Smart strategies that may save you money and make it less stressful at tax-filing time.
Procrastination rarely pays. That’s particularly true when it comes to taxes. Since most tax-smart strategies take time to implement and come with a December 31 deadline, an early start can save you money and stress. Wouldn’t you rather be enjoying the December holidays than scrambling to meet a tax deadline?
Many of the smart tax moves for 2014 are familiar ones—such as contributing to tax-advantaged retirement plans and increasing deductions—but there are a few new twists. The Affordable Care Act (ACA), for example, has tax implications for some people, as does the legal recognition of same-sex marriages. Also, Congress hasn’t renewed several popular deductions, which could affect your year-end tax-planning decisions. The sales tax deduction, and the ability for people over age 70½ to give required IRA distributions directly to a charity and save on taxes, are two examples.
“Regardless of your income or tax situation, one rule applies to everyone,” says Mark Luscombe, principal federal tax analyst for accounting research and software provider Wolters Kluwer, CCH. “The sooner you get started, the more effective you can be in managing your taxes.”
Here are 12 tips to get you started.
1) Contribute to a tax-advantaged savings plan.
Contributing to a 401(k) or an IRA may be the smartest tax move that most taxpayers can make. Not only does it reduce your taxable income for the current tax year and allow your potential earnings to grow on a tax-deferred basis, it also helps get you closer to achieving your retirement savings goal. Contributions to your 401(k), 403(b), or similar workplace retirement plan must be made by December 31, 2014, to impact your 2014 taxes, so you need to act quickly to increase your deferral. The 2014 401(k) contribution limit is $17,500 ($23,000 for people age 50 or older). With an IRA, you have until April 15, 2015, to make a 2014 tax-deductible contribution1 of up to $5,500 ($6,500 if you’re age 50 or older).
Other possibilities for tax-advantaged plan contributions are a Simplified Employee Pension plan (SEP), for self-employed individuals, or a Health Savings AccountLog In Required (HSA). Contributions to either of these plans can be made up until April 15 and still apply to 2014
2) Adjust your withholding.
Ideally, the amount of money withheld from your paycheck or sent to the IRS in quarterly payments should come very close to your actual tax liability. Withhold too little and you could have a big tax bill when you file your return. Withhold too much and you’re giving the IRS what amounts to a tax-free loan of money that you could be using to pay down debt or save for retirement (and, potentially, reduce your taxes).
There’s still time to adjust your withholding for 2014 by making changes to the W-4 you have on file with your employer, or, if you make quarterly payments, by increasing or decreasing your payments between now and when the last 2014 payment is due in January. Keep in mind that the longer you wait, the fewer pay periods you’ll have to reach your target. To learn more about how to adjust your withholding, read Viewpoints: “Are you giving the IRS an interest-free loan?Log In Required”
3) “Harvest” your investment losses.
If you have capital gains outside of your retirement accounts, you may be able to lower your tax liability through tax-loss harvesting. That simply means selling losing investments that no longer fit your investing strategy and using the loss as a write-off against some or all of your gains. If you employ a tax-loss harvesting strategy, you must be aware of the wash-sale rule that disallows the write-off if you purchase substantially the same investment 30 days before or after the loss sale. Viewpoints “Tackle taxes: Got gains or losses?Log In Required” explains in more detail how tax-loss harvesting works.
4) Contribute to charity.
Contributing to charitable causes before the end of the year is a tried-and-true tax-reduction strategy. But remember to get a receipt for every contribution you make, not just those over $250. Also, if you want to be more strategic, you could open a donor-advised fund, which offers several advantages for managing your charitable-giving activity. You could, for example, contribute a lump sum to the fund before December 31, take the entire deduction on your 2014 tax return, and then instruct the fund to use the money to make next year’s gifts.
One strategy that offers two tax benefits is donating appreciated securities, such as stocks or bonds, to charity. The tax code allows you to use the current market value of the asset as a deduction without having to pay tax on the capital appreciation, so you get the charitable contribution deduction and avoid capital gains tax. ReadViewpoints: “Planning your year-end charitable giving.Log In Required”
5) Use your annual gift tax exemption.
An individual can give up to $14,000 a year to as many people as you choose ($28,000 if you and your spouse both make gifts) to help reduce the amount of your estate and help reduce or avoid federal gift and estate taxes. This may include cash, stocks, bonds, and portions of real estate. However, anything above $14,000 per person per year may be subject to gift taxes, so it’s important to keep track of this information. For more information, speak with your tax adviser and review IRS Publication 559, Survivors, Executors, and Administrators.
