Taxpayers for a long time always try to find a way to defer their income and tax payments. Deferring income means taxpayers can keep their money for a while, and the longer they can keep their money, the more they can use their money for themselves. It allows them to set aside their income in the future when they may qualify for a lower tax bracket which causes them to have tangible tax savings. Since the maximum federal income tax rate and the maximum capital gains rate increased, itemized deductions phased-out, the new percentage of Medicare tax on earnings, and new percentage of net investment income tax, deferring one’s income became even more sought out by taxpayers. The Tax Reform Act of 1986 allowed individuals and business implement the income deferral techniques because the maximum tax rate was reduced from 50% to 28%.
There are various income deferral strategies that you can use. Some of them are simple, others are extremely difficult. There are those that are supported by the government through its tax policies and laws. Illegal and unusual strategies exist too which is why one should never quickly decide what strategy to use without looking into them closely. Tax deferral allows you to use your money in the future instead of using it now and it typically gives you the control on when to pay your tax liabilities.
Types Of Income Deferral Techniques
Retirement Savings. One of the most common income deferral technique is through using retirement savings vehicles. Having an Individual Retirement Account (IRA), for example, allows you to make a tax-deductible contribution of $5, 500 for this year. Your contribution and earnings you get from a traditional IRA will not be subject to tax. It will only be taxed once the distributions are made. This results in the deferral of the original contributions and the growth of your assets.
For business owners, an employer-sponsored qualified retirement account allows them to defer income for themselves and for their employees by deferring their salaries and additional employer contributions. Examples of accounts that can grow tax-deferred until distributions are made are 401 (k) plans, 403 (b) plans, and payroll deductible among others. There are also nonqualified deferred compensations plans which are compensations of employees earned in one year but is paid in the next following year. This plan defers payment of salary, bonuses, incentive compensation, or supplemental retirement plans. The law under which is under can be complicated but it offers great benefits in terms of income deferrals.
Pure Tax-Deferral Technique. A taxpayer who has a permanent life insurance policy can take advantage of this technique because it allows their cash to grow tax-deferred and accumulate rapidly compared to a taxable investment. Not only that, you as a policyholder can also borrow against the cash value of the policy for a low-interest rate without tax being generated. Policy dividends are considered tax free returns of capital and death benefits shall also be income-tax free once beneficiaries received them.
The 1031 Exchange. They appear as installment sales and like-kind exchanges. They are also an effective deferral technique that taxpayers should tax advantage every tax season. Tax principles state any gain or loss from the sale or exchange of property is recognized as income. An installment sale, on the other hand, is the selling of property and payments are made every end of the year where the sale occurred. Paying through installments allows the reporting of the payments and the gain within the year of receipt instead of the year of the sale. Like-kind exchanges happen when taxpayers properly exchange business or investment property for another business or investment property. If you decide to enter a like-kind exchange, you can defer your gain on the property exchange or the transaction. It must be noted however that there are complicated rules and requirements for a like-kind exchange that needs to be followed. However, as long as the exchange was properly executed, you will definitely be able to take advantage of income and tax deferrals.
There are more deferral income techniques that only businesses can benefit from but it requires careful execution to avoid penalties in the future. Taxpayers will always try to defer income although not everyone can be successful. There have been cases of taxpayers targeted by the IRS and lawmakers because of their errors. Nevertheless, it won’t hurt to ask for professional help such as tax preparers and accountants who are experienced and knowledgeable about the income tax deferrals.
