Assuming your tax rates are the same or higher this year than they will be next year, then you should consider accelerating deductions into this year.
If you are on the cash basis, almost all individuals are, then you can prepay deductible items that are due next year. For example:
- Real estate taxes, in NC they are generally not late until after January 5th of next year but is it really worth waiting an entire year for the deduction to keep the money for five days?
- Personal property taxes.
- Charitable contributions.
- Final state and local estimated tax payments that are traditionally due in January of the next year.
- Pay outstanding medical bills if you will be able to itemize medical deductions (usually only amounts in excess of 10% of your adjusted gross income are deductible).
- Pay your January home mortgage payment early. Make sure the mortgage company gets it before the end of the year so they credit it to the year you paid.
- If you are in business, consider:
- Buying assets subject to the Section 179 deduction. Currently, the limit is a maximum of $25,000 but Congress is considering changing the limit. Eligible assets are typically tangible personal property but the rules are complex. Check first to see if the asset is eligible as getting a refund from the seller may be difficult. There are other limits to keep in mind too that are not detailed here.
- Pay year-end bonuses this year that are due in January of next year. Bonuses are still wages and subject to withholding taxes when paid to an employee.
- Stock up on office supplies.
- Prepay part of next year’s rent. Do not go overboard, only up to twelve months prepaid is deductible.
- Complete repairs (not improvements) and pay for them this year.
- Sell capital assets (e.g. stocks, mutual funds, and bonds) at a loss to offset capital gains and net a loss of $3,000 that can be deducted against other income. Watch out for the wash sale rule. This rule postpones losses if you buy the same or a similar asset (e.g. an option on the stock you sold) within 30 days before or after the loss sale date. For some people it is best to pretend it is 31 days as IRS does not forgive you for counting the days wrong.
- If you pay off your credit card balance every month, consider using your credit card to pay your deductions. There is no tax advantage in using a credit card versus paying in cash. The advantage comes from getting the deduction when the charge goes through versus when the payment is made to the credit card company next year. If you carry a balance on your credit card (i.e. you pay interest) then this option is much less attractive and may be cost more in interest than it saves in taxes.
- Businesses on the accrual method of accounting cannot generally accelerate deductions by paying them early. For example, an accrual business gets no benefit from paying this year for inventory to be received next year. The prepayment is treated as non-deductible deposit. Accrual businesses can take advantage of the Section 179 deduction and they have other options.
Keep in mind that if you claim the standard deduction instead of itemizing, accelerating deductions may not make much sense. Instead you should consider bunching itemized deductions into one year so that you can itemize and claiming the standard the next year (or vice versa – standard this year then bunch next year).
Finally, keep in mind that tax planning is a multiple year process. Saving tax this year at the cost of even more tax next year does not make sense. Also, be aware that if you owe Alternative Minimum Tax or are close to owing then accelerating some deductions, such as taxes, may not save any federal tax.
Do not allow the “tax tail to wag the dog.” In other words, the most important thing is how much you have after taxes. For example, a contractor should not buy a new generator just for the tax deduction when her old generator works just fine. The tax savings are less than the cost of the new generator.