Tax Deduction Time Machine

Moving Your Tax Deductions from One Year to the Next Can Net You Significant Tax Savings

As we approach the end of the year, tax season seems a lifetime away. The last thing many of you want to do coming into the holidays is a little tax planning. The last few months of the year, however, is an ideal time to start thinking about your taxes while you still can do something about them. Waiting until April 15 of next year means, with rare exceptions, you’re stuck with your expenses and tax deductions.

By planning in October, November, and December, you may have the option to bring some of next year’s tax deductions back in time to this year, or send some of this year deductions forward in time to next year. Regardless of the amount of deductions you have, a quick end of year review can net big tax advantages.

How the Time Machine Works

Tax deductible expenses are counted in the calendar year you pay them. This seems obvious, but a clever tax planner can use it to their advantage by choosing whether to pay an expense at the end of this year or the beginning of next. Any tax deductible expense you pay in the last few months of the year or the first few months of the next year are the key. By pre-paying next year’s expenses in December, you can move those tax deductions up one year.

Alternatively, by delaying to January those expenses you normally pay in November and December, you can send tax deductions forward in time to the next year. Make the timing of tax deductions a regular conversation with your tax advisor.

For Those with Few Itemized Deductions

Those who often take the standard deduction on their taxes can make the mistake that tax planning isn’t for them. If your itemized deductions are regularly very close to the standard deduction, you can still take advantage of the time machine by viewing your taxes in two-year chunks rather than single year periods.

Assume that the standard deduction is $10,000 and you have $9,000 in itemized deductions each year. You might mistakenly think there is little you can do other than take the $10,000 standard deduction each year. This would total $20,000 worth of deductions over the two years, which is better than itemizing for $18,000.

But what if you could take $4,000 of one year’s deductions and move them into the other year? You could take an itemized deduction of $13,000 in one year, and then take the standard deduction of $10,000 in the year you moved deductions out of. Over the two year period, you would have increased your total tax deductions to $23,000.

At the end of each year, review your current tax deductions to see how close they are to the standard deduction. Then see if there are any deductions you can pay early (see below for more information) so you can boost your deductions this year. If your itemized deductions for this year won’t be significantly above the standard deduction, consider paying those expenses in January to give you a head start to the next year. 

For Those with Lots of Itemized Deductions

If your itemized deductions regularly exceed the standard deduction, you can still take advantage of this tax planning strategy by looking at your estimated income this year and next. If your income varies from year to year, you can maximize the benefit of tax deductions by moving deductions from a year you earn less income to a year you earn more income. Since your marginal tax bracket increases as your income increases, tax deductions will provide a greater benefit in years when you are taxed at a higher marginal rate. 

Assume your income varies between the 15% and 25% tax bracket depending your earnings from bonuses, commissions, overtime, or business sales. Also assume you identify $10,000 worth of deductions you could move from one year to the other. In a year when your marginal tax bracket is 15%, the $10,000 tax deduction would net you a $1,500 benefit. If you can move the deduction to a 25% marginal tax bracket year, the same deduction would provide you with a $2,500 benefit.

Time Machinable Tax-Deductions

The following expenses are commonly able to be postponed or accelerated from one year to the other. You may have additional tax deductions or limitations on your ability to move deductions. Consult your tax advisor to identify your exact deductions that qualify for this strategy.

Mortgage Payments

Your January mortgage payment’s interest, as well as other tax-deductible interest, can often be accelerated into the current tax year. Interest accumulates throughout the month between your payments. If you make your January 1st mortgage payment in the last few days of December, all the interest accumulated during December will be credited as paid in this tax year. Normally this interest would be applied to next year’s taxes.

When your bank sends you form 1098, they will report all the interest paid in that tax year, which will include the interest you normally would have paid with your January 1st payment. A similar strategy can be used for any other tax-deductible interest such as second mortgages or student loans.

Property Taxes

If your property taxes are due at the end or the beginning of the year, check to see if you can choose to make payment in December or January. Again, you may have the ability to move the deduction from one year to the other, which can make a big difference in your taxes.

Capital Losses

Your capital gains or losses generally will not have any impact on your income taxes. But you can use losses you’ve had on an investment to offset capital gains in another investment. If you’ve lost money on an investment and are planning to sell it next year, consider taking the loss in this tax year to offset any gains from other investments. 

Alternatively, you can delay the sale of the investment or carry over losses from this year to the next tax year to offset any future gains you might have. Your tax planning advisor or CPA can easily show you how to carry capital losses forward into future years.

Non-Life-Threatening Medical Procedures

Medical expenses that exceed 10% of your modified adjusted gross income become tax deductible. If you’ve met the threshold, paying for any medical procedures this year will allow you to take a tax deduction on each of the procedures. 

Of course, if your medical expenses don’t hit the 10% threshold, you can’t deduct any of your medical expenses. If you won’t meet the 10% threshold, postponing medical procedures until next year may be an advantageous jump start to meeting next year’s threshold. Obviously, you should consult both a tax advisor and a medical professional before using this tax strategy. 

Professional Development and Job-Related Expenses

Many professional development or job-related expenses may be tax-deductible, including union and professional dues, subscriptions to trade journals or industry publications, government licensing fees, and professional education expenses. Paying for these dues or fees in advance or postponing payments can help you boost tax deductions in the year they will do you the most good. Contact the related companies and agencies to see if you can pay these expenses in January or accelerate payments into December.

Additional Retirement Contributions

If you make additional retirement contributions at the end of the year to boost your retirement accounts, determine which year the deduction will do you the most good. If you regularly get close to maxing out your retirement accounts, you will still want to make the extra payment this year as any postponed contribution will start eating up your ability to contribute in the next year. If the choice is a higher tax deduction or missing the opportunity to max out your retirement investing, choose the max on your retirement account.

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