December is a time to look forward to the holidays and take a bit of a break from business. For business and property owners, though, it should also be the time to look into the next fiscal year and forecast likely revenues and expenses. If a 2016 expense can safely be moved up into December, it may be wise to purchase the needed item before December 31st to capture a fresh deduction against 2015 income. The companion tax tactic is to defer revenue into January. This moves the tax due on that income twelve months back, into 2017. Be careful though: Think through the pros and cons to discern what best fits your own circumstances.
Effective tax planning works as much on the timing of incoming and outgoing cash events as it does on structuring business or property deals to minimize tax obligations and maximize gain. So, my recommendation in working through this end-of-year decision-making process is to keep two key thoughts in mind when making timing decisions.
Never spend money just to “earn” an income deduction. As soon as I hear a client say that they need to go out shopping for deductible expenses, I urge them to pause and do some simple math first, because it’s a losing proposition to buy stuff you “may need” just to offset income. You will be spending $1 to capture $0.30 or so in tax savings!
Take the example of a heavy-duty pick-up truck that qualifies for a nice batch of accelerated depreciation if it is bought for business purposes. Perhaps you are general contractor who has a used but quite serviceable truck with a few more years of use still to go. Is it a wise move to purchase the new truck? First, the entire depreciable value of the truck can be taken as an expense in the first year of use as a Section 179 expense. Saving $9,000 is a pretty good reason to buy a shiny new truck, isn’t it? The math, however, may not support that supposition. Let’s look at the real “bottom line:”
|New Truck Cost:
|Possible First-Year Deduction:
|Taxes saved (30% total tax rate):
|Net Cost to You of the New Truck:
Plus, if you add in the financing costs of the truck over the term of the loan, you may discover that the deduction that looked so appealing might end up being as great a benefit as you thought. Assume, for example, you financed the purchase 100% at a 6% annual interest rate (APR) over 60 months. You would have to add back $6,718.66 in interest paid, thereby bringing your overall net cost of the vehicle to $39,719.
Unless your old truck is reaching the end of its useful life, and maintaining it is going to cost an additional $40,000 over the next five years, buying a new truck to grab the attractive deduction probably doesn’t make sense.
Forecast all of next year’s revenues and expenses before deciding to move expenses up or revenue back. If you think your business will do better next year than this year, you may want to consider moving revenue up and expenses back! A breakout year in 2016 could move your personal income into a higher tax bracket:
- In this case keeping your income as is for December earns it this year’s lower tax rate.
- Holding off on expenses to offset them against next year’s income saves a few more pennies per dollar. And at today’s cost of money, waiting twelve months for the payoff doesn’t cost you much in net present value, one of the determining factors used to analyze profitability.
Similarly, you may have had a big year for expenses in 2015, and don’t forecast spending as much in 2016 on supplies, services or equipment. You may simply have all the deductions you need to shelter income for this year, and may want to move back or “bank” some expenses to offset income next year.
Finally, you might be planning to sell property or a business next year, which will either create a big batch of taxable revenue or a loss that can offset income. Here again, moving expenses up may not pay off once you do the math and understand the bigger picture.
Each small business owner’s situation is unique. They need to carefully inspect their own set of circumstances and ask and answer every question in order to discern what would earn them the greatest tax benefit. The assumption that moving expenses up into December and revenue back to January doesn’t always stand up to close scrutiny.