End of Year Tax Planning
Taxes may not be top of mind in December. However, financial decisions made before the end of the year can impact your tax return, and how much you owe the IRS. Taking strategic steps before the December 31 deadline on many deductions can significantly lower your tax liability. Lowering taxes involve reducing income, increasing deductions, or qualifying for tax credits. Here are a few areas which can represent tax savings:
Deferred Income Strategies
The US has a staggered tax rate, which charges different percentages based on taxable income. The tactic becomes particularly valuable when earnings near the next tax bracket. However, nearly everyone can benefit from lowering taxable income using a tax deferment strategy.
There are several ways to defer income, which could include the following:
- Contribute to the company retirement plan, which directly reduces taxable income by the contribution amount. You may also receive an employer match as deferred compensation. Participants can contribute up to $18,000, and those over 50 can deposit an additional $6,000, for an annual total of up to $24,000, plus any matching dollars from your employer.
- Fund a Traditional IRA or other tax-deferred retirement plan. Everyone, without a work plan can contribute pre-tax dollars to a Traditional IRA up to $5,500 per year, and $6,500 for anyone 50 and older. If you are self-employed, you qualify for retirement plans with higher contribution limits. Employees with access to a work plan must meet the income thresholds to qualify for tax-deductible IRA contributions. It is possible to reduce taxable income through 401k or other work plans, to lower your AGI (adjusted gross income) enough to qualify for the pre-tax IRA benefit.
- Contribute to an HSA (healthcare savings account). The rise of health care deductibles qualifies more individuals for HSA accounts. For the 2017 tax year, you can contribute up to $3,400 for an individual and $6,720 for a family. To meet the requirements, individuals must enroll in a health care plan with a minimum deductible of $1,300, and families must have a deductible of $2,600 or higher, with a maximum out of pocket costs of no less than $6,550 and $13,100, respectively. The HSA reduces taxable income through contributions, and you receive the money tax-free on withdrawal, provided you use funds for qualified medical expenses.
- Defer your holiday bonus. Employers often allow you to delay a holiday bonus until the new year, which will delay taxation of the money until the following tax year. You can also adjust your withholdings to reduce the initial taxation on the bonus, which can be at a higher rate than regular pay.
- Sell assets strategically. Selling short-term investments result in taxable income at the highest rate. Holding investments for 12 months or longer produces taxable income at the lower capital gains rate.
- Invoice strategically. Self-employed businesses can hold December Invoices until after the New Year to reduce December income and lower company profits.
Bulk Up on Last-Minute Tax Deductions
Raising deductible expenses can lower personal income or company profits, reducing the amount of taxes owed. Individuals can itemize taxes to lower AGI. Itemizing taxes make sense when deductions are higher than the standard deduction. Some expenses which can help you qualify for itemization include the following:
- Medical deductions: Completing treatments, exams, or other medical procedures towards the end of the year can raise out of pocket costs enough to qualify for the medical deduction. Expenses must exceed 10% of income to qualify. Medical, dental, hearing and eye care costs qualify. You can reach the threshold quickly if you have medical needs not covered by insurance. In many cases, premiums count towards the deduction. However, you cannot double dip and count funds withdrawn from a flexible spending or HSA accounts.
- Charitable contributions: Donating money or goods to a qualified charitable organization is 100% deductible up to December 31, provided you itemize. Making less traditional donations such as investments or vehicles will take longer to gain the deduction and should not be completed at the last minute.
- Tax benefits for your residence: As a homeowner, there are several ways to receive additional tax breaks. If you itemize, you can deduct the mortgage interest. To double up on savings, pay January’s mortgage payment by December 31st, allowing you to deduct the additional interest on your upcoming tax return. You can also achieve the same benefit by paying property taxes by year-end.
- Pay college costs early. Valuable tax credits and deductions apply to out of pocket costs for attending school, as well as interest payments on student loans. The American Opportunity Tax Credit or the Lifetime Learning credit can reduce your tax obligation by up to $2,000. For more deductions, turn to the tuition and fees deduction, which caps out at $4,000 and up to $2,500 on student loan interest payments.
Check IRA Contributions and Distributions
- Saver’s Credit provides an additional deduction for households which meet income thresholds. You may deduct up to 50% of IRA contributions, in addition to the pre-tax benefits. To qualify, couples filing a joint return must have adjusted gross income (AGI) below $62,000, and singles must report AGI under $31,000. The maximum credit is $1,000 for singles and $2,000 for couples.
- RMDs. Failing to take required mandatory distributions from Traditional IRAs or work plans after age 70 ½ can result in a 50% tax penalty. All distributions must occur before December 31 to avoid the penalty.
Watch Flexible Spending Account Balances
Employer Flexible Spending Accounts, (FSA) often expire at the end of the year. To empty the account, you can use funds for routine visits, prescriptions, or other qualified items, which can include over the counter medications, eyeglasses, contacts and so forth.
You may contribute up to $2,550 to your FSA account for either medical or childcare costs. All contributions lower taxable income.
The US Treasury recently updated the rules, allowing plans to roll over funds to the next year, although not all employers participate. For employers who allow rollovers, you can leave up to $500 in the account to use the following year.
Check Your Health Insurance
The law requires everyone to carry health insurance. Failing to do so could raise taxes due to the penalty, which could cost $695 per person or up to 2.5% of income. Signing up for coverage in December can prevent the fee in 2018.
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