Year-End Acceleration/Deferral Techniques

Year-End Acceleration/Deferral Techniques

You may be considering accelerating or deferring income or deductions now that we’re here at the end of the year, but if you don’t have the right techniques it can be frustrating since many tax law provisions are deliberately uncertain, particularly this year-end. It is more crucial this year than ever to have increased tax knowledge and understand certain tax techniques. Because the “fiscal cliff” talks are leaving the raising of tax revenues ambiguous, the timing of these techniques in eleventh-hour 2012 tax planning is crucial.

Different fiscal cliff agreement scenarios will require different strategies. An example: a few weeks ago, experts predicted a marginal tax rate increase on higher-income individuals. So if you were strategizing, an increased tax rate would generally involve income acceleration into the current tax year and deduction deferral into the next for those that fall within the affected income levels. However, other tax scenarios make the planning much more complicated.

In particular, a recently proposed cap on certain deductions for higher-income individuals would then make this strategy risky for some but fine for others, depending on your tax bracket. Because taxpayers are currently very confused about what deductions are likely to be capped and which income tax brackets will be affected in 2013, one might inadvertently increase his or her future tax liability without all the necessary information by loading income into 2012 and relying on deductions that may be limited in 2013 to decrease next year’s tax liability.

Deduction Acceleration/Deferral

Included in the fiscal cliff negotiations is a proposed cap on deductions starting in 2013. This generally would make it important to accelerate deductions into 2012 to offset income dollar-for-dollar, even if the income tax rates are higher in 2013. If a general 28 percent-value cap were placed on deductions in 2013, those currently in the 33 and 35 percent brackets for 2012 will derive more benefit from accelerating deductions into 2012.

The same holds true for a cap on particular deductions, for example, the home mortgage deduction or the charitable deduction, would call for acceleration of those expenses or contributions into 2012 where possible. A cash basis taxpayer generally deducts an expense the same year it’s paid, although prepayment of an expense generally will not accelerate a deduction.

Here are some exceptions:

Package Payment

An agreement for services or other deliverables that require full upfront payment may gain a full, immediate deduction, depending upon the circumstances (for example, payment up front for an orthodontia program). However, a pledge made for a future charity in advance of the actual collection of payment is not deductible.

Tuition Prepayment

Payments made in 2012 for tuition for the period beginning in 2012 or during the first three months of 2013, qualify for an education credit taken for this year 2012. Since Code Sec. 25A(g)(4) treats such accelerated tuition payment as if paid for a semester that begins in 2012, payments made in December 2012 will qualify for the enhanced American Opportunity Tax Credit, which reverts to the HOPE credit in 2013 unless Congress extends it.

Estimated State Taxes

Although the deadline is generally not until January 15, 2013, payment of fourth quarter state and local estimated taxes made in 2012 is deductible for 2012.

Business Vehicle Purchases

Should Congress not extend bonus depreciation into 2013, a vehicle purchased for business use and placed in service by year end 2012 receives an additional $8,000 first year depreciation deduction over and above what a vehicle purchased in 2013 would be allowed. Heavy, business-use SUVs (over 6,000 lbs and on a truck frame) would be able to gain even more favorable treatment based on sun setting Code Sec. 179 limits. Delaying an expense deduction into 2013, on the other hand, is generally accomplished simply by delaying actual payment until 2013. Merely being billed for an expense does not control its deduction by a cash-basis taxpayer.

Cash Accounting and Deferral

Taxpayers using the cash method basis of accounting can defer or accelerate income using a variety of strategies. These may include:

Sell Appreciated Assets

It is probable that the capital gains rate will not decrease which means the risk of losing out on savings from a lower tax rate is removed if the sales were completed before 2013. Also identical securities, specifically appreciated securities may be sold and repurchased. At the worst, this would simply mean a downside of some accelerated tax liability.

Received Bonuses Before January

If an employer pays a bonus in the same year of service—in this case 2012–rather than the first two and half months of 2013 which is more customary to get the same deduction, the employees can call the bonus 2012 income. Higher income employees will not enjoy the option of paying at the lower 2012 income tax rates, but they will certainly avoid the new 0.9 percent additional Medicare Tax on earned income.

Complete Roth Conversions in 2012

Also be aware that for a 2012 Roth conversion to be effective for this past tax year, the transfer from the regular IRA to the Roth IRA must take place by December 31, 2012.

Maximize Retirement Distributions

If you are planning withdrawals for 2013 and 2014 from IRAs over and above the required minimum distribution (RMD), amounts can be accelerated into 2012 by withdrawing now. For those who have reached the age of 7 years, 6 months in 2012, making the first minimum distribution in 2012 rather than waiting until April 1, 2013, also makes sense.

Accelerate Debt Forgiveness Income

If you are looking to benefit from a determination of debt forgiveness, you must convince a lender to issue a Form 1099-C, Cancellation of Debt, for the 2012 tax year. Also to be considered is application of the bankruptcy and insolvency exceptions to recognizing discharged debt. Also mortgage debt on a principal residence that expires at the end of 2012 is excluded unless it is extended by Congress.

Avoid Mandatory Like-Kind Exchange Treatment

Taxpayers may also avoid tax deferred, like-kind exchanges by taking steps to disqualify the transaction from Code Sec. 1031 treatment. Such steps might include delaying identification of replacement property, transferring cash to an intermediary, or switching to a sale-and-reinvestment arrangement.

What is A “Higher-Income” Taxpayer?

If you fall into a higher tax income bracket, the year-end timing of income and deductions in 2012 is a little more involved. If taxpayers apply the traditional year-end tax planning strategy of deferring income into 2013 they might unintentionally enter the “higher-income” category. Likewise, if lawmakers later decide to define “higher-income” taxpayers as those with income over $450,000, for example, then accelerating income into 2012 for someone at or below that $450,000 for both 2012 and 2013 would yield no rate benefit.

Also the deferment of itemized deductions into 2013 to bring next year’s taxable income down from higher-income bracket status, might not work depending upon how fiscal cliff negotiators finally define “higher-income.” Many annual incomes have been thrown around as being the higher income bracket but has yet to be resolved by Congress.