Prepaying Expenses a Way to Soften Blow of New Tax Law / Advantageous to Shift Deductions

Article excerpt

Prepaying certain expenses is one way of softening the blow of the new tax law.

Because of the lower tax rates in future years, most deductions will provide a greater tax benefit in 1986. Therefore, it is more advantageous than to shift deductions into this year.

Items that lend themselves to prepayment include:

State and local taxes - According to current tax law, state and local income, property and sales taxes are an itemized deduction in the year they are paid.

Under the new law, sales taxes will no longer be deductible. Thus, it is especially important to accelerate sales tax payments into 1986, since such amounts will not be deductible in 1987.

In addition, beause of the declining tax rates enacted by the new law, taxpayers may want to pay final installments of estimated state income taxes in 1986 and take the deduction this year.

Likewise, taxpayers who can choose to pay real estate taxes in either 1986 or 1987 may want the deduction against 1986's higher rates.

However, if real estate taxes are paid through an escrow agent, your deduction is in the year in which the agent pays them, not in the year in which they are paid into the escrow account.

Medical expenses - This year, unreimbursed medical expenses - including medical insurance - are allowed as an itemized deduction to the extent they exceed 5 percent of adjusted gross income. Next year, the new law raises this floor to 7 1/2 percent.

It may make sense to prepay any of these expenses in 1986 to take advantage of the lower threshold.

Interest Expenses - Despite the five-year phase-out period, most taxpayers will be affected by the repeal of the deductibility of personal interest expense starting in 1987.

Neither current law nor the new law allows deduction of prepaid interest - that is, interest paid before it is incurred.

However, taxpayers can mail January loan payments in December to increase 1986 deductions, since interest is usually incurred the month before it is due.

Next year's stricter limits on investment interest - margin interest, for example - also call for greater attention this year. Under current law, investment interest is deductible to a limit of $10,000 plus any investment income.

Starting in 1987, the $10,000 amount is phased out over five years. Taxpayers whose estimated 1986 investment interest expense will exceed this year's more generous limit may want to recognize unrealized short-term gains or convert tax exempt interest into taxable interest in order to increase investment income in 1986. …