Controlling the Time When Your Tax Must Be Paid

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Controlling the Time When Your Tax Must Be Paid

In broad terms, you can minimize taxes in the current year by postponing the receipt of income so that more of it will be taxed next year, and by accelerating deductions into the current year to reduce currently taxable income. Assuming that you expect your tax rate to stay the same year to year—which is by no means always true—it’s generally better to pay taxes later, because you’ll then have the use of those tax dollars longer. This kind of tax planning is primarily available to the self-employed and business owners; much less so to employees who work for wages.

What a businessperson can do

The business owner or sole proprietor can, for example, delay billings near the end of the year a bit, so that payments won’t arrive (and be included in income) until early the next year. Likewise, he or she probably has some financial flexibility to postpone year-end salary or dividend distributions until early the next year.

Conversely, business owners and sole proprietors should usually accelerate payments. Consider prepaying in the current year those business expenses that can be deducted this year, such as rent, taxes, insurance, as well as operating expenses. If practical, for example, pay for those repairs before year-end and buy that needed equipment or supplies now rather than early next year. The same principle is true of larger, depreciable business property or real estate within the current year. All of this assumes that the business uses the cash method of accounting.

What investors can do

Investors should usually plan to hold an asset for more than one year before selling it at a gain, in order that tax be paid at the favorable long-term capital gains rate. If it is otherwise practical, it might also make sense to defer a planned sale from late in the current year until early the next year, if you expect a gain.

Contribute to a retirement plan

Of course, it almost always makes sense, if possible, to put in place a retirement plan such as a 401(k) and to make the maximum contributions allowed for the year. Those contributions you make will be excluded from your income and will grow tax-deferred to build a nest egg.