Why Making More Now Could Save You Money Later
In years past, an accountant would typically tell you to “defer” your income, which basically means pushing your income off so it hits your bank account in January 2013 instead of now. It’s not hard to see why–the less income you make in 2012, the less you’ll pay in taxes in April 2013.
This year, however, things are different. Since it’s very possible that taxes will go up in 2013, you want to make sure that as much of your income as possible comes in now–known as accelerating income–so it’s taxed at a lower rate. For example, selling stocks or collecting your freelance checks in December, instead of January, if possible.
What if the Fiscal Cliff Doesn’t Happen?
You may be wondering right now if this is akin to gambling with your money. You’re betting that taxes go up next year, but will you lose money if they don’t?
Nah, this is actually a pretty safe bet:
- If taxes go up next year, a typical household would save about 5% of the income that’s accelerated into 2012. For example, if you’re able to shift your year-end bonus of $5,000 from January to December, you could save $250 in taxes.
- If Congress passes legislation to keep taxes in 2013 at 2012 levels, it’s a wash–you’ll pay the same amount overall, just a little more this April and less in 2014.
- If Congress lets some tax cuts expire, while keeping others in place, you’ll save less than you would if they let everything expire, but you’ll still save.
How You Can Accelerate Your Income
It’s not like you can ask your employer to pay out your 2013 salary early, but there are ways to shift some of your income. (Just be aware that these are general guidelines, and you should always talk to your tax professional before making any big moves.)
- Sell stocks now. If you’re planning to sell investments because, for example, you’re going to use that money to buy a home, do it now instead of January. Capital gains taxes, which are applied to the profits that you make from buying and selling stocks and mutual funds, are 15% right now–but they might jump to 20% next year. Even if you’re not planning to make a big purchase, you could still sell some investments that have been doing particularly well and lock in the gains, and then shift that money to another investment with better growth prospects. Just make sure that you’ve held all the investments you’re selling for at least a year. Otherwise, you’ll pay a higher short-term capital gains tax.
- Collect your freelance or contract income now. Try to convince a client or company to pay you in December instead of January, or complete a project earlier.
- Ask for your bonus now. This probably won’t fly at a big corporation, but if you work at a smaller company, talk to HR to see if you can get your year-end bonus in 2012, noting that it could save you a lot in taxes.
- Convert your Roth now. If you’re planning to convert your traditional IRA into a Roth IRA, it will be taxed–so do it before the end of the year.