Taxpayers are often advised to use year-end tax planning to help reduce taxes. This can often mean postponing income or accelerating deductions to shift tax burdens to a later year. It could also involve the reverse planning if taxes are expected to be higher in a later year. There are a number of rules that apply in determining in what year a particular item of income or expense falls.
Understanding those rules is essential to permit a taxpayer to do effective year-end tax planning and to file an accurate tax return.
- The taxpayer must know if they are on the cash method or accrual method of tax accounting. Individuals are typically on the cash method
- Under the cash method, income is included in the year the income is actually or constructively received
- Constructive receipt is when the income is within the taxpayer’s control but not actually received, with no substantial limitation on the taxpayer’s right to the funds
- Under the cash method, deductions or credits are permitted in the year when actually paid, unless they are required to be allocated to a different period to more clearly reflect income
- There may be a limit on the deduction of a payment if it creates an asset having a useful life extending substantially beyond the end of the year in which the payment is made
- Credit card payments are deductible in the year charged even if the credit card bill is not paid until the following year
- Checks can be deducted in the year mailed even if not cashed or deposited until the following year
- Items such as mortgage interest, real estate taxes, and property insurance can be prepaid in the current year for some portion of the following year
- A recent revenue ruling from the IRS clarifies that a taxpayer’s failure to cash a retirement plan distribution check received before year-end, but not deposited until after year-end, is still income in the year the check was received
Federal tax expert Mark Luscombe, JD, LL.M, CPA, Principal Federal Tax Analyst at Wolters Kluwer Tax & Accounting, is available to discuss the rules involving year-end inclusion of income and expense items and tax planning to minimize taxes.
The content of this article is designed to provide accurate and authoritative information in regard to the subject matter covered. The information is provided with the understanding that Wolters Kluwer Tax & Accounting is not engaged in rendering legal, accounting, or other professional services.