investments that have lost value so you can take the losses on your 2012 return.
- Increasing your 401(k) or IRA contributions.
Deduction Deferral StrategiesDeferring deductions attempts to delay making tax-deductible expenses until a subsequent year when tax rates are higher, and thus the deductions can produce more tax savings. For example:
- Defer paying medical bills, charity donations, property tax and other deductions until next year.
- Consider funding a Roth IRA instead of a tax-deductible traditional IRA. By forgoing the deduction, you'll be locking in a known tax rate on your contribution in return for tax-free investment returns.
AMT Tax PlanningPeople who are or might be impacted by the alternative minimum tax have additional considerations to think about. The AMT eliminates or reduces the federal tax savings for medical expenses, state and local taxes, property taxes, and miscellaneous itemized deductions. The suggestion here is to pay those expenses when they are due instead of trying to accelerate or defer them. For example, instead of prepaying the next installment of your property tax, wait until the actual due date to pay that since property tax is an adjustment for the AMT calculations. Similarly, anyone impacted by the AMT should sell any incentive stock options that they exercised during the 2012 calendar year since the value of an exercised but unsold ISO is added to your income for calculating the AMT.
When planning for the AMT, taxpayers should be aware that the AMT could pose a bigger problem in 2012 than in 2011, as the exemption amounts for 2012 are expected to be dramatically lower in 2012, which will in turn create larger alternative minimum tax liabilities.