If you would like to contribute money toward a child’s education, consider a 529 plan account. Contributions are generally considered to be removed from your estate. You can also make a payment directly to an educational institution and pay no gift tax.
6) Accelerate deductions.
In addition to charitable contributions, other types of deductions offer some flexibility. If you make estimated state or local tax payments, for example, you could send in the January payment before the end of this year. And maybe you could do the same with a property tax bill that’s due near the beginning of the next year. Other possibilities include accelerating payments for medical services or purchasing work-related items, such as uniforms, for which you are not reimbursed. Recognize, however, that increasing your tax deductions only makes sense if you have enough of them to exceed the standard deduction of $6,200 for single taxpayers, $12,400 for married couples filing jointly, and $9,100 for heads of household.
7) Beware of deduction limitations.
Thresholds and limits apply to many types of deductions, including medical expenses and charitable contributions, which could lower or even eliminate your deductions. If you’re a high earner, another concern is the Pease limitation, which affects single taxpayers with taxable income of $254,200 or more, and married couples filing jointly with income above $305,050. Finally, if you’ve been subject to the alternative minimum tax (AMT) in the past or think you might be this year, you should reevaluate your itemized deduction strategy. Under the AMT, many deductions are disallowed. Read Viewpoints: “The AMT and you.Log In Required“
8) Defer income.
On the flip side of accelerating deductions is deferring income. Not everyone has the option to push income into next year, but if you can, you might consider doing it. This may also keep your income below the level that would subject you to the net investment income tax this year. But take into account what you expect your tax situation to be next year. If you anticipate earning significantly more next year and moving up a tax bracket, deferring income might not make sense for you.
9) If you’re a same-sex couple, evaluate your options.
The legal status of same-sex marriage has changed greatly over the past couple of years and continues to be affected by judicial and administrative rulings. In general, however, legally recognized same-sex married couples now have the option to jointly file federal income taxes and, in many cases, state income taxes. If you’re in this group, you may have new possibilities for managing your tax situation, the benefits and drawbacks of which will vary from couple to couple. If you think you might file jointly for the first time with your 2014 return, you should evaluate your situation before the end of the year to optimize your tax strategies. Unless you’re well versed in tax regulations, you should consult a tax professional—preferably one with expertise in same-sex marriage law—about the strategies that are right for your situation.
10) Know your flexible spending account (FSA).
The standard advice for people with an FSA at work used to be to spend the money on medical expenses before the end of the year or lose the balance. A change in the law, however, now allows employers to offer either a 2½-month grace period to use up the money for the previous year or a $500 carryover per year to use in the following year. The new flexibility isn’t automatic, so make sure you know the rules for your employer’s plan, or you will run the risk of losing some of the money you deferred into an FSA.
11) Get health insurance or face a penalty.
The Affordable Care Act (ACA) requires every individual, with some exceptions, to have qualifying health insurance coverage in 2014 or owe an “individual responsibility payment” of the greater of 1% of household income above the income tax filing threshold ($10,150 for an individual) or a flat amount of $95 for an adult and $47.50 per child under age 18, up to a maximum of $285. The payment will be due with your 2014 tax return. If you’re uninsured for just part of the year, 1/12 of the yearly penalty applies to each month you’re uninsured. If you’re uninsured for less than three months, you don’t have to make a payment.
12) Watch for last-minute Congressional action.
Several popular tax breaks that expired this year have yet to be reinstated by Congress. Among the most significant is the sales-tax deduction, which gave taxpayers in states with low or no income tax the option of deducting state and local sales tax instead of income tax. If you live in one of those states and were planning to accelerate a large purchase before the end of the year—a car or a boat, for example—to take advantage of the sales tax deduction, you might hold off to see what Congress plans to do. Other tax breaks that are up in the air are those for certain unreimbursed teachers’ expenses, tuition, mortgage insurance premiums, exclusion of employer-provided mass transit and parking benefits, and exclusion for debt forgiveness on foreclosed homes.
Twelve tips aren’t enough? Here’s one more as a bonus: Start now to manage your 2014 tax bill and to begin putting in place longer-term strategies for 2015 and beyond. Early tax planning is always smart tax planning.
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