Whether you are having a good year, rebounding from recent losses, or still struggling to get off the ground, you may be able to save a bundle on your taxes if you make the right moves before the end of the year.
1. Defer your income
Income is taxed in the year it is received – but why pay tax today if you can pay it tomorrow instead?
It’s tough for employees to postpone wage and salary income, but you may be able to defer a year-end bonus into next year – as long as it is standard practice in your company to pay year-end bonuses the following year.
If you are self-employed or do freelance or consulting work, you have more leeway. Delaying billings until late December, for example, can ensure that you won’t receive payment until the next year.
Whether you are employed or self-employed, you can also defer income by taking capital gains in 2015 instead of in 2014.
Of course, it only makes sense to defer income if you think you will be in the same or a lower tax bracket next year. You don’t want to be hit with a bigger tax bill next year if additional income could push you into a higher tax bracket. If that’s likely, you may want to accelerate income into 2014 so you can pay tax on it in a lower bracket sooner, rather than in a higher bracket later.
2. Take some last-minute tax deductions
Just as you may want to defer income into next year, you may want to lower your tax bill by accelerating deductions this year.
For example, contributing to charity is a great way to get a deduction. And you control the timing. You can supercharge the tax benefits of your generosity by donating appreciated stock or property rather than cash. Better yet, as long as you’ve owned the asset for more than one year, you get a double tax benefit from the donation: You can deduct the property’s market value on the date of the gift and you avoid paying capital gains tax on the built-up appreciation.
You must have a receipt to back up any contribution, regardless of the amount. (The old rule that you only had to have a receipt to back up contributions of $250 or more is long gone.)
Other expenses you can accelerate include an estimated state income tax bill due January 15, a property tax bill due early next year, or a doctor’s or hospital bill. (But speeding up deductions could be a blunder if you’re subject to the alternative minimum tax, as discussed below.)
Make sure you’ll be itemizing for 2014 rather than claiming the standard tax deduction. Unless the total of your qualifying expenses exceeds $6,200 if you are single, or $12,400 if you’re married filing a joint return, itemizing would be a mistake.
If you’re on the itemize-or-not borderline, your year-end strategy should focus on bunching. This is the practice of timing expenses to produce lean and fat years. In one year, you cram in as many deductible expenses as possible, using the tactics outlined above. The goal is to surpass the standard-deduction amount and claim a larger write-off.
In alternating years, you skimp on deductible expenses to hold them below the standard deduction amount because you get credit for the full standard deduction regardless of how much you actually spend. In the lean years, year-end planning stresses pushing as many deductible expenses as possible into the following year when they’ll have more value.
3. Making “Big” Gifts to Charity
If you plan to make a significant gift to charity this year, consider giving appreciated stocks or mutual fund shares that you’ve owned for more than one year. Doing so boosts the savings on your tax return. Your charitable-contribution deduction is the fair-market value of the securities on the date of the gift, not the amount you paid for the asset, and you never have to pay tax on the profit.
If your favorite cause can’t accept donations of appreciated securities, consider opening a donor-advised fund instead. The fund administrator will sell the securities for you and add the proceeds to your account. You can deduct the value of the securities on your 2014 tax return and decide later where you want to donate the money.
A tax break that allowed individuals 70 ½ to make a tax-free distribution of up to $100,000 from their IRAs directly to charity expired on Dec. 31, 2013. Congress is expected to renew it, but not until after the mid-term elections. The charitable transfer lets you give the money to charity and count it as a required minimum distribution but avoid taxes on the withdrawal. Not including RMD in your adjusted gross income can also help you stay under the income cutoffs for the Medicare Part B and Part D high-income surcharge or taxable Social Security benefits. If you’re charitably inclined and have more money than you need in your IRA, postpone taking RMDs for as long as possible. Just don’t wait too long, because the penalty for failing to take an RMD by Dec. 31 is 50% of the amount you should have withdrawn.
4. Beware of the Alternative Minimum Tax
Sometimes accelerating tax deductions can cost you money… if you’re already in the alternative minimum tax (AMT) or if you inadvertently trigger it.
Originally designed to make sure wealthy people could not use legal deductions to drive down their tax bill, the AMT is now increasingly affecting the middle class.
The AMT is figured separately from your regular tax liability and with different rules. You have to pay whichever tax bill is higher.
This is a year-end issue because certain expenses that are deductible under the regular rules—and therefore candidates for accelerated payments—are not deductible under the AMT. State and local income taxes and property taxes, for example, are not deductible under the AMT. So, if you expect to be subject to the AMT in 2014, don’t pay the installments that are due in January 2015 in December 2014.
5. Sell loser investments to offset gains
A key year-end strategy is called “loss harvesting” –selling investments such as stocks and mutual funds to realize losses. You can then use those losses to offset any taxable gains you have realized during the year. Losses offset gains dollar for dollar.
