As end of the year approaches, the most frequent questions I get asked from friends, neighbors and relatives are related to 2010 year-end tax planning decisions. They want to know how to maximize the use of eligible deductions and credits to reduce their taxable income. There may be instances where a shift of income and/or deductions from one year to another could result in lower income tax payments for each year.
The majority of taxpayers file their federal income tax on a calendar year basis, which means that the opportunity for tax planning ends on December 31. After this date it is too late to make any decisions that could possibly reduce your taxes. You should not wait two to three months from now when you meet with your tax preparer or accountant to discuss ways to save on your 2011 income taxes.
If you have a choice between taking a deduction or credit in 2010 vs. 2011, it is better to take the deduction or credit this year if you anticipate being in a lower tax bracket next year. This rule also applies in reverse, i.e., delay the deduction or credit until next year if you anticipate being in a higher tax bracket. Alternatively, if you are going to be in a lower tax bracket next year you will want to postpone income to next year (and vice versa).
To illustrate the principle, suppose that you were planning to make a $1,000 charitable contribution to your church. This year your taxable income is $40,000, including the $1,000 charitable deduction, but next year, because you've just take a new job at a much higher salary, you anticipate your taxable income to be $50,000. You can save taxes if you make the charitable contribution after January 1, 2011 rather than on or before December 31, 2010. The reason for this savings is that your anticipated tax bracket in 2011 is higher than your 2010 tax bracket. This makes your tax deduction more valuable.
The principle applies to all situations where you expect a significantly different taxable income in one year than the next or because of changes in the tax law. You should examine your individual or family situation for anticipated income changes.
Here are some common situations which can dramatically change your tax bracket and the value of your tax deductions or credits.
- Higher wages in one year for special salary bonuses or commissions
- Additional income (or loss of income) of a working spouse
- Temporary loss of employment
- Working a second job
- Sudden increases or decreases in business income
- Substantial income from investments or lottery winnings
- Changes in tax laws
Here is a check list of year-end tax strategies:
- Make gifts of clothing, furniture and other household items (maintain full information about these gifts such as items contributed and their values.)
- Donate securities that have increased in value to charitable organizations, e.g., churches and colleges. (You may deduct the full fair market value of securities and the increased value is not taxed to you.)
- Avoid all year-end tax shelters (bad limited partnership tax shelters are usually offered during this part of the year.)
- Take first-year write-offs for a home computer purchased if you use it more than 50% of the time for your business or your employer requires you to use your home computer. The tax bill that Congress is currently working on will allow you deduct 100% of the total cost of such business equipment, in the year purchased. You will not have depreciate the equipment over a number of years.
- Shift as much income as possible to family members who are in lower tax brackets.
- Shift charitable contributions made to your church or any other organizations to the 2010 or 2011 tax year to obtain the maximum tax benefits.
- Prepay real estate taxes on any property that you own.
- Review the amount of support that you have provided your parents (especially if they are receiving social security payments) if you plan to claim them as your dependents. It may be necessary to make an additional contribution to bring you share of support to over 50% which allows you to claim your parents as your dependents.
- Estimate your total personal deductions before December 31, 2010 to see if the total deductions exceed the standard deduction for married persons, for single persons and for married persons filing separately. If your total personal deductions do not exceed the appropriate standard deductions to achieve the benefits of itemizing, shift as many deductions as you can to the year which will allow you to exceed the standard deductions.
- Contribute all that you can to your 401(k) retirement plan by December 31, 2010.
Following these tips is sure to ease the stress that income tax filing season can bring upon many taxpayers.
Theodore R. Daniels is the Founder and President of the Society for Financial Education and Professional Development (SFEPD). Founded in 1998, SFEPD is a non-profit organization whose mission is to enhance the level of financial and economic literacy of individuals and households in the United States and to promote professional development at the early stages of career development through mid-level management.