Income
tax rates will be lower next year than this year. In
most cases there will be a tax benefit in shifting — deferring — some of your
2002 income to next year. This strategy is often
overlooked, yet can result in hundreds of dollars, if not thousands in tax
savings.
Deferral Strategies:
Self-employed
persons typically defer income to next year by delaying billing for 2002 work
until 2003. Employees may defer income by arranging
in appropriate cases to have bonuses or other special compensation items paid
in 2003. Investors can defer capital gains income
by postponing sales to next year though such a move wasn’t created by the
2001 Tax Act's rate cuts since capital gains rates weren't changed.
You
get the effect of income deferral by accelerating into 2002 itemized deductions
that would otherwise fall into 2003. Examples
include: prepayment of state and local as well as real estate taxes that would
be owed for the current year anyway, but are usually paid as a fourth quarter
estimate at the beginning of the following year, charitable contributions
and investment advisory fees.
Deferrals
don’t always work.
Deferral
may not work in the following situations:
- The alternative minimum tax (AMT) can frustrate some deferral
moves. One case is where taxable ordinary
income is deferred leaving a higher proportion of tax preference and adjustment
items to be hit by AMT. Another is where too
much state income tax (not deductible for AMT) is accelerated.
- Time value of money. The
more cash income you defer (through postponing income or accelerating deductions),
the less money you have working for you now. Make
sure the payoff from deferral (the taxes saved) is worth it.
- Estimated tax. Deferring
income from 2002 to 2003 may not mean postponing tax payment for a full
year. Remember quarterly estimated tax obligations
for taxes not collected by withholding still need to be paid in a timely
manner.
During
year-end tax planning, one should explore the issues of deferral and its possible
drawbacks:
(1)
which items
to defer and how to defer them,
(2)
AMT, and
(3)
the real payoff
after time-value-of-money and estimated tax considerations.
For further information, contact Louis P. Stanasolovich, CFP™ at (412)
635-9210 or legend@legend-financial.com