By the time a lot of taxpayers get around to thinking about taxes, it could be too late to be proactive, and all you can do is close your eyes and write that check! By taking a look at your financial situation now, you may be able to take advantage of some tax saving strategies before the end of year to improve your tax outcome.
Make a projection of your taxable income
When it comes to year-end tax planning, the first thing to do is project what your taxable income will be at the end of the year, what your tax liability will be, and how much you will have paid in, either through withholdings or estimated tax payments. In the case of a salaried taxpayer with only W-2 wages, use your most recent paystub for total wages, pre-tax deductions (e.g. 401(k) contributions, pre-tax employee benefits, etc.), and income tax withheld to date. Determine the number of pay periods you have left during the year and estimate what the remaining wages, pre-tax deductions, and withholdings will be for those pay periods and add it to your year-to-date amounts. If there are no significant changes from the previous year, you can use your 2018 tax return to estimate other sources of income (e.g. interest and dividends, Social Security Benefits, etc.) and deductions to arrive at your taxable income. If you are expecting to receive an end of year bonus, make sure you include it your calculation and adjust your withholdings accordingly. Use an online tax calculator for the 2019 tax year to calculate your total tax liability. Deduct any credits you expect to have, taking into account the income limits and phase-outs for these credits. See the IRS website for a list of credits available to individual taxpayers.
Next, calculate if your withholdings and/or estimated tax payments are sufficient to cover your projected tax liability. If not, one option is to do nothing and accept that you will have a balance due when it comes time to file your tax return. This option works best if you’ve paid in the minimum to avoid any interest and underpayment penalties. The general rule is that as long as you have paid at least 90% of your 2019 tax liability or 100% of your 2018 tax liability you will not owe the underpayment penalty or if you’re a higher income taxpayer the 100% is substituted for 110%.
Adjust your withholding
If you’re one of those people who don’t like writing big checks, you can increase your withholding for the rest of the year by the amount of tax you are short divided by the remaining number of pay periods. It won’t change the amount of tax you pay, but you’ll feel better about it! If you do this, remember to re-adjust your withholding after the end of the year so you are not withholding too much for 2020. The longer you wait to assess your withholding, the fewer pay periods you have remaining in the year to spread the pain across so I encourage you to do this projection now. If you make estimated payments, increase the remaining quarterly payment so that your total estimated payments for the year are adequate.
Reduce your taxable income
Doing a projection and adjusting your withholding or estimated payments based on your projection are good for eliminating unwelcome surprises, but they don’t change your tax liability. The other side of the equation is to reduce your taxable income. Here are a few easy steps that apply to most taxpayers.
Increase your 401(k) contributions
If you aren’t maxing your 401(k) contributions ($19,000 for 2019 or $25,000 if you are 50+), increase your contributions as much as you reasonably can. Only pre-tax contributions will reduce your taxable income so keep in mind that if your plan offers a Roth option, those contributions are after-tax and won’t reduce taxable income. Besides socking away more for retirement, you are paying yourself instead of paying the government. Consider a taxpayer in the 25% tax bracket. If she increases her 401k contribution by $5,000, she saves $1,250 in tax dollars (25% x $5,000). So she puts away $5,000, but it really only cost her $3,750. This is a quick and dirty calculation—depending on whether the taxpayer is in the top or bottom of the bracket, the result could be a little more or little less, but you get the picture.
Make your charitable contributions now—including Goodwill
As long as you itemize your deductions and your deductions are not limited due to your income, charitable deductions will lower your tax bill. However, there are many charitable causes where contributions are not tax deductible (for example, did you know most GoFundMe contributions are not tax deductible). So do your homework to make sure the organizations you are donating to are qualified 501(c)(3) organizations so your deduction won’t be disallowed by the IRS. You can search for qualified tax exempt organizations through the IRS search tool to ascertain if a charity is legitimate.
Remember, non-cash contributions to Goodwill and the Salvation Army are every bit as valuable from a tax perspective, and we all have too much stuff! So get busy now, clean your closets, your house will have less clutter, and you’ll reduce your taxes. There are different record keeping requirements for non-cash so make sure you are aware of them. As long as you itemize your deductions, your tax savings from charitable contributions can be estimated in a fashion similar to the 401(k) contributions—a taxpayer in the 25% tax bracket will save $125 on his tax bill with a $500 donation, and if it was from his closet, it didn’t cost him anything.
