With a little over two months left before year-end, the window is closing to address your taxes for 2016. Too often, tax payers take the time to review their tax picture in February or March of the following year - usually after it is too late to do something about it. Instead, consider using the 4th quarter of this year as a time for last minute strategic year-end tax planning. The strategies noted below may help you address your tax situation while you still have time to reduce tax liability.
Bunch itemized deductions
Many deductions go unclaimed each year due to taxpayers missing certain adjusted gross income(AGI) thresholds. For example, medical expenses can be deducted if they exceed 10 percent of your AGI for those younger than 65 and 7.5 percent for taxpayers age 65 and older. While you should never delay time sensitive medical care, it may be beneficial to bunch or group non-urgent medical procedures in the same tax year to improve your chances of hitting certain thresholds. The same may be true for the 2 percent threshold for miscellaneous expenses such as professional fees (legal and tax planning), unreimbursed business expenses and investment advisory fees. Bunching deductions in the same tax year may help improve your chances of maximizing deductions.
Review tax withholdings
Did you experience an increase in income or a decrease in deductions this year without reviewing and adjusting your tax withholdings? If so, you may be setting yourself up for an underpayment penalty surprise from the IRS. The good news is that this may be avoidable by simply reviewing your income and estimated tax with your CPA tax professional throughout the year. Doing so may help ensure you are properly withholding while also reducing the chances of penalties and interest from Uncle Sam.
Depending on your circumstances, estimated payments of 110 percent of the prior year tax liability may be necessary to avoid underpayment penalties. Consider reviewing Publication 505, Tax Withholding and Estimated Tax, for more information.
Take Required Minimum Distributions (RMDs)
The IRS requires most taxpayers that reach age 70 ½ to take Required Minimum Distributions (RMDs) by December 31 of that year. (One exception is if your retirement funds are in a 401(k) with an employer you still work for.) First year RMDs offer taxpayers some flexibility as the first payment can be delayed until April 1 of the year following the year in which you turn age 70½ if you choose. Keep in mind, this approach will result in two RMDs being withdrawn in one year. However, it can be useful for taxpayers that expect to be in a significantly lower tax bracket the year after they turn age 70 ½.
Taxpayers that inherited a traditional IRA must also take RMDs each year based upon their life expectancy. So why is taking your RMD on time so important? For starters, the IRS may hit delinquent retirement account holders that miss their distribution with a hefty 50 percent penalty on the amount of the RMD that should have been taken. That’s right – 50 percent of the RMD amount. In the event that an RMD is missed, consider filing Form 5329, with your federal tax return for the year in which the full amount of the RMD was not taken as it may be possible to waive the penalty due to a reasonable error. Consult with your CPA and Publication 590-B for additional information.
Accelerate deductions/boost income
Depending on your situation, accelerating or deferring income and deductions that you may be able to control can be beneficial. For example, deferring higher than usual self-employment income or bonuses until the following year may help smooth income and tax liability. In addition, accelerating the payment of state and local income taxes, interest payments, real estate taxes or other deductible payments may help you reduce your taxes if income is higher than expected or you underpaid estimated taxes through the year. Either way, adjusting the aspects of your taxable income and deductions can help you strategically plan prior to year-end.
Review retirement plan contributions
The 4th quarter is also an appropriate time to review year-to-date retirement plan contributions. For 2016, taxpayers can save up to $18,000 in their 401(k) plan and those over the age of 50 can add another $6,000 for a total of up to $24,000. Unfortunately, many taxpayers under-withhold and do not catch it until after year-end. Consider reviewing contributions and making adjustments in the final two months of the year to maximize deductions.
While pre-tax contributions will reduce taxable income for 2016, after-tax Roth 401(k) contributions may be more advantageous depending on your circumstances. Remember, 401(k)s generally must be funded by December 31.
Increase charitable donations
Making charitable contributions is mutually beneficial way to help organizations you care deeply for while also reducing tax liability. Too often, taxpayers make donations to charities but fail to properly account for the donation. In order to properly claim the deduction, you must file form 1040, itemize your deductions and donate to a qualified charity.
It is critical to maintain detailed records that substantiate the contributions. For example, Donations of cash or property in the amount $250 or more require a written statement from the organization with a description of the donation amount. Alternatively, donations of noncash gifts greater than $500 require the filing of Form 8283 - Noncash Charitable Contributions.
Taxpayers in the highest tax brackets may want to focus on donating highly appreciated assets as it also allows the taxpayer to give away the taxable gain too. Donating appreciated stock held for greater than one year can be great way of maximizing a charitable deduction while sidestepping capitals gains taxes. Remember, donating appreciated assets held for less than one year may result in your deduction being limited to the original cost or investment so take special care.
Year-end tax planning can be an effective way of gaining clarity on tax situation while taking steps to reduce your tax liability while you still have the opportunity to do so. Since everyone’s situation is unique, consider speaking to your financial and tax advisers to determine the most appropriate tax strategies for you.
Kurt J. Rossi, MBA is a Certified Financial Planner Practitioner & Wealth Advisor. He can be reached for questions at 732-280-7550732-280-7550, kurt.rossi@Independentwm.com, www.Independentwm.com and www.bringyourfinancestolife.com - LPL Financial Member FINRA/SIPC.