A challenge in tax planning is that you don't know what Congress will do with taxes in the future. Its hard to say what taxes will look like for 2015 when we weren't sure what taxes would look like for 2014 until yesterday (with 2 weeks left in the year!) Congress renewed a series of extenders (tax breaks) for a one year term yet again - ensuring very little change from last year. The items which didn't make the cut don't affect the individual or the average small business.
One new interesting provision is in place - ABLE accounts. These will work like 529 accounts for expenses for qualified disabled individuals. Contributions will not be deductible, but the accounts can grow tax-free if used for qualified expenses.
Last week I talked about tax planning when income is the same or higher than usual. This week i'll focus on what to do when income is lower than normal. Why do anything if your taxes will already be low? Well, you may be able to save a lot of money in the long-run if you are thinking beyond this year. You may be able to take advantage of 0% or 15% rates instead of 28-39.5% in the future.
Step 1: Know your tax position: Sound familiar? see part 1 to familiarize yourself with this step.
Step 2: Take Action. If this year's income is low: There are options to shift some of your income or expenses, or roll over IRAs.
Shift income into the current year, and delay expenses - If you recognize income in December instead of January, you have changed your tax position. Likewise, you may be able to make a deductible expense payment in January instead of December.
Consider selling some of your appreciated stock - If you are married and make less than 72k, capital gains are now at 0%. This may be chance for you to recognize some of your gain. Rates may not be this low forever.
Sell IRAs or Roll IRAs into Roth IRAs - By rolling over your IRA into a Roth IRA, you will recognize income in the current year, but the money will not be taxed again. This is perhaps the easiest way to recognize income sooner.
I have a successful client who decided to take 2014 off and live in Paris. Without the day job, her income is way down, so she is rolling some of her IRA into a Roth IRA this year, taking advantage of the low rates.
Another client is elderly and in a nursing home, but with large IRAs. Rather than just taking out the required minimum amount, he is withdrawing larger amounts each year, so they can be taxed at his low rate. His children will inherit cash rather than an IRA being taxed at 28% to them.
Summary: Effective tax planning involves taking into account your current tax position, where you may be in the future, and possible changes you can make. Every tax situation is unique. The tax code is littered with limitation and exceptions, but these basic concepts will help over time. If you want to find out just how much you can save, talk to your tax specialist.
Year-end tax planning is not just reserved for the wealthy. Most of us could benefit from a little year-end planning. I’ll review the concept at a high level and give you a few ideas to bring to your accountant or do yourself. December is a good time to evaluate your tax position and make adjustments. Aside from the suggestions below, you can work with an accountant in December to make sure you have paid in enough tax during the year to cover your liability. You can’t take any one of these suggestions individually – you need to think about how each one affects your whole tax picture.
Step 1: Know your tax position. Basic tax planning is about paying less tax in the long run, not over a single year. Before year-end, try to gauge whether your income is the same, higher, or lower than upcoming years. You are better off planning around your income than trying to guess at future tax legislation – as of the date of this post, tax extenders for the current year haven’t even been passed.
Step 2: Take action. If your income is the same or higher than normal: You don’t really want to earn less money, of course. You can make some of your income tax-deferred, or you may be able to change the timing of your income and expenses if your job is flexible or you are self-employed.
Defer taxable income – Maximize your IRA and 401k or SEP accounts. I’ll cover these in more detail in future posts. These accounts essentially move your current income out of this year into a future year when you are retired.
Delay income – This is a bit easier if you are self-employed. If you have the option to receive payment in December or January, think about your tax position and receive the payment in January if it makes sense to move the income into another tax year.
Accelerate expenses – Business expenses, medical expenses, and other deductible expenses are recorded on the tax return in the year you pay them. This gives you the flexibility to reduce your income by paying expenses earlier. In California, property tax is a good example. You can pay both halves of your property tax payment in December, rather than in December and April. Then, if you need to delay expenses in another year, you can split them up again.
Give to charity – This is recorded on the tax return as an itemized deduction. You can time your gift to offset high income. As I do every year before the holidays, I just donated old toys today to make some room.
Harvest capital losses – If you have high capital gains, you may want to sell stocks with losses to offset some of these gains.
If your income is lower than normal – stay tuned – that will be the topic of my next post.