Here we are: December. This month means chilly weather, holiday cheer, and… the end of another tax year!
Now is a great time to make some smart tax moves to help reduce your tax bill and increase your tax refund when you file. While that may not warm you as much as a mug of hot cocoa or sitting by the fireplace, taking care of these tasks before December 31st will hopefully lower your stress level before the new year begins.
1. Postpone your income
Income is taxed in the year it’s earned. But why pay tax today if you can pay it tomorrow instead?
If you think that you’ll be in the same tax bracket, or even a lower tax bracket next year, defer your income.
You don’t want to have a larger tax obligation next year if additional income could push you into a higher tax bracket. (If that’s the likely case, try accelerating income into the current year so that you can pay the tax in a lower bracket sooner, rather than in a higher bracket later.)
And if your income is lower, it’s easier to meet the 2 percent floor required for taking certain deductions, like miscellaneous itemized deductions.
Ways to Postpone Income
Defer Year-End Bonuses
This extra bit of cash may bump you up to the next tax bracket, so if you can delay your bonus, do it! By receiving your bonus in January, you’ll still receive it close to year-end—without having to pay taxes on it this year.
If you have self-employment income, like from freelance or consulting work, you have a little more leeway. All you need to do is delay billings until late December, which ensures you won’t receive payment until the new year.
Take Capital Gains
Whether you’re a corporate employee or self-employed, you can also defer income by taking capital gains next year instead of this year.
Hold your incentive stock options (ISOs)
If your employer grants you ISOs, remember that you don’t recognize any taxable income until you exercise the options and sell the stock.
Use Like-Kind exchanges
If you have a business or investment property, you can defer recognition of capital gain or loss if you trade your property for another of a “like kind.”
Ask for installment payments on sales
Do you plan to sell property in the near future? If you receive payments in installments over the next few years, instead of all at once, you may be able to defer recognition of some of the capital gain on the sale.
2. Accelerate your deductions
Another way to lower your tax bill is by accelerating your deductions. By accelerating your deductions, you’ll spend money on expenses that will generate a tax deduction now rather than next year.
Ways to Accelerate Deductions
Get a mortgage interest deduction
If you make an extra mortgage payment on December 31, you may be able to claim the additional interest paid as a deduction in the tax year paid. You’ll get the tax deduction immediately instead of waiting an additional 12 months.
If you purchased a home before December 15, 2017, you can deduct the mortgage interest you paid on a home loan up to $1 million. If you purchased after that date, you can deduct up to $750,000.
Document your charitable contributions
You control the timing. You even have the option to step up your tax benefits by donating appreciated stock or property rather than cash.
Better yet, if you’ve owned the asset for over a year, you can unlock a double tax benefit from the donation: Deduct the property’s market value on the date of the gift to avoid paying capital gains tax on the built-up appreciation.
Just remember to hold onto your donation receipt, regardless of the amount.
Prepay state and local income tax
When you prepay state and local income tax, you can accelerate deductions for these taxes.
Deduct investment expenses
Deduct investment-related expenses like office rent, investment counsel fees, legal and accounting fees, secretarial fees, and some travel expenses. These expenses are deductible if they exceed 2 percent of your AGI, and are related to the process of buying, selling, and maintaining your investments.
Deduct investment interest
Deduct interest on loans used for investment purposes against net investment income. Past this limit, you can absorb the excess deduction by selling appreciated property. As always, discuss the tax consequences with a tax professional.
3. Mind the Alternative Minimum Tax (AMT)
The AMT is calculated separately from your regular tax liability and with different rules. You’re obligated 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) aren’t deductible under the AMT. For instance, state and local income taxes and property taxes aren’t deductible under the AMT—so if you expect to be subject to the AMT in 2020, don’t pay the installments that are due in January 2021 in December 2020.
Make sure you aren’t already in the AMT or have inadvertently triggered it. If that’s the case, accelerating tax deductions can actually cost you money.
4. Buy low, sell low
Loss harvesting involves selling investments like stocks and mutual funds to realize losses. This key year-end strategy allows you to use those losses to offset any taxable gains, dollar for dollar, that you’ve realized during the year.
Do you have more losses than gains? You can use up to $3,000 of excess loss to wipe out other income.
Do you have more than $3,000 in excess loss? It can be carried over to the next year. Use it to set off next year’s gains, plus up to $3,000 of other income. You can carry over losses year after year for as long as you live.
5. Contribute the maximum to retirement accounts
Whether you contribute to a 401(k) or 403(b), traditional IRA or SEP IRA, you can reduce your taxable income while taking advantage of tax-deferred growth.
At the very minimum, contribute at least the amount that will be matched by your employer. If you’re over age 50, remember to take advantage of the catch-up contributions.
Here’s a helpful tip: you can consolidate all your old 401(k)s into an IRA for easier, better investing.
