Tax professionals often recommend shifting your tax burden from one year to the next—but what exactly does it mean? Putting this into practice requires careful planning and a clear understanding of your financial situation. By understanding the rules and leveraging the flexibility of the tax code, you can control your taxable income and potentially lower your overall tax obligation across multiple years.
Understanding the Concept of Income Shifting
The idea of reducing your tax responsibility for the year always sounds good! But the concept isn’t exactly straightforward. The tax code is intricate, which is both tricky and useful. There are opportunities to minimize your tax liability by controlling when your various forms of income and expenses are recognized.
Depending on your income and filing status, your income tax rates range from 0% to 37%. From there, it’s important to realize that many tax breaks, such as credits and deductions, have income limits or phase-out ranges. Higher income can trigger additional taxes, like the Alternative Minimum Tax (AMT).
By strategically shifting your income and expenses, you can potentially keep your taxable income in a lower bracket, preserve valuable tax breaks, and reduce your overall tax liability. Here are six strategies to help you put income shifting into practice.
- Know Where You Stand
The first step is understanding whether income shifting will benefit you. For example, single filers may see a significant jump in their tax rate once earnings exceed $47,150. For married couples, that threshold occurs at an adjusted gross income of $94,300.
- Bunch Your Charitable Contributions
If you itemize deductions, consider bundling your charitable donations into a single year to maximize their tax impact. For instance, instead of splitting your contributions to your church or favorite charities over two years, you could make all the donations in one year.
- Use the Cash Basis Rule to Your Advantage
Under the cash basis system, you can claim a deduction in the year you make a payment. For example, a credit card transaction counts for the current year even if you don’t pay the bill until the following month. This gives you flexibility. You might pay property taxes, mortgage payments, or other deductible expenses slightly early or slightly late, depending on which year you want the deduction to apply. Small timing adjustments like these can have a significant impact on your taxable income.
- Control Your Income from Work
For some individuals, reducing or delaying work income can help avoid unexpected tax consequences. This is particularly relevant for those receiving Social Security benefits before reaching full retirement age. Earning too much can not only increase the taxes you owe but could also reduce the benefits you receive.
Similarly, if you or a dependent are near the income threshold for the Health Insurance Premium Tax Credit, earning just a bit more could mean losing valuable tax assistance. In such cases, it may make sense to manage your hours or even delay a paycheck to keep your income in a lower tax bracket.
- Plan Your Retirement Distributions Wisely
If you’re over 59½, you can control taxable income by strategically withdrawing from pre-tax retirement accounts like 401(k)s or traditional IRAs. Taking a little more out this year could allow you to pay taxes on that income at a lower rate than if you waited until next year. The key is to evaluate your tax situation and balance withdrawals for maximum tax efficiency.
- Manage Capital Gains and Losses
Timing the sale of investments is another effective income-shifting strategy. If you sell stocks or other investments at a loss, you can use up to $3,000 of that loss to offset ordinary income, which is often taxed at higher rates than capital gains.
If you’re holding an underperforming stock, consider whether it makes sense to sell this year or next. Aligning your investment losses with years where you have higher taxable income can result in a significant tax benefit.
Smart Planning Can Help Lower Your Tax Bill
By carefully shifting income and expenses to optimize your taxable income, you can take advantage of the opportunities within the tax code to reduce your overall tax bill. If you’re unsure how these strategies apply to your situation, just reach out to NSO & Company for a detailed review! Proper planning now can mean meaningful savings when tax time comes around.