Posted November 17, 2016
The holidays are here and people start thinking about year-end moves to minimize their taxes. Every week between Christmas and New Year’s Day we field a zillion questions on year-end tax planning. There are several pitfalls and traps to some of the ideas. We’ll talk about deductions in general. We’ll talk about last-minute tax moves. And Yes, we’ll talk about automobiles. They always seems to top the list of good ideas (or at least most business owners think so). Here we go-
Marginal Tax Rates
Quick lesson on deductions. When you write a check and it has a tax savings element (401k, IRA, charity, etc.) it is not a dollar for dollar savings. For example, if you are in the 25% marginal tax bracket, you must write a check for $4,000 just to save $1,000 in taxes. Keep this in mind as you read this information on year-end tax savings. Also keep in mind that cash is king, and that perhaps paying a few more taxes today with the added flexibility of cash in the bank can be comforting.
Another way to look at this is this- most people say “I want to save taxes” but really what they are saying is “I want to save cash.” In other words, most people are in the cash-saving business not the tax-saving business. If we can do both, great. However, most tax-savings moves take cash, and cash is what you want to keep. So keep this concept in mind as review some of the year end tax moves listed below.
Another consideration is your income in 2016 versus 2017. If you are going to have a better year in 2017, then delay your tax deduction until January 1. Why pile on tax deductions in a low income year? Silly. Conversely, if 2016 is unusually high, then Yes, pile on those tax deductions. Either way, have a plan! Don’t be shortsighted. Don’t save taxes just because you can- make sure it is the right move.
Some taxpayers have their refunds kept by the IRS because of back taxes, or other obligations such as student loans. In these situations, you can put yourself in a “tax due” position by decreasing your withholdings on your pay checks and putting more money in your pocket today. Yes, you will still owe whatever it is you owe, but at least the extra cash you pay in the form of excess income taxes withheld won’t be used to accelerate your debt payoff.
401k / IRA
The simplest way to save taxes is to contribute to your 401k plan or traditional IRA. You saves taxes and pay yourself in the meantime. Remember this as well- this is an IOU to the IRS. When you retire and are forced to withdraw this money, you will be taxed on it. IRA and Roth IRA contributions are due April 17 2017, no exceptions.
Business owners- SEP IRAs are old school. Lousy contribution limits. No Roth options. A 401k plan is much better. Ask how we can help.
Roth conversions- perhaps you should have us review the conversion of your traditional IRA into a Roth IRA. Yes, pay more taxes today, but perhaps your 2016 income is lower and it makes sense. Or your income is on a rocket trajectory, and this year is the only year it makes sense.
Writing a check to your church is good. Don’t forget the theater, educational organizations, and others. Also, what is not just good, but actually great, is donating to Goodwill, Salvation Army, Arc Thrift, etc. Donating items from the hollows of your closet doesn’t require cash since that money is already spent.
Keep in mind that some states, such as Arizona, offer huge tax credits (much better than tax deductions) for donations to schools and charities.
Need some cash? Sell some of your profitable stocks along with your dogs. Not literally your dogs, but your under-performing stocks. Sell enough stock to create a $3,000 gain and sell some more to add a $6,000 loss, and presto! You’ve pulled out some cash and create a $3,000 loss and tax deduction.
Pay Bills Earlier
You can pay some bills early such as property taxes, child care, tuition (possibly) and other deductions. Even for business owners, you can pre-pay rent up to 12 months, insurance, stock up on some office supplies, etc.
What a beautiful color! 2017 Porsche 911 in Carmine Red. Someday. Ok. Here we are on everyone’s favorite topic. Buckle up…
A question we entertain almost daily is “I want to save taxes. Should I have the company buy me a car?” Our auto-attendant replies with, “Do you need a car?” If you answer with “Yes” the auto-attendant replies with, “Hold please.” If your “Yes” is not quick or mumbled, or if there is any recognition of hesitation, the auto-attendant is unhappy and will send you to our call center in Hawaii.
We digress. There are only a few questions you need to ask yourself when considering a car purchase. Are you the type of person who buys new? How long do you typically keep your cars? Is the car 100% business use? How many miles do you plan to drive? There is a decision tree you can review on our website.
Back up for a bit. Remember our previous discussions about tax deductions, and how only a fraction of the money you spend is returned to you? So, back to our auto-attendant, “Do you need a car?” If the answer is “Yes” because your bucket of bolts is getting exceedingly dangerous, then Yes, buy a much-needed car out of a sense of safety. If the answer is “Not really, but I want to save taxes,” then don’t. Two rules to live by-
- Cash is King (keep it!)
- Depreciation is a tax deferral not a tax avoidance system (typically)
There might be some other external forces at play. For example, if you need a car next year but your income is ridiculously and unusually high in the current tax year, then reducing your income now makes sense. Again, tax modeling and planning is critical. Here is some more information-
Tax Planning with Depreciation Recapture
Please understand that depreciation is a tax deferral system rather than a tax avoidance system. Huh? When you sell or dispose of an asset, you might have to pay tax on the portion that was depreciated.
For example, you buy a $200,000 piece of machinery and use Section 179 depreciation to deduct the entire $200,000 in the first year. Five years later you sell the equipment for $150,000 because you slapped some new paint on it and you are a shrewd negotiator with your buyer. You will now have to recognize $150,000 of taxable ordinary income. Yuck. But there is a silver lining- depreciation recapture is taxed at your marginal tax rate up to a maximum of 25% tax rate. So, you could have depreciated your asset during 39.6% marginal tax rate years just to pay it all back at 25%. Bonus. Tax planning is a must! How many times have we mentioned that?
You can kick this depreciation recapture can down the road with a Section 1031 exchange (also referred to as a like-kind exchange). Perform your favorite internet search on this topic- way too involved to explain here except that a Section 1031 exchange in most situations allows the deferral of depreciation recapture and capital gains. And if you think you know what a 1031 exchange is, try learning about a reverse 1031 exchange- where you buy the replacement property first. Yup. It exists.
This one gets a little tricky. Let’s say you are a commercial real estate agent, and you sell a lease and collect a $10,000 commission. But there are provisions that if the tenant breaks the lease within three years, you have to pay some of the $10,000 back. Accountants would call this “Unearned Revenue” and we can kick this revenue into the subsequent years. So if you collect money today and there is a bona fide chance you might lose it, then perhaps you should consider accrual based accounting and defer some of this income. Again, this gets tricky.
If you’re Ebenezer Scroog then you’re done reading. If you are paying out year-end bonuses, then keep reading. This might be a no-brainer, but make sure paychecks that are for bonuses are dated for 2016.