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Midnight on New Year’s Eve: confetti falls, champagne corks pop, couples kiss. A year evaporates into the past, and so (to a great extent) do your opportunities to lower your tax bill for the year that’s just faded away.
Those champagne corks won’t pop for a little while yet, though—so what can you do now to make sure you still feel like celebrating on April 15?
1. Max Out Your Retirement Accounts
Yes, you’ve heard this advice before, repeatedly. There’s a reason for that: it’s good advice that benefits you not only at tax time, but years into the future. Focus on tax-deferred retirement accounts, which can grow, tax-free, for decades. If you have a 401(k) plan sponsored by your employer, take advantage of it, especially if your employer matches your contributions. You can slash your taxable income by contributing the maximum allowed for 2016: $18,000 for many employees, and up to $24,000 for those over 50s.
You can also contribute to a traditional IRA to lower your tax bill. You do have until April 15, 2017 to do this for 2016, but the sooner you put money in, the sooner it can start to grow. A Roth IRA is also worth contributing to for this reason, although, since contributions are taxed, it doesn’t offer the same tax-lowering benefit.
2. Defer Income (With One Caveat)
Why would you pay taxes on income today if you can do it a year from now? You wouldn’t—so take advantage of opportunities to defer income where you can. You pay income tax on income the year it’s received, not necessarily the year in which it’s earned. So if you have the opportunity to delay receipt of income until next year, you’ll delay the tax bill on that income as well.
This is tough to do with paychecks, of course, which are issued on a schedule. However, if your company is willing to delay payment of bonuses or commission into the next year, and this is not a departure from standard policy, that is a way to reduce your 2016 income. Likewise, if you are self-employed, and can invoice clients and customers near the end of December, it’s likely you won’t receive payment until January.
There’s one circumstance in which you don’t want to delay receipt of income, and that’s if you expect to be in a higher tax bracket for 2017, or if you think the deferral of income could force you into one. In that case, it may be less costly to pay sooner.
3. Accelerate Deductions (With Two Caveats)
On the flip side of deferring income is accelerating deductions you can take against the income you do have for this year. As you begin your holiday shopping, purge your closets and cabinets of unused things you can donate to charity. In addition to making room for the new, clearing out the old can yield charitable deductions. Even greater charitable deductions can be realized if you make monetary donations to worthy qualifying organizations. (Bonus if any of these donations are holiday gifts to loved ones).
On the flip side of deferring income is accelerating deductions you can take against the income you do have for this year.
Think beyond charity, too. If you have deductible medical expenses, pay them in 2016 if you can. Likewise with property tax bills, often due in mid-January, or estimated state income tax.
What are the caveats? Well, the advice above only helps you if you itemize deductions. If you take the standard deduction they don’t apply. Also, if your income is such that you may be income to the Alternative Minimum Tax (AMT), accelerating your deductions could hurt more than it helps. Once a tool to prevent the wealthy from reducing their tax bill with deductions, more and more middle-class families are now finding themselves subject to the AMT.
4. Use it, Don’t Lose It
If you’re like the many Americans who receive flex spending accounts as a benefit of employment, you’re already familiar with some of their benefits. You can use the pre-tax dollars in these plan to pay for all manner of medical expenses or child care.
Unfortunately, the downside to flex benefits is that you decide your contribution amount up front, and if you don’t use all the funds in the account, you lose them, negating the tax benefit. The good news is that there are lots of ways to use them up. Need new eyeglasses? Does the medicine cabinet need restocking? Do you have any outstanding medical bills? Use your flex dollars. Even better: you have until March 15, 2017 to do spend these funds. For future years, make note of expenditures this year so that you can better plan for your flex account benefits.
5. Say Goodbye to Bad Investments
Unlike a well-known individual who reportedly lost almost a million dollars in a single year and apparently didn’t pay income tax for nearly two decades, you probably won’t be able to offset all your taxes. But if you have investments that have lost money, you can sell them and “harvest” the loss to offset any taxable gains you had in 2016.
If your losses exceed your gains in a year, you can even use up to $3,000 worth of losses to negate other income. And if you have excess loss above and beyond that amount, you can carry it forward into the next year.
We can connect you with tax professionals who can help make tax planning for 2016 and beyond more fruitful, and less painful. Contact us us so that all you need to think about on New Year’s Eve is confetti and champagne.