You have until April 15 to make IRA contributions, but the sooner you get your money into the account, the sooner it can start growing tax-deferred.
6. Avoid the kiddie tax
The kiddie tax is a tax imposed on minors whose investment and unearned income is higher than an annually determined threshold. This rule was created to prevent families from shifting the investment income tax bill from Mom and Dad’s high tax bracket to junior’s low bracket.
The kiddie tax is applied to any unearned income over $2,200. This tax applies even if your child is 19 to 24 years old, a full-time student, and provides less than half of their support.
Be careful if you plan to give your child stock to sell or pay for school expenses. If the gain exceeds $2,200, your tax bill will be figured using the steep tax brackets for estates and trusts.
7. Check IRA distributions
You’re required to make your required minimum distributions (RMDs) from your traditional IRA beginning April 1 following the year that you reach age 72.
Failing to take your RMDs triggers one of the most drastic of all IRS penalties: a 50 percent penalty 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, you must take your RMDs by December 31 every year in order to avoid the penalty. Consider asking your IRA custodian to withhold tax from the payment; this allows you to avoid the hassle of making quarterly estimated tax payments.
Want to sidestep RMDs? Open a Roth IRA. The original owner is never required to withdraw money from the accounts.
Revamp your tax planning strategy
As we all know, planning is the pathway to success. This is an important time to revisit your tax plan with me. Let’s make sure you are prepared to prosper in the new year.
Get in touch to start the conversation today!
8. Watch your flexible spending accounts (FSAs)
Flexible spending accounts (FSAs), also known as flex plans or cafeteria plans, are fringe benefits offered by employers. Employees can direct part of their pay into a special account, which you can then use to pay for certain medical and dependent care expenses.
Because you’re paying with pre-tax dollars, you can reduce your taxable income and tax obligation.
However, the catch is the notorious “use it or lose it” rule: At the beginning of the year, you must decide how much to contribute to the plan. By the end of the year, you forfeit the excess.
Before the end of the year, check to see whether your employer has adopted a grace period (permitted by the IRS). If so, you’ll have until March 15, 2021 to spend the money. If not, make a last-minute trip to the pharmacy, dentist, or optometrist to use up the remaining funds in your account.
9. Make W-4 Withholding Allowance Adjustments
If you didn’t have the tax outcome you were expecting this year due to:
- Pandemic-related job changes
- Tax law changes
- Life changes, like having a baby, getting a pay increase or decrease, unemployment, or a new job
Now is a good time to adjust the amount of taxes withheld from your paycheck. Adjust your withholding on your W-4 and refile the form with your employer so that there are no surprises at tax time.
10. Use your Gift Tax Exclusion
If you’re helping your aging parents or children just starting their careers, you can give up to $15,000 in a single year without having to file a gift tax return.
Be thoughtful about whether you want to give cash or non-cash gifts. By gifting securities, you can help your recipient get started in investing for their personal goals. You can also remove both the present value and any potential future growth of the transferred assets from your taxable estate.
11. Offset qualified education expenses
The American Opportunity credit and the Lifetime Learning tax credit can make higher education costs more affordable.
The American Opportunity credit offsets up to $2,500 for each eligible student:
- 100% of the first $2,000 of a student’s qualified education expenses, plus
- 25% of the next $2,000
- The MAGI phase-out range for unmarried individuals is $80,000 to $90,000.
- The MAGI phase-out range for married couples filing jointly is $160,000 to $180,000.
The Lifetime Learning tax credit can help cover undergraduate costs for a student who is not eligible for the American Opportunity credit because they’re carrying a limited course load or already have four years of college credit.
It covers up to $2,000 of undergraduate and graduate school costs for your dependent child, yourself, or your spouse:
- 20% of up to $10,000 of qualified education expenses
- The maximum credit is $2,000 before any phase-outs
- The MAGI phase-out range for unmarried individuals is $59,000 to $69,000.
- The MAGI phase-out range for married couples filing jointly is $118,000 to $138,000.
- Regardless of your income, you are not eligible if you use married filing separate status.
You can’t claim both the American Opportunity credit and the Lifetime Learning credit for the same student for the same year. However, you can potentially claim the American Opportunity credit for one or more students and the Lifetime credit for up to $10,000 of qualified expenses for other students in your family.
We Can Help
Whether you’re having a good year or rebounding from a lean one, you may be able to save on taxes if you make the right moves before the end of the year.
Tax planning is complicated, but it’s worth considering strategies that could help you reduce your tax bill.
If you need help navigating your current tax situation, please fill out the form below and we’ll get back to you shortly. We look forward to hearing from you.
DISCLAIMER: Prosperity Financial Group and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. Advisory Services offered through Prosperity Financial Group, Inc., an Independent Registered Investment Advisor. Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Prosperity Financial Group, Inc. and Fortune Financial Services, Inc. are separate entities.