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.
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.
Disclaimer