Year-end tax planning is always a challenge, and this year is no exception.
No one likes to pay taxes any sooner than required. So, traditional year-end strategies tend to focus on deferring income from 2011 to future years and accelerating deductions from 2012 into 2011. In recent years, those strategies have been complicated by the uncertainty surrounding the potential for higher tax rates in the future.
Federal and state governments face budget deficits that tend to pressure elected officials to raise taxes. However, 2012 is an election year, so those facing re-election may try to postpone tax increases as long as possible.
The key to success in any year-end tax strategy involves considering at least two years – in this instance, 2011 and 2012 at the same time. Unfortunately, this tactic requires you to predict a series of future events. Despite the difficulties involved, you will need to make educated guesses and reasonable assumptions. Remember, no tax strategy is cast in stone until the time for changing strategies has passed. Tax planning is a dynamic process.
Before going into more specific, detailed planning tips, here are some basic principles that can help guide your overall thinking:
- If you expect your tax rate will be higher in 2012, you may benefit from accelerating income into 2011 and deferring deductions into 2012.
- If you think your tax rate might be lower next year, consider deferring income to 2012 and accelerating deductions into 2011.
The second strategy is generally preferred when your tax rate in both years is expected to remain the same.
Remember, the focus is on your marginal tax rate. That is the highest rate at which your last, or marginal, dollar of income will be taxed. Even though overall tax rates may rise in the future, if your income will be substantially lower in 2012 than in 2011, your marginal tax rate may actually decrease because of our graduated tax bracket system.