"I will gladly pay you Tuesday for the tax owed today."
The Wimpy Approach to Tax Planning:
Simply replace "hamburger" with "taxes owed" and you have a pretty good summary of today's Tax Tip 2016: Deferral of Income.
For those taxpayers reporting on a cash basis, income is generally taxed in the year it is received; however, why pay tax now if you can pay it tomorrow instead? Generally, W-2 employees can't postpone income from wages or salary, but a year-end bonus might be pushed into next year if it is standard practice for the employer to pay year-end bonuses the following year.
Further, there are some complex rules that can permit an accrual method taxpayer to take a current year deduction for bonuses payable in the following year, which allow for the exception of the matching of income and deductions in the same tax year; this allows for instances where a tax arbitrage can accelerate a deduction from January into the prior tax year.
If your business reports on a cash basis, a simple strategy might be to combine November and December in to a late December invoice that will most likely generate payment until the following tax year, which can have a business purpose of consolidating billing effort. It is also best to temper this approach with the cash flow needs of the business, but with interest rates relatively low, a simple mathematical calculation may create a viable tax arbitrage over a three-week period.
Of course, this is just a timing issue, not a permanent item. So this might only excite those CFOs who get bonuses on lower cash taxes. Further, deferring income might only make sense if the same or lower tax bracket applies next year. Also, remember that it's possible that the deferred income could bump the taxpayer into a higher bracket or perhaps trigger greater AMT exposure, so this strategy is best for the taxpayer with relatively predicable receivables from low credit risk customers.
Conversely, this may also apply under the appropriate circumstances. As mentioned above, you might be able to reduce the risk of exposure to a higher tax bracket by accelerating income into the current year, which could allow for tax to be incurred at a lower bracket just a bit sooner, rather than in a higher bracket a bit later.
There is a saying among tax professionals that there is no "theory" in tax. For our firm, we approach taxation as the ultimate zero-sum game that it is. Taxation is where fiscal and monetary policy are realized and recognized every quarter through estimated tax payments; and the score tallied annually on the tax return. The cost or benefit to each taxpayer can be greatly affected through careful planning and strategizing. Tax should be more than just an economic consequence from you business efforts; rather it should also be an opportunity and goal achieved as part of the business's operating plan.
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Donald Katz, PLLC
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