High Income Year or Low Income Year

To be more precise, we are talking about whether one’s taxable income is high or low in a given year — relative to expected income in future years.  And what we can do to take advantage of the fact that some folks are going to have higher or lower incomes now versus in the future.

In particular, we are interested in taking advantage of one’s current tax situation.

For example, if your income is higher this year than you expect it to be in the future, you may want to maximize any tax deductions you can, thereby lowering your taxable income — and taxes — and because it’s a high-tax year, those deductions may be worth more than they’d be in a future lower income year.

Let’s be more specific.  Suppose you got a huge bonus this year and it pushed your taxable income all the way up into the 33% bracket.  That means a taxable income (in 2014) for a single person of more than $186,350 or for married-filing-jointly earning more than $226,850.   Above that level, every dollar in tax deduction you take saves you 33 cents.  (Not to mention potentially adding to that savings if you live in a state with a high income tax, like California, where the state rate may be another 9.3% or 10.3%).  And let’s suppose that normally, your income is in the next bracket down, where your marginal rate would be 28%.  That difference of 5% is a real, honest-to-goodness tax savings you can get via carefully trying to accelerate deductible expenses into this year which you’d otherwise get next year.  If you normally give $1000 to some charity each year, consider making next year’s gift now — double up this year rather than giving your traditional $1000 now and another $1000 next year.  The difference is, effectively, a free $50 in your pocket, while the charity gets exactly the same amount (and may even be quite happy to have gotten it sooner rather than later).

How about the other direction?

Consider what happens if you take a year off of work (for any of a million possible reasons) and so this year, your income is a lot lower than normal, and certainly lower than you expect it to be, say, next year.  That may mean that your marginal tax rate is a lot lower than it normally will be.  In this case, you may want to consider accelerating taxable events and postponing deductible things.  For example, instead of giving to charity this year, when you know your income will be a lot higher than next year, postpone the charitable gift until January and get that deduction in a high-income/high-tax year.  Or consider making Roth conversions with your IRA.  If you’re having a low-income year, take advantage of it – don’t let it slip away!

Your income, and therefore, your marginal tax rate, may go up and down.  And when it does, you may be presented with some great financial planning opportunities.  Look for them!

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