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TAX PLANNING FOR SOCIAL SECURITY RECIPIENTS

        Year End Tax Planning         

Now that the close of another year is coming up, it is time to consider year-end strategies that can potentially reduce your tax bill.  However, in order to make effective use of the strategies we are about to discuss, it will help significantly to have your prior year return in front of you along with your latest pay stubs or income reports from your business.

 

If you don't know where you currently stand, it can be difficult to impossible to make wise decisions about where you need to be.  As we will discuss below, many year-end tax strategies are only appropriate under very specific situations that may not apply in your particular case.

 

As always, please call our office if you are uncertain whether a specific recommendation will benefit you. 

As always, please call our office if you are uncertain whether a specific recommendation will benefit you. 

Defer Income / Accelerate Deductions

The knee-jerk reaction of most people doing year-end tax planning is to defer income to the following year.  While this is typically good advice since a tax dollar saved now is worth more on a time-value basis than a tax dollar saved later, there are caveats to consider.

If your taxable income is going to be higher next year for some reason (better job, fewer deductions, etc), then you may want to consider keeping your income in the current year when your tax bracket is lower.  Deferring income into a year with a higher tax bracket can offset your time-value savings.

However, if you expect to be in a lower tax bracket next year, you will certainly want to postpone income from this year to next. At the same time, you may want to accelerate your deductions in order to pay less tax this year.

These are a few of the most popular income items that are often deferred or postponed a few weeks past year-end:

  • Year-end bonuses
  • Sales of capital gain property (or take installment payments rather than a lump-sum payment)
  • Retirement account distributions (other than required minimum distributions)

Accelerating the following deductions has the same tax effect as postponing income:

  • Consider paying medical expenses in December rather than January, if doing so will allow you to qualify for the medical expense deduction
  • Prepay deductible interest (mortgage, investment)
  • Prepay alimony payments
  • Make next year's charitable contributions this year 

Watch Your Withholdings

If you think you may owe a substantial sum when you file this year's income tax return, you may want to increase your federal income tax withholding amounts. If you have other income in addition to your wages that makes you subject to estimated tax payments, there's an added benefit to increasing your year-end withholdings instead.: 

Even though the additional withholding may need to come from your last few paychecks, it is generally treated as having been withheld evenly throughout the year. This may help you avoid paying an estimated tax penalty.

On the other hand, if you have significantly overpaid your taxes and estimate that you will receive a large refund, you should reduce your year-end withholding to possibly receive more money for the holidays rather than waiting several weeks or months for a refund check.

Sideline Business/Hobby

If you operate a small business in addition to your regular line of work such as selling on Ebay or raising horses that generally loses money, you could be able to claim a tax loss.  You are allowed to deduct losses for what the IRS might consider a hobby as long as you make a profit three out of every five years (or two out of seven for horse racing, breeding, showing or training).  

Many taxpayers manipulate the timing of receipts and expenses with their small business/hobby so that they incur a small operating profit in certain years and much larger losses in others.  If you are close to showing a profit on your sideline business this year, it may be wise to postpone some expenses into next year so that you can eke out a profit this year and take a large loss next year.

However, please be aware that the IRS can still challenge your business losses even if you meet the profit/loss rules.  Your advantage is that the onus is on the IRS to prove that your activity is a long-term loser.  If you can demonstrate the expectation of future gains from eventually selling all of your assets, you should be safe from challenge.

Charitable Contributions

If you are considering a contribution to your favorite charity and you have appreciated stock or other investments that you have held for more than a year, you may want to consider donating the investment to the charity rather than cash.  The reason is that you will avoid paying tax on the appreciation of the investment, but you will still be able to deduct the full market value as a contribution.

If you still want to maintain your position in the shares of stock, you can simply repurchase the same number of shares after the donation.  The "wash sale" rules do not apply to stock shares that you sell for a gain or contribute to charity.  Also, do not be concerned that your charity will not want the stock.  Most charities are well aware of the advantageous rules around donating appreciated property and will be more than happy to assist you with the transaction.

Be Aware Of The Alternative Minimum Tax

The alternative minimum tax (AMT) was put into place many years ago as a means to tax wealthy individuals who were sheltering large amounts of income with tax shelters.  With all the recent tax cuts however, more and more middle-income taxpayers are falling victim to its provisions.

You could be subject to the AMT If you have any of the following: a large number of personal exemptions; large amounts of state and local taxes paid; large amounts of miscellaneous itemized deductions; large deductible medical expenses; the bargain element of incentive stock options (ISOs); and/or large capital gains. 

As you can see from the list above, year-end tax planning strategies which consist of moving itemized deductions into the current year can potentially make you subject to the AMT.  The difficult tax planning aspect of AMT is that each situation is unique so if you are concerned that you may fall subject to its provisions, you may want to call our office before making tax planning decisions.

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