Nora Tellifson, CPA •
By the time a lot of taxpayers (and their accountants) get around to thinking about end of year tax planning, it’s too late to have much impact. If you take a look at your financial situation now, there are still a lot of moves you can make before the end of the year to improve your tax outcome.
By the time a lot of taxpayers (and their accountants) get around to thinking about end of year tax planning, it’s too late to have much impact. If you take a look at your financial situation now, there are still a lot of moves you can make before the end of the year to improve your tax outcome.
Make a projection of your taxable income
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 withholding or estimated 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., 401k contributions), and income tax withheld to date. Calculate the number of pay periods you have left during the year, calculate what your additional wages, pre tax deductions, and withholding will be for those pay periods, and add it to the year to date amounts. If there are no significant changes from the previous year, you can use your 2015 tax return to estimate your other income items (e.g., interest and dividends, social security), deductions, and exemptions to arrive at your taxable income. If you receive an end of year bonus, make sure you include it in your calculation. Use an online 2016 tax calculator (available from many banks, investment advisors, and tax preparers) to calculate your tax. Deduct any credits you expect to have, taking into account that you might have phased out of some if you made more money than in 2015, and see if your withholding is sufficient to cover your projected tax liability. If it’s not, you have some choices. You can do nothing and accept that you will have a balance due. As long as you have paid in enough to avoid a penalty, which is 90% of your estimated 2016 tax or 100% or 110% of your 2015 tax liability (dependent on your income), it won’t make a difference and you can hang onto your money longer.
Adjust your withholding
Most of us don’t like writing big checks. In that case, 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 2017. 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 two quarterly payments 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, and you still have three months to spread this over. Here are a few easy ones that apply to most taxpayers.
Increase your 401(k) contributions
If you aren’t maxing your 401(k) contributions ($18,000 or $24,000 if you are 50+), increase your contributions as much as you reasonably can. Only pre- tax contributions will reduce your taxable income so keep that in mind if your plan offers a Roth option because those are after tax contributions 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 put away $5,000, but it really only cost her $3,750. And furthermore, she has a whole 3 months to spread that additional $5,000 contribution over. 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, start planning and making your charitable contributions now. Unless our contributions are made through payroll deduction, most of us tend to wait until the end of the year to make our cash contributions. The problem with that is that there are lots of things competing for our funds in December so we end up contributing less than we intended to the organizations we want to support. So come up with a plan now, and spread your contributions over these last three months. A caution though: most GoFundMe contributions are not tax deductible. See my previous article on the subject for more information.
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 contributions which I discussed last December (see article here) 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.
Shifting income and expenses
Sometimes a taxpayer has some discretion regarding what year they will take income or deductions in, and depending on where you think your income will be or where tax rates are going, you can use this to your advantage. This gets a little fancier, but here are a few examples.
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.
Capital gains and losses
If a taxpayer has investments and has capital gains from the sales of stocks or mutual funds, she might want to consider selling stocks or funds that have lost value to offset those gains. This is sometimes called “harvesting losses”. Another consideration is where you think capital gains tax rates are going. Because the decision to hold or sell an investment is up to the taxpayer, depending on which way you think future capital gains rates are going, you may decide to sell now or hold the stock and sell it later when your gains will be taxed at a lower rate. In election years like this, that’s always a great area of speculation!
Timing of deductions
If your income is low this year, but you know next year will be much higher, you may choose to hold off on those charitable contributions until January because they are more valuable to you next year than this year. Similarly, if this year your income is high, and you expect next year to be much lower, you may want to pay your January real estate tax bill early in December. A caveat here: deductions can be limited for high income earners so make sure you aren’t moving your deductions to a year you are going to be limited.
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.
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 withholding or estimated 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., 401k contributions), and income tax withheld to date. Calculate the number of pay periods you have left during the year, calculate what your additional wages, pre tax deductions, and withholding will be for those pay periods, and add it to the year to date amounts. If there are no significant changes from the previous year, you can use your 2015 tax return to estimate your other income items (e.g., interest and dividends, social security), deductions, and exemptions to arrive at your taxable income. If you receive an end of year bonus, make sure you include it in your calculation. Use an online 2016 tax calculator (available from many banks, investment advisors, and tax preparers) to calculate your tax. Deduct any credits you expect to have, taking into account that you might have phased out of some if you made more money than in 2015, and see if your withholding is sufficient to cover your projected tax liability. If it’s not, you have some choices. You can do nothing and accept that you will have a balance due. As long as you have paid in enough to avoid a penalty, which is 90% of your estimated 2016 tax or 100% or 110% of your 2015 tax liability (dependent on your income), it won’t make a difference and you can hang onto your money longer.
Adjust your withholding
Most of us don’t like writing big checks. In that case, 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 2017. 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 two quarterly payments 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, and you still have three months to spread this over. Here are a few easy ones that apply to most taxpayers.
Increase your 401(k) contributions
If you aren’t maxing your 401(k) contributions ($18,000 or $24,000 if you are 50+), increase your contributions as much as you reasonably can. Only pre- tax contributions will reduce your taxable income so keep that in mind if your plan offers a Roth option because those are after tax contributions 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 put away $5,000, but it really only cost her $3,750. And furthermore, she has a whole 3 months to spread that additional $5,000 contribution over. 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, start planning and making your charitable contributions now. Unless our contributions are made through payroll deduction, most of us tend to wait until the end of the year to make our cash contributions. The problem with that is that there are lots of things competing for our funds in December so we end up contributing less than we intended to the organizations we want to support. So come up with a plan now, and spread your contributions over these last three months. A caution though: most GoFundMe contributions are not tax deductible. See my previous article on the subject for more information.
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 contributions which I discussed last December (see article here) 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.
Shifting income and expenses
Sometimes a taxpayer has some discretion regarding what year they will take income or deductions in, and depending on where you think your income will be or where tax rates are going, you can use this to your advantage. This gets a little fancier, but here are a few examples.
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.
Capital gains and losses
If a taxpayer has investments and has capital gains from the sales of stocks or mutual funds, she might want to consider selling stocks or funds that have lost value to offset those gains. This is sometimes called “harvesting losses”. Another consideration is where you think capital gains tax rates are going. Because the decision to hold or sell an investment is up to the taxpayer, depending on which way you think future capital gains rates are going, you may decide to sell now or hold the stock and sell it later when your gains will be taxed at a lower rate. In election years like this, that’s always a great area of speculation!
Timing of deductions
If your income is low this year, but you know next year will be much higher, you may choose to hold off on those charitable contributions until January because they are more valuable to you next year than this year. Similarly, if this year your income is high, and you expect next year to be much lower, you may want to pay your January real estate tax bill early in December. A caveat here: deductions can be limited for high income earners so make sure you aren’t moving your deductions to a year you are going to be limited.
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.
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