In the midst of holiday celebrations with family and friends, it’s easy to forget that tax time is just a quarter away. There are steps you can take before the year ends to minimize your tax bill. If you have some down time, it’s never too early to gather receipts for tax deductible expenses and consider just what your upcoming tax picture might look like. The earlier you organize, the better positioned you will be to make the most effective decision on these tax-saving strategies:
Defer income: If you will earn a year-end bonus, this extra money could bump you up to another tax bracket and increase your tax liability. Sometimes companies will agree to make these payments in January rather than December. If you have freelance income, you might decide to hold December invoices until January. Therefore, you need to check where you are in your bracket and take the appropriate action.
Accelerate deductions: If make an extra mortgage payment by December 31, you can claim that additional tax deduction on this year’s taxes, potentially reducing your tax liability.
Donate goods to charity: Clean out your closets and give clothes and household items giving to those in need. These donations are tax deductible, but you need a receipt for anything over $250. If you volunteer at a qualified charitable organization, you can’t charge for your time, but you can deduct your mileage. And if you make a donation by credit card by December 31, you can deduct that in 2016 even if you don’t pay the bill until January.
Max out your 401(k) contributions: Your pre-tax contributions to a traditional 401(k), 403(b), or similar workplace retirement plan reduce your taxes by the amount of your total contribution for the year, times your marginal tax rate. You have until December 30, 2016, to make the contribution count for this year and the maximum you can contribute for 2016 is $18,000. If you’re age 50 or older, you can contribute an extra $6,000 via the catch-up, for a maximum contribution of $24,000.
Individual Retirement Accounts (IRAs) and the Simplified Employee Pension (SEP) IRA for the self-employed offer similar tax breaks to a 401(k). However, you have until April 15, 2017, to make a contribution and apply it to your 2016 tax return. The maximum IRA contribution for 2016 is $5,500 for those under age 50 and $6,500 for those 50 and older. SEP contributions by self-employed individuals are limited to $53,000 or 25% of eligible income, whichever is less.
Harvest portfolio losses: If you have investments in your portfolio that have gone down in value, you can sell those positions and record those losses to offset investment gains elsewhere in your portfolio. If you have offset all gains and still have losses, you can offset $3,000 of your ordinary income. Losses beyond that can be carried over to the next tax year. Because this process is governed by the IRS’ Wash Sale Rule, it’s best to consult with your tax advisor before harvesting losses.
Consider a qualified charitable distribution (QCD): If you want to donate to charity and you’re 70½ or older, you can make a direct transfer of funds from your IRA custodian, payable to a qualified charity. This counts toward your RMD for the year, up to $100,000, but it is not included in your gross income and does not count against the limits on deductions for charitable contributions. Here, too, the rules are complex, so consult your tax advisor.
Plan ahead with a big picture view: Perhaps most importantly, whether you’re taking additional deductions, deferring income, or making charitable contributions, your 2016 tax strategy cannot exist in a vacuum. The best decisions are made with a multi-year view. For example, you need to factor in if your income will in increase or decrease next year, what expenses you have coming up and how far away you are from taking Required Minimum Distributions (RMDs) from your retirement accounts.
Happy Holidays and follow the advice of Judge Learned Hand who said “Anyone may arrange his affairs so that his taxes shall be as low as possible.”