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'Fiscal Cliff' follies: Why it may pay to take deductions early

20121202iabizWith the potential "fiscal cliff" tax rate hikes looming, the math tells us that deductions will be more valuable to top-bracket taxpayers next year. The top federal individual tax rate is scheduled to rise to 39.6% next year, from the current 35%.  A $100 deduction is worth $39.60 next year, vs. $35 this year.

Yet the math may be deceiving. The politicians may end up with a fiscal cliff compromise that can make many deductions worthless after this year.  Republican negotiators, including Iowa's Senator Grassley, have floated a $50,000 cap on allowable itemized deductions.  

Such a cap would pose a huge problem for entrepreneurs whose income is taxed on their 1040s via S corporations or partnerships. State income taxes on their business income are itemized deductions on the owner 1040s. When combined with home mortgage interest and charitable contributions, many reasonably successful entrepreneurs would shoot past a $50,000 cap.

Nothing has been enacted yet, and such a cap may never happen. But it may happen effective for 2013, and prudent taxpayers should keep this in mind. Possible self-defense steps include making sure state income tax liabilities are paid in 2012, rather than waiting until 2013. Taxpayers with big charitable pledges may want to be ready to make them this year, possibly via a donor-advised fund; the Des Moines Community Foundation sponsors one. 

Whatever you do, make any moves only in consultation with your tax advisor. Each tax situation is different. Taxpayers who owe alternative minimum tax this year will get no benefit from prepaying state income taxes, for example. Be ready and stay flexible. 

More reading on this issue here.

Related: What the fiscal cliff looks like from the back side of the election.


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