Year-end Planning

Tackling taxes now can be a bonus for you—not Uncle Sam


You donate to charity during the gift-giving season. You purchase presents for loved ones. You may even tip your postal worker. But it's no doubt safe to assume that the Internal Revenue Service is not on your holiday list.

Indeed, by failing to take advantage of all tax breaks to which you are entitled, you not only lighten your wallet but effectively give Uncle Sam an undeserved bonus.

John Lund | Blend Images | Getty Images

Ferreting out deductions, however, has become increasingly complex with higher income eligibility thresholds, the growing number of taxpayers subject to the Alternative Minimum Tax (AMT) and the two new taxes levied on high-income earners that took effect in 2013— namely, the 0.9 percent Medicare surtax and 3.8 percent net investment tax.

(The AMT, which effects a growing percentage of middle-income earners, is a parallel tax system that disallows many of the most common deductions and credits.)

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Thus, before year-end tax-planning opportunities end, individuals should make sure to calculate an accurate projection of their income so they don't leave money on the table—or make tax-planning moves that fail to provide a benefit, said Marc Minker, a certified public accountant and managing director at CBIZ MHM financial services firm.

It's not uncommon, he said, for taxpayers to accelerate deductions into the current calendar year with the goal of lowering income, only to find out later that they owe the AMT and are ineligible to claim such write-offs.

Deferring and accelerating

"The whole concept of year-end tax planning has in many respects been turned on its ear with new income thresholds and the changes pushed through last year," said Minker. "Sit down and try to get as close as you can to a projected income so you can identify items where you may have flexibility."

If you find yourself bumping up against income threshold triggers, he said, it may make sense to defer income to next year where possible, including year-end bonuses and the realization of capital gains. The self-employed can also delay billings to ensure compensation is received in 2015.

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Those who are not caught in the AMT net can also potentially lower their tax bill by accelerating deductions into the current year, which is especially wise if you expect to be in a lower tax bracket next year.

The most effective strategies include prepaying deductible interest, accelerating capital losses, paying estimated taxes in December instead of January and making charitable contributions, said Minker.

Note: You'll get more bang for your buck if you donate appreciated stocks, bonds or mutual funds instead of cash to a qualified charity. You can deduct the property's fair market value on the date you gift and avoid paying capital gains tax on the appreciation.

Before you donate, however, check to ensure you are eligible to claim charitable donations as a deduction, Minker said.

The Pease limitation reduces the value of itemized deductions (including mortgage interest and charitable gifts) available to married taxpayers filing jointly who earn more than $305,050 annually. (The income threshold for single filers is $254,200.)

Fund your retirement

Your tax-deferred retirement plan can also help reduce your 2014 tax bill.

Be sure you've fully funded your 401(k) plan at work, or at least contributed enough to benefit from an employer match. (If you can't fully fund this year, put plans in motion to direct future raises and bonuses toward your 401(k) next year.)

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The deadline for claiming a current-year deduction is Dec. 31, but you can still make prior-year contributions to your traditional IRA all the way up until the income-tax filing deadline on April 15.

Those over age 70½—and those who inherited a traditional IRA—should also check to be sure they've taken the required minimum distribution from their IRA before Jan. 1. Any amount not withdrawn will not only be taxed as ordinary income but also assessed a hefty 50 percent penalty.

If you expect your income to be lower next year or remain the same, it may make sense to harvest losses.
Thomas Scanlon
certified financial planner with Raymond James Financial Services

Likewise, if you have a second source of income (e.g., speaking fees, book royalties, consulting gigs, etc.), you should take advantage of the opportunity to make additional tax-deductible contributions to your traditional IRA or other retirement plans, said John Napolitano, a certified financial planner and CEO of U.S. Wealth Management.

Taxpayers with supplemental income can potentially save an additional $210,000 per year in a defined benefit plan and $52,000 more in a defined contribution plan.

"Many taxpayers aren't even aware of it," said Napolitano. "That's one we catch for clients all the time."

Harvest losses

Depending on your tax bracket and income, you may also reduce your tax liability by selling off some of the losers in your investment portfolio to wipe out any gains, said Thomas Scanlon, a certified financial planner and certified public accountant with Raymond James Financial Services.

The IRS allows investors to offset capital gains with capital losses dollar for dollar. Any excess capital loss can be used to offset ordinary income, up to $3,000 per year. Leftover capital losses beyond that can be carried forward to offset gains and income in future years.

"If you expect your income to be lower next year or remain the same, it may make sense to harvest losses," said Scanlon.

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Such strategy yields the biggest tax savings for single filers making over $200,000 and married couples earning more than $250,000, who are subject to the additional 3.8 percent Obamacare/Affordable Care Act Net Investment Income Tax on unearned income.

Just be mindful of the wash-sale rule.

The IRS rule prevents investors from claiming a loss on shares they repurchase within 30 days after, or before, the date of the sale.

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Check your FSA

Many employees elect to participate in a flexible spending account through work, which allows them to pay for eligible out-of-pocket health-care expenses and work-related dependent day-care expenses with pretax dollars.

If you count yourself among them, keep in mind that any funds left in your account at year-end get forfeited.

Thus, it's important to check your balance and use what you have, said Jackie Perlman, principal tax researcher for The Tax Institute at H&R Block. "This is a good time to check your account and your plan," she said. "Some plans have a grace period that lets you cover expenses after the first of the year, but others do not. You don't want to leave money on the table."

Avoid penalties

Lastly, if you claim Social Security, realized significant capital gains, own rental properties or are self-employed, it's important to ensure you've paid enough quarterly taxes this year to avoid an underpayment penalty, said Scanlon.

The IRS has a safe harbor rule that helps taxpayers avoid a penalty.

To qualify, the total of your withholding and estimated tax payments must be at least as much as your 2013 tax, you must have paid all required estimated tax payments on time, and the tax balance due on your 2014 return must be no more than 10 percent of your total 2014 tax.

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High-income earners have a different threshold. If your 2013 adjusted gross income was more than $150,000, or $75,000 for married filing separately, you must pay the smaller of two amounts—either 90 percent of your expected tax for 2014 or 110 percent of the tax shown on your 2013 return—to avoid an estimated tax penalty.

A little year-end tax planning goes a long way toward maximizing your take-home pay.

By projecting your annual income, you'll be far better positioned to manage your tax liability and take advantage of valuable deductions that might otherwise be overlooked.