And if your losses are more than your gains, you can use up to $3,000 of excess loss to wipe out other income.
If you have more than $3,000 in excess loss, it can be carried over to the next year. You can use it then to offset any 2015 gains, plus up to $3,000 of other income. You can carry over losses year after year for as long as you live.
6. Contribute to “Tax Advantaged” Accounts
There may be no better investment than tax-deferred retirement accounts. They can grow to a substantial sum because they compound over time free of taxes.
Company-sponsored 401(k) plans may be the best deal because employers often match contributions.
Try to increase your 401(k) contribution so that you are putting in the maximum amount of money allowed ($17,500 for 2014, $23,000 if you are age 50 or over). If you can’t afford that much, try to contribute at least the amount that will be matched by employer contributions.
Also consider contributing to an IRA. You have until April 15, 2015 to make IRA contributions for 2014, but the sooner you get your money into the account, the sooner it has the potential to start to grow tax-deferred. Making deductible contributions also reduces your taxable income for the year. You can contribute a maximum of $5,500 to an IRA for 2014, plus an extra $1,000 if you are 50 or older. Use our IRA Calculator to see how much you can contribute.
If you are self-employed, the retirement plan of choice is a Keogh plan. These plans must be established by December 31 but contributions may still be made until the tax filing deadline (including extensions) for your 2014 return. The amount you can contribute depends on the type of Keogh plan you choose.
Make a contribution to your Health Savings Account (HSA), which can be made up until April 15, 2015 and still apply to 2014.
7. Avoid the kiddie tax
Congress created the “kiddie tax” rules to prevent families from shifting the tax bill on investment income from Mom and Dad’s high tax bracket to junior’s low bracket. For 2014, the kiddie tax taxes a child’s investment income above $2,000 at the parents’ rate and applies until a child turns 19. If the child is a full-time student who provides less than half of his or her support, the tax applies until the year the child turns age 24.
So be careful if you plan to give a child stock to sell to pay college expenses. If the gain is too large and the child’s unearned income exceeds $2,000, you’ll end up paying tax at 15 percent on the gain, rather than the zero percent rate that is applicable for most children.
8. Check IRA distributions
You must start making regular minimum distributions from your traditional IRA by the April 1 following the year in which you reach age 70 ½. Failing to take out enough triggers one of the most draconian of all IRS penalties: A 50 percent excise tax on the amount you should have withdrawn based on your age, your life expectancy, and the amount in the account at the beginning of the year. After that, annual withdrawals must be made by December 31 to avoid the penalty.
When you make withdrawals, consider asking your IRA custodian to withhold tax from the payment. Withholding is voluntary, and you set the amount, but opting for withholding lets you avoid the hassle of making quarterly estimated tax payments.
Important note: One of the advantages of Roth IRAs is that the original owner is never required to withdraw money from the accounts. The required minimum distributions apply to traditional IRAs.
9. Watch your flexible spending accounts
Flexible spending accounts, also called flex plans, are fringe benefits which many companies offer that let employees steer part of their pay into a special account which can then be tapped to pay child care or medical bills.
The advantage is that money that goes into the account avoids both income and Social Security taxes. The catch is the notorious “use it or lose it” rule. You have to decide at the beginning of the year how much to contribute to the plan and, if you don’t use it all by the end of the year, you forfeit the excess.
With year-end approaching, check to see if your employer has adopted a grace period permitted by the IRS, allowing employees to spend 2014 set-aside money as late as March 15, 2015. If not, you can do what employees have always done and make a last-minute trip to the drug store, dentist or optometrist to use up the funds in your account.
10. Get health insurance or face a penalty.
The Affordable Care Act (ACA) requires every individual, with some exceptions, to have qualifying health insurance coverage in 2014 or owe an “individual responsibility payment” of the greater of 1% of household income above the income tax filing threshold ($10,150 for an individual) or a flat amount of $95 for an adult and $47.50 per child under age 18, up to a maximum of $285. The payment will be due with your 2014 tax return. If you’re uninsured for just part of the year, 1/12 of the yearly penalty applies to each month you’re uninsured. If you’re uninsured for less than three months, you don’t have to make a payment.
11. Watch for last-minute Congressional action.
Several popular tax breaks that expired this year have yet to be reinstated by Congress. Among the most significant is the sales-tax deduction, which gave taxpayers in states with low or no income tax the option of deducting state and local sales tax instead of income tax. If you live in one of those states and were planning to accelerate a large purchase before the end of the year—a car or a boat, for example—to take advantage of the sales tax deduction, you might want to hold off and see what Congress plans to do. Other tax breaks that are up in the air are those for certain unreimbursed teachers’ expenses, tuition, mortgage insurance premiums, exclusion of employer-provided mass transit and parking benefits, and exclusion for debt forgiveness on foreclosed homes.
Sources: Intuit Tutbo Tax, Fidelity and Kiplinger