Patrick Cox, an attorney specializing in taxation and small business in the New York office of law firm Withers Bergman, says he sometimes feels as if he’s crying wolf when he warns clients about looming tax changes at year’s end. “All you want, as a business owner or a tax planner, is the ability to forecast what’s coming next. But for the past five or six years, I’ve been telling people to hurry up because everything is going to change—and then Congress eventually reaches an agreement to extend tax rates, sometimes even retroactively,” he says.
Then came 2012, when the tax cuts put in place by President George W. Bush expired for high earners and new taxes tied to Obamacare went into effect on the wealthy, including many clients whose small businesses are organized as flow-through entities such as S-corps and LLCs. “I felt bad for them because I could not convince some of them to dispose of assets to take advantage of the lower rates and then they got caught,” he says.
This year, things aren’t so dire. Still, it’s a good time to meet with your accountant or financial adviser to see what you can do to minimize the taxes you and your business will owe for 2013. Typically, that means deciding whether to accelerate or defer income before the end of the calendar year, plus taking stock of expiring tax provisions to see whether you should take advantage of any before they disappear.
Here’s some guidance on how to approach your invoicing, purchasing, and giving decisions for the next couple of months.
Take stock of your income. Start by adding up your 2013 business or self-employment income to date and determine if you’re likely to be in the same tax bracket this year as you were in 2012. Then think about 2014 and whether you are likely to have less income then—or additional income that could bump you into a higher tax bracket.
If you expect to be in a lower tax bracket next year, it’s best to defer as much income as possible until after year-end, accelerating any deductions you plan to take, anyway. Similarly, if you have new clients or contracts lined up now that are likely to push you into a higher tax bracket next year, it’s better to bring in more income now and pay taxes on it at the lower rate.
What if you determine that nothing much will change? “If a taxpayer’s overall tax rate is the same in both years, accelerating deductions achieves tax savings this year rather than waiting for those tax savings to materialize next year,” Rick Rodgers, a certified financial planner and president of Rodgers & Associates in Lancaster, Pa., writes in an e-mail.
If you’d like to defer income, ask clients to pay you in January, rather than December. And put off taking distributions from your retirement accounts, unless they are required minimum distributions. In order to accelerate deductions, make your planned charitable contributions now rather than in 2014.
If you can pay medical bills in December, you may become eligible for the medical expense deduction on your tax return. Be aware that the Affordable Care Act raised the income threshold for that deduction to 10 percent of adjusted gross income from the previous threshold of 7.5 percent. (Taxpayers 65 and over are still subject to the 7.5 percent threshold.). “You may need to prepay or defer medical bills to lump expenses into a single year to get the deduction,” Rodgers writes.
Make retirement contributions. Self-employed individuals not covered by a retirement plan can put money into their IRAs or other retirement accounts to reduce their taxable income for 2013. If you want to accelerate income this year so as to avoid paying at a higher rate next year, you can convert a traditional IRA to a Roth IRA. And you don’t have to decide what to do immediately: You can make IRA contributions for 2013 as late as next April, when your federal income tax return is due.
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