Many tax experts talk about shifting your tax burden from one year to the next. While in theory it may make sense, in practice how can you make it work for you?
Since the tax code is complex in its construction, there are often opportunities to reduce your tax burden by controlling the amount of your taxable income. This is because:
- Income tax rates vary from 0 to 39.6% depending on your income and filing status.
- Many tax breaks have income limits.
- Tax breaks have income phase-out ranges.
- Incremental taxes like the Alternative Minimum Tax and deduction phase-outs are triggered by income level.
So if you can shift your income and expenses from one year to the next, you could create a net tax obligation for both years that might be lower than if you did nothing. Here are six great ideas to accomplish this.
Six great ideas
Idea 1. Know the rules. Identify whether you are a good candidate for using shifting as a tax planning strategy. For singles, the income tax rate increases by 66% or more on earnings over $37,000. For married couples, that increase occurs with adjusted gross income over $74,000. But other tax benefits are lost at different income levels. Common tax breaks subject to income limits are child tax credits, earned income credits, educational credits, premium health care credits and many educational tax benefits.
Idea 2. Load up your contributions. If you itemize your deductions, consider loading up your cash and non-cash contributions into the year that lowers more highly taxed income. For example, you could shift next year’s donations to your church into this year. Consider making last minute runs to goodwill with clothing and other items.
Idea 3. Leverage the cash basis concept. You can take a deduction when you pay for it. A credit card receipt is good on the date you run the transaction and not when you pay the bill. Knowing this, you could pay a property tax statement or a house payment either a little early or a little late to change whether that deduction is in this year or next.
Idea 4. Stop working. There are many cases when this technique is an important tax shifting tool. The most common example applies to those who are under the full retirement age and are receiving Social Security Benefits. If this applies to you, you will want to actively manage your part time work or you could end up paying taxes on some of your Social Security benefits or even losing some of them. Work can also hurt your tax situation when a dependent’s wages put you over the earnings threshold to receive the Premium Tax Credit. It may make sense to stop working or arrange to get your last paycheck delayed into the following year.
Idea 5. Manage retirement plan distributions. Those over 59 ½ years old can use distributions from pre-tax retirement plans to tightly control their taxable income. Your withdrawal calculation should include evaluating how to maximize the tax efficiency of your income. An analysis may indicate it is better to take out a little more this year to get these retirement earnings taxed at a lower rate than if you waited until next year. There is a special caution using this technique if you are over 70 ½ years old and are subject to the Minimum Required Distribution rules.
Idea 6. Manage your stock and investment sales. You have up to $3,000 in investment losses that can offset your typically higher taxed ordinary income. Use this to your advantage when deciding whether to take a stock loss this year or next. If done correctly, you can match your stock loss against ordinary income taxed at a high rate.
By shifting your taxable income to the right level, you can often reduce your tax bite. Please call if you wish a review of your situation.