For the last two weeks, we've been discussing items that you might consider to reduce your 2000 tax bite. We're on a roll now... let's look at a few more.
Income Planning
A time-honored aspect of tax planning is to estimate both your 2000 and 2001 adjusted gross income (AGI). It might be difficult, but in many cases it can save some tax dollars in the long run.
Why? Because, if you anticipate being in a higher bracket in 2001, you might benefit from accelerating income into 2000 and paying taxes on that income at a lower rate. If you believe that you'll be in a lower tax bracket in 2001, you can reverse the strategy and attempt to defer income into 2001.
Just remember that any time you mess with your AGI you are also indirectly messin' with other tax items. Deductible IRA contributions, Roth IRA contributions, Roth conversions, medical expense deductions, miscellaneous itemized deductions, taxation of Social Security benefits, and the threshold for various tax credits are just a few of the items that can be affected when your AGI is increased or decreased. So, be aware of how other items on your tax return will be impacted by your decision to "tinker" with it.
If you'll be in a higher tax bracket in 2001, ways to accelerate income into 2000 include:
Year-End Bonuses — If your employer generally pays bonuses after the end of the current year, you might try to negotiate to have your bonus paid to you before the end of 2000.
Retirement Plan Distribution — If you are taking money from a retirement plan, consider taking your withdrawals before the end of 2000, rather than waiting until next year. Even if you have no immediate use for the money, paying tax in 2000 and simply putting the money in the bank (or other investments) may be a smarter way to go.
Accounts Receivable Collection/Billing — If you are self-employed and report your income and expenses on a cash basis, issue year-end 2000 bills early to hopefully receive payment by the end of the year. You'll also want to attempt collection on any current or overdue accounts prior to the end of the year. Remember that many of your customers might also be in "tax planning" mode and might want to pay their bills (and take their deductions) prior to the end of 2000. They might be happy to pay for January 2001 goods or services in advance.
Roth IRA Conversion — As you should know, if you convert a regular IRA to a Roth IRA, you'll be required to report taxable income in the year of the conversion. So you might want to increase your 2000 income by making a Roth IRA conversion prior to the end of the year.
Investments — Review your portfolio now. Try to determine your gains and losses for the year. See if there are stocks, bonds, or mutual funds you might want to sell. You might want to take some additional short-term stock gains in 2000. Your investment portfolio is the one area in which you have direct control. Don't overlook it.
If you expect your AGI to be higher in 2000 than in 2001, you'll benefit by deferring income into 2001. You can accomplish this by:
Investments — Review your short-term gains and see what you might be able to defer into 2001. Additionally, be careful of year-end mutual fund purchases. As we discussed in Part I of this series, mutual funds can throw off income at the end of the year... most of it in the form of ordinary income -- so plan any mutual fund purchases carefully.
Other Issues — Basically, as you can imagine, other techniques would simply "reverse" the items that we noted above. If you're self-employed, you might want to delay your billing and collection of your bills into 2001. Don't make a taxable Roth IRA conversion until early in 2001. Take your retirement plan distributions in 2001 rather than 2000. See if you can talk your employer into delaying your year-end bonus into 2001 rather than paying it late in 2000. I'm sure that you can see how it all works. It all depends on which side of the fence you find yourself.
Deduction Planning
This goes hand-in-glove with income planning. If you believe that your marginal tax rate will be greater for the 2000 tax year (this year) than it will be for the 2001 tax year (next year), you'll want to accelerate deductions into your 2000 tax return. If you believe that the opposite is true (that your 2001 marginal rate will be greater), then you'll want to defer deductions into next year to claim on your 2001 tax return.
Deduction planning is difficult, because many deductions are affected by your Adjusted Gross Income (AGI). Deduction planning is also made difficult because of the standard deduction. If your itemized deductions don't exceed your standard deduction, they do you absolutely no good. So, make sure that you've got a firm foundation on deduction planning before you attempt this gambit.
If deduction planning works for you, and you are a cash-basis taxpayer (which virtually all of us are), please remember these important deduction tips:
- An expense is only deductible in the year in which it is actually paid. (This is especially important for people trying to "bunch" their deductions into any one specific tax year. Remember that you can't bunch expenses paid in different years.
- If you use a credit card to pay expenses (such as last-minute charitable contributions, medical expenses, business expenses, etc.), the IRS considers the expense deductible in the year that the charge is incurred... not in the year that the credit card bill is paid. So consider using your credit card for those last-minute deductible purchases, services, and charitable contributions.
- If you make a payment by check, make sure that it is dated and mailed before the end of the year. It's not important whether the check actually clears the bank by the end of the year... just that you made the payment before the end of the year.
- Remember that a mere promise to pay (making a pledge for a charitable contribution, for example) doesn't constitute an actual payment and is, therefore, not deductible until the year actually paid.
- If you have a business, don't forget the impact of the Section 179 election relative to various assets purchased. That election allows you to expense (i.e., deduct currently) purchases of business assets and property that you would otherwise be required to depreciate and deduct over a number of years. In 2000, you can elect to expense up to $20,000 of qualifying equipment.
Next week we'll conclude our series on year-end tax planning issues. I just know you can't wait.
Related Links:
Charitable Contributions of Stock
Limits on Itemized Deductions
Deductions -- An Overview
Section 179 Expense
If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2000: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)
November 17, 2000