Thoughts on Itemized deductions
As you may have noticed last year, the standard deduction for individual taxpayer increased due to the Tax Cut and Jobs Act of 2017 which is still holds true for the 2019 tax year although the limits are slightly higher at $12,200 for single and married filing single taxpayers, $24,400 for married filing joint taxpayers, and $18,350 for taxpayers filing as head of household. If you took the standard deduction last year, chances are you will take it again this year, however, consider these changes to determine if itemizing your deductions would be more beneficial in 2019:
Roth conversions
If you find yourself with lower income than usual in 2019, it might be an ideal time for you to make a Roth conversion and take advantage of the lower tax bracket you find yourself in. You need to make the conversion before the end of the year. See our article on Roth Conversions.
Timing of retirement distributions
In the case of a retired taxpayer who is not yet required to take minimum distributions, they may want to draw down retirement plan accounts in an amount that keeps them from going into the next higher tax bracket. For example, if our taxpayer is married and right in the middle of the 15% tax bracket and decides haphazardly to withdraw $30,000, $11,450 of that distribution will be taxed at 25% instead of 15%. If the taxpayer had planned ahead, and perhaps consulted his accountant, he might have decided to only withdraw the amount that would keep him in the 15% bracket this year and take out that additional $11,450 at 15% in the following year, resulting in a tax savings of $1,145 over the two years.
Get help if you need it
These are some simple examples. As you get into higher income levels, there are phase out ranges and limitations for credits, deductions, and exemptions, and depending where the taxpayer is, they may encounter these limitations. Sometimes utilizing the techniques above can get a taxpayer below those thresholds as well, which makes them even more powerful in reducing tax liability. But no matter how you slice it, it’s always better to know where you stand before April 15! So do a tax projection to see where you stand, call if you have questions, or just have your accountant do it. You’ll have no surprises in April and peace of mind until then.
There are always special situations that can occur so if you have any questions regarding payments for sole proprietors, speak with your trusted tax advisors. As always, our CPAs at Mason + Rich are ready to answer any additional questions. Feel free to call us at 603-224-2000.
Original post by Nora Tellifson (December 2017) with 2019 updates by Lena Rozzi.
When it comes to year-end tax planning, the first thing to do is project what your taxable income will be at the end of the year, what your tax liability will be, and how much you will have paid in, either through withholdings or estimated tax payments. In the case of a salaried taxpayer with only W-2 wages, use your most recent paystub for total wages, pre-tax deductions (e.g. 401(k) contributions, pre-tax employee benefits, etc.), and income tax withheld to date. Determine the number of pay periods you have left during the year and estimate what the remaining wages, pre-tax deductions, and withholdings will be for those pay periods and add it to your year-to-date amounts. If there are no significant changes from the previous year, you can use your 2018 tax return to estimate other sources of income (e.g. interest and dividends, Social Security Benefits, etc.) and deductions to arrive at your taxable income. If you are expecting to receive an end of year bonus, make sure you include it your calculation and adjust your withholdings accordingly. Use an online tax calculator for the 2019 tax year to calculate your total tax liability. Deduct any credits you expect to have, taking into account the income limits and phase-outs for these credits. See the IRS website for a list of credits available to individual taxpayers.
Next, calculate if your withholdings and/or estimated tax payments are sufficient to cover your projected tax liability. If not, one option is to do nothing and accept that you will have a balance due when it comes time to file your tax return. This option works best if you’ve paid in the minimum to avoid any interest and underpayment penalties. The general rule is that as long as you have paid at least 90% of your 2019 tax liability or 100% of your 2018 tax liability you will not owe the underpayment penalty or if you’re a higher income taxpayer the 100% is substituted for 110%.
Adjust your withholding
If you’re one of those people who don’t like writing big checks, you can increase your withholding for the rest of the year by the amount of tax you are short divided by the remaining number of pay periods. It won’t change the amount of tax you pay, but you’ll feel better about it! If you do this, remember to re-adjust your withholding after the end of the year so you are not withholding too much for 2020. The longer you wait to assess your withholding, the fewer pay periods you have remaining in the year to spread the pain across so I encourage you to do this projection now. If you make estimated payments, increase the remaining quarterly payment so that your total estimated payments for the year are adequate.
