How to Defer Income to the Next Tax Year

Income deferral involves postponing the recognition of income for tax purposes from the current tax year to a subsequent year. This method allows individuals and businesses to manage their taxable income by shifting when certain earnings are reported to tax authorities. By delaying the taxation of income, it is possible to reduce the current year’s tax liability. This can be particularly advantageous for individuals who anticipate being in a lower tax bracket in the future.

Deferring Income from Employment

Individuals employed by an organization have several avenues to defer income, primarily through various employer-sponsored retirement plans and health savings accounts. These mechanisms allow for pre-tax contributions, which directly reduce an individual’s taxable income in the year the contribution is made. The earnings within these accounts then grow on a tax-deferred basis, meaning taxes are not paid until funds are withdrawn, typically in retirement.

Employer-sponsored retirement plans, such as 401(k), 403(b), and 457(b) plans, are common tools for income deferral. Employees can elect to contribute a portion of their salary to these plans before taxes are calculated, thereby lowering their current taxable income. For 2025, the employee elective deferral limit for these plans is $23,500. Individuals aged 50 and over can contribute an additional $7,500 as a catch-up contribution, bringing their total to $31,000.

A special catch-up contribution of $11,250 applies for those aged 60 to 63, increasing their total possible contribution to $34,750. The total contributions from both employee and employer to a 401(k) plan are capped at $70,000 for 2025.

Traditional Individual Retirement Accounts (IRAs) also offer a path to income deferral, allowing individuals to contribute pre-tax dollars that can reduce their current taxable income. For 2025, the annual contribution limit for a Traditional IRA is $7,000. Those aged 50 and older are eligible to make an additional catch-up contribution of $1,000, bringing their total to $8,000.

The deductibility of Traditional IRA contributions can be subject to income phase-out rules if an individual is also covered by a workplace retirement plan. If neither the individual nor their spouse is covered by a workplace plan, contributions may be fully deductible regardless of income.

Health Savings Accounts (HSAs) provide a triple tax advantage, allowing for tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. To be eligible for an HSA, an individual must be covered by a high-deductible health plan (HDHP). For 2025, an HDHP must have a minimum deductible of $1,650 for self-only coverage or $3,300 for family coverage.

The maximum annual out-of-pocket expenses for an HDHP cannot exceed $8,300 for self-only coverage or $16,600 for family coverage in 2025. The HSA contribution limits for 2025 are $4,300 for individuals with self-only coverage and $8,550 for those with family coverage. An additional catch-up contribution of $1,000 is permitted for those aged 55 and over.

In certain instances, an employer might permit employees to defer the receipt of a year-end bonus until the subsequent calendar year. This arrangement depends on the employer’s specific policies.

Deferring Income from Self-Employment and Business Operations

Self-employed individuals and small business owners, particularly those operating on a cash basis, have distinct strategies for deferring income. These methods leverage specialized retirement plans and the timing of financial transactions to manage taxable income. The flexibility inherent in cash-basis accounting allows for more direct control over when income is recognized and expenses are deducted.

Self-employment retirement plans, such as SEP IRAs and Solo 401(k)s, offer substantial income deferral opportunities for business owners without common-law employees. These plans allow for significant pre-tax contributions based on net self-employment income, which reduces the current year’s taxable income.

A Simplified Employee Pension (SEP) IRA allows contributions up to the lesser of 25% of an employee’s compensation or $70,000 for 2025. For self-employed individuals, compensation is net earnings from self-employment. The maximum compensation that can be considered for contribution calculation is $350,000 for 2025. Contributions to a SEP IRA are made by the employer.

A Solo 401(k), also known as an Individual 401(k), is designed for self-employed individuals or business owners with no full-time employees other than themselves or a spouse. This plan allows contributions in two capacities: as an employee and as an employer. For 2025, the employee elective deferral limit is $23,500, with an additional $7,500 catch-up contribution for those aged 50 and over, or $11,250 for those aged 60-63.

As the employer, a business owner can make a profit-sharing contribution of up to 25% of their compensation. The combined employee and employer contributions to a Solo 401(k) can reach $70,000 for those under age 50, and up to $77,500 or $81,250 with catch-up contributions for older individuals, depending on age. The maximum compensation that can be taken into account for contributions is $350,000 in 2025.

For cash-basis taxpayers, the timing of revenue recognition can be a deferral strategy. Delaying the invoicing or collection of payments for goods or services until the beginning of the next tax year shifts the income from the current year to the subsequent year. For example, if a service is completed in December but the invoice is sent and payment is received in January, the income is recognized in the later tax year.

Conversely, accelerating deductible business expenses can also defer income. Cash-basis taxpayers can prepay certain expenses before the end of the current tax year to increase their deductions and reduce net taxable income. Examples include purchasing office supplies, paying for professional services, or making advance rent payments for the upcoming year. These prepaid expenses must be for a period not extending beyond 12 months past the end of the current tax year to be deductible in the current year.

Deferring Income from Investments

Investment income deferral strategies primarily involve managing when capital gains are realized and utilizing specific investment vehicles designed for tax-deferred growth. These approaches allow investors to control the timing of their tax liabilities, potentially aligning them with periods of lower income or more favorable tax rates. The decision to defer investment income often balances immediate financial needs with long-term tax efficiency.

Delaying the realization of capital gains is a method of income deferral. When an investor holds appreciated assets, such as stocks, mutual funds, or real estate, in a taxable brokerage account, no capital gains tax is due until those assets are sold. Not selling an asset in the current tax year postpones the recognition of the gain and the associated tax liability to a future tax year. This strategy allows the investment to continue growing without being immediately subject to taxation.

Deferred annuities are another type of financial product that offers tax deferral on earnings. With a deferred annuity, the money invested grows over time, and the earnings are not taxed until they are withdrawn, typically during retirement. The tax deferral feature allows the earnings to compound more rapidly, as taxes are not eroding the principal each year.