Thursday, August 12, 2010

Time to Recalibrate Your Year-End Tax Strategy

As the tax year end approaches, the smart thing to do is minimize taxable income by stalling income and accelerating expenses, right?  Maybe not -- at least for awhile.  This axiomatic, ingrained belief among business owners may cost you a lot of money if you stick with it for the next couple of years.  It came up today in a Chief Executive Boards International meeting, stated as if it was a physical law of the universe.  It's not.  Don't delay -- you have 4 months left to make some major changes in your year-end tax strategies, and they may need to be completely revamped from what you're used to.

Why? The game has changed. Let's examine the assumptions -- that we're going to have to pay tax on the income sometime, and later is better than sooner, since we get to hold onto the cash and keep it earning interest for us. Embedded in that assumption is that the tax rate later is the same as the tax rate sooner, right?

The changed game is that you're probably not earning meaningful interest on the deferred taxes, and also that the tax rate you will be paying in the future is going to be higher than this year's tax rate.  Further, if your 2010 income is likely to be soft, you may have the further advantage of being able to accelerate income into an even lower marginal bracket this year, as well.

The fact is that on ordinary income the highest federal bracket will go up from 35% this year to 40.8% next year, including the effect of some lost itemized deductions.  In 2013, left unchanged, the maximum rate on "unearned" income like dividends and interest goes to a stunning 44.6%. As far as capital gains are concerned, this year's 15% rate goes to 21.2% next year, and since you'll be patriotically helping to pay for the health care of the nation (whether you want to or not), to 25% for 2013.

So, what's the better plan?  For most taxpayers, it's the reverse of decades of conventional wisdom.  Accelerate income. Stall expenses and deductions. For every dollar of taxable income you move into this year, you have a "window" into which you can accelerate 2012 income into 2011 for some of the same benefits.

This also might be a good year to convert some of your tax-deferred IRA investment into a Roth 401(k).  Pay the income tax now at rates lower than we're likely to see for awhile and your future gains become tax-free for life.  See: "Roth IRA Conversions -- Potentially Great Opportunity for 2010" for more details.

If you have a point of view on changes in tax strategy for 2010 vs. prior years, please click on "Comments" below and share them with others.

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

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