Reduce your taxable income
Doing a projection and adjusting your withholding or estimated payments based on your projection are good for eliminating unwelcome surprises, but they don’t change your tax liability. The other side of the equation is to reduce your taxable income. Here are a few easy steps that apply to most taxpayers.
Increase your 401(k) contributions
If you aren’t maxing your 401(k) contributions ($19,000 for 2019 or $25,000 if you are 50+), increase your contributions as much as you reasonably can. Only pre-tax contributions will reduce your taxable income so keep in mind that if your plan offers a Roth option, those contributions are after-tax and won’t reduce taxable income. Besides socking away more for retirement, you are paying yourself instead of paying the government. Consider a taxpayer in the 25% tax bracket. If she increases her 401k contribution by $5,000, she saves $1,250 in tax dollars (25% x $5,000). So she puts away $5,000, but it really only cost her $3,750. This is a quick and dirty calculation—depending on whether the taxpayer is in the top or bottom of the bracket, the result could be a little more or little less, but you get the picture.
Make your charitable contributions now—including Goodwill
As long as you itemize your deductions and your deductions are not limited due to your income, charitable deductions will lower your tax bill. However, there are many charitable causes where contributions are not tax deductible (for example, did you know most GoFundMe contributions are not tax deductible). So do your homework to make sure the organizations you are donating to are qualified 501(c)(3) organizations so your deduction won’t be disallowed by the IRS. You can search for qualified tax exempt organizations through the IRS search tool to ascertain if a charity is legitimate.
Remember, non-cash contributions to Goodwill and the Salvation Army are every bit as valuable from a tax perspective, and we all have too much stuff! So get busy now, clean your closets, your house will have less clutter, and you’ll reduce your taxes. There are different record keeping requirements for non-cash so make sure you are aware of them. As long as you itemize your deductions, your tax savings from charitable contributions can be estimated in a fashion similar to the 401(k) contributions—a taxpayer in the 25% tax bracket will save $125 on his tax bill with a $500 donation, and if it was from his closet, it didn’t cost him anything.
Thoughts on Itemized deductions
As you may have noticed last year, the standard deduction for individual taxpayer increased due to the Tax Cut and Jobs Act of 2017 which is still holds true for the 2019 tax year although the limits are slightly higher at $12,200 for single and married filing single taxpayers, $24,400 for married filing joint taxpayers, and $18,350 for taxpayers filing as head of household. If you took the standard deduction last year, chances are you will take it again this year, however, consider these changes to determine if itemizing your deductions would be more beneficial in 2019:
- You incurred large uninsured medical and dental expenses
- Paid interest or taxes on your home
- Had “large” other deductions (line 16 on Form 1040, Schedule A)
- Had large uninsured casualty or theft losses from a Federally declared disaster, or
- Made large contributions to qualified charities
Roth conversions
If you find yourself with lower income than usual in 2019, it might be an ideal time for you to make a Roth conversion and take advantage of the lower tax bracket you find yourself in. You need to make the conversion before the end of the year. See our article on Roth Conversions.
Timing of retirement distributions
In the case of a retired taxpayer who is not yet required to take minimum distributions, they may want to draw down retirement plan accounts in an amount that keeps them from going into the next higher tax bracket. For example, if our taxpayer is married and right in the middle of the 15% tax bracket and decides haphazardly to withdraw $30,000, $11,450 of that distribution will be taxed at 25% instead of 15%. If the taxpayer had planned ahead, and perhaps consulted his accountant, he might have decided to only withdraw the amount that would keep him in the 15% bracket this year and take out that additional $11,450 at 15% in the following year, resulting in a tax savings of $1,145 over the two years.
Get help if you need it
These are some simple examples. As you get into higher income levels, there are phase out ranges and limitations for credits, deductions, and exemptions, and depending where the taxpayer is, they may encounter these limitations. Sometimes utilizing the techniques above can get a taxpayer below those thresholds as well, which makes them even more powerful in reducing tax liability. But no matter how you slice it, it’s always better to know where you stand before April 15! So do a tax projection to see where you stand, call if you have questions, or just have your accountant do it. You’ll have no surprises in April and peace of mind until then.
There are always special situations that can occur so if you have any questions regarding payments for sole proprietors, speak with your trusted tax advisors. As always, our CPAs at Mason + Rich are ready to answer any additional questions. Feel free to call us at 603-224-2000.
Original post by Nora Tellifson (December 2017) with 2019 updates by Lena Rozzi.
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