A well-executed year-end tax planning strategy that will maximize all available tax benefits usually takes weeks, even months, to develop. Nevertheless, certain timing techniques may be adopted relatively quickly at the last minute and often with significant returns for the effort. As New Year's Day 2007 approaches, reviewing some of the general mechanics that go into timing a tax deduction or credit usually benefits most taxpayers in one way or another. Whether it pays more for you to accelerate deductions and credits into 2006, or to defer them until 2007, knowing how to control such timing is critical to success. Here are some considerations.

Time of payment

Paying by credit card.  An expense paid by credit card is considered incurred at the time the charge to your account is made, rather than when the statement is sent out or when you pay the statement. The assumption is that use of a credit card triggers a loan. Just as you would be entitled to a deduction if you paid cash that had been acquired through a bank loan, use of a credit card represents a similar circumstance.

Paying by debit card. Again, an expense applied to a debit card is incurred (or a charitable contribution made, as the case may be) for tax purposes when the sale with the debit card is completed. This is the case even if your bank may not actually deduct the funds from your account until the next day.

Paying by check.  If you pay by check and the check goes through in due course, you are considered to have paid when your check is tendered in the purchase transaction. If you are paying by mail, the payment is considered made when it is mailed.  If a check "bounces," however, the expense is not considered to have been ever paid.

Publicly-traded stock. For year-end sales of publicly-traded stocks and bonds, realization of taxable gain occurs when the sale is entered or an agreement to sell specified securities is made. This is known as the trade date. However, gain or loss on short sales of securities is recognized on the later settlement date as set by exchange rules.

Pledging. You pledge in December 2006 by return postcard to make a charitable contribution. You follow through on your payment as promised in January 2007. A mere pledge or promise of a charitable contribution does not constitute payment for the purpose of allowing a current deduction.

Prepaying an expense

The concept of prepaying an expense and determining when you are entitled to the deduction for the payment is often misunderstood. This confusion is justified in certain cases since the concept can be elusive. Here are some examples:

• Subscriptions. You pay for a one year subscription to a professional magazine on December 29, 2006 rather than January 2, 2007. You may deduct that expense in 2006 since subscriptions are usually paid on at least an annual basis. The fact that your first issue won't be mailed to you until mid-January is considered irrelevant.
• Mortgage payments. You make your mortgage payment for January 2007 in December 2006. You are entitled to the deduction for mortgage interest in 2007 only since that interest payment obligation did not accrue until January 1, 2007. If the mortgage note says otherwise, however, an interest prepayment may be validly paid and reflected on a Form 1098 in the earlier year. In another exception, a cash-basis buyer can deduct seller-paid points paid in connection with the acquisition of a principal residence.
• State taxes. You send additional money to your state tax department as an estimated income tax payment in 2006 for 2006, even though you aren't required to do so. You may be entitled to a state tax itemized deduction on your 2006 federal return unless you eventually receive a state refund and your sole intention for making the 2006 payment was to generate an itemized deduction in that amount for 2006.
• Real estate taxes. You prepay your local real estate taxes before its payment date next year. Depending upon your local real estate rules, you may be able to deduct the portion allocable to the year of payment. For example, if your county tax is due on May 1, 2007 for the July 1, 2006 to June 30, 2007 period, you may pre-pay half of it in December and receive a deduction for that amount. If you wait until May 1, 2007 to pay it all, on the other hand, the entire amount would be deductible on your 2007 return. In any event, if you make real estate escrow payments with your mortgage payments, the real estate taxes are not considered paid for deduction purposes until your bank pays them.
• Medical expenses. You prepay a medical expense. Medical expenses are generally deductible in the year in which they are paid, except that prepayments of medical expenses are not generally deductible until the year the medical expenses are incurred. Certain lump-sum payments required to be paid for institutional care may be deducted. However, if your orthodontist or physician wants payment "up front" on a service once it begins, that expense generally may be deducted in the year of prepayment since your doctor is setting the rules.

Paying late

Most individuals are cash-basis taxpayers. That means that an expense that is owed is deductible only when it is also paid. Deferring deductions into the following year is considerably more cut-and-dried under the tax law than trying to accelerate an expense. Even if a mortgage payment or a doctor's bill or a state income tax payment is owed and due in 2006, if you don't pay it until January 2007 you are entitled to the deduction for it in 2007.

Placed in service requirement

Sometimes timely payment is not sufficient to win a deduction, especially in a business context. For example, business assets must not only be paid for but also must be "placed in service" before a depreciation deduction may be taken. Similar rules for business tax credits also apply.

If you'd like further information on what prepayments or delayed payments might work best in your tax situation, please do not hesitate to call our offices. Once January 1 rolls around, however, there's no turning back the clock on this tax opportunity.