Editor's Note: This article is part of our 2013 Tax Tips series. Robert Flach is an expert with almost 40 years of experience as a tax professional and also blogs as The Wandering Tax Pro.
NEW YORK (MainStreet) — While the average taxpayer tends to avoid thinking about taxes until the approaching April 15 deadline forces him to, once the ball drops in Times Square at midnight on December 31 and the New Year is rung in, there is very little that can be done to cut your 2013 tax bill.
But during the last two months of the year you can do a great deal to reduce your liability.
Sit down with paper and pencil, and list your taxable income and allowable deductions to date. Using your 2012 return as a guide, prepare a projected 2013 tax return. From this beginning, you can decide what steps to take to make sure you pay the absolute least amount of federal, state and local income tax for 2013.
Before I begin let me point out some important items that you should keep in mind -
- There are no year-end tax planning strategies that apply to all taxpayers in all cases. Year-end actions must be evaluated in the context of the facts and circumstances of your individual situation.
- You must consider the state and local tax consequences of your year-end actions. And also beware of the Alternative Minimum Tax (AMT). While a year-end strategy may reduce your "regular" federal income tax for 2011, it may end up costing you additional state income taxes or make you fall victim to AMT.
- Your first criteria for evaluating any financial transaction you are considering should always be economic. Tax considerations should come second.
- Be sure to review your year-end situation with your tax professional before taking any actions.
THE GENERAL RULE
Traditional year-end planning calls for postponing the receipt of taxable income until 2014 and accelerating allowable deductions to be claimed in 2013. This strategy will generally apply if you expect to be in the same tax bracket for both 2013 and 2014, or if you expect to be in a lower bracket in 2014.
If you anticipate a substantial jump in income in 2014, which may push you into a higher bracket, you should do the reverse and accelerate the receipt of taxable income for 2013 and postpone deductible expenses until next year. Income will be taxed at a lower rate in 2013, and deductions claimed in 2014 will yield a greater tax savings.
Unfortunately we can only guess at what the Tax Code will look like for 2014. We do know that several temporary tax benefits are scheduled expire on December 31, 2013. There has been talk of Congress addressing tax reform before year-end, and in the process taking away or limiting tax deductions and credits and lowering rates. But Congress has not been able to accomplish anything lately, so the deductions, credits and rates for 2014 are up in the air.
The usual advice in such a situation is "when in doubt, defer." Postpone income and accelerate expenses.
TIMING OF DEDUCTIONS
It does not pay to itemize on Schedule A unless your total deductions exceed the Standard Deduction that applies to your filing status, plus any additions for age or blindness.
For 2013, standard deduction is $6,100 for Single filers and married couples filing separately, $8,950 for Head of Household, and $12,200 for Married Filing Joint and Qualifying Widow(er). The additional Standard Deduction amounts for age 65 or older and/or blind are $1,500 for Single and Head of Household and $1,250 for married (joint and separate) filers and Qualifying Widow(er).
If you usually do not have enough deductions to itemize, but after preparing your projected 2013 return discover you will be able to do so this year, you should incur, and pay for, as many deductible expenses as possible during these last two months of the year.
But if your projected return indicates that you don't have anywhere near enough deductions to provide a tax benefit from itemizing, postpone making any deductible payments until 2014. Making these payments in 2013 would not produce any tax savings, but it is possible that by deferring them until next year you may be able to itemize in 2014.
If you itemize every year I would recommend accelerating deductions. As mentioned above, we do not know if all the current itemized deductions available for 2013 will still be allowed on the 2014 Schedule A.
If you expect to be able to itemize for 2013--and you will elect to deduct state and local income taxes, and you are making quarterly estimated state tax payments, and you will not be subject to Alternative Minimum Tax--make the 4th-quarter estimated state tax payment in December instead of waiting until the January 15, 2014 due date so you will be able to deduct the payment on your 2013 Schedule A.
One of the temporary tax benefits that are scheduled to expire in 2013 is the option deduct state and local general sales taxes instead of state and local income taxes. If you are planning to buy a new car soon you may want to do it before the end of 2013, if adding the sales tax on the auto purchase to the sales tax amount allowed in the IRS Optional Tables will result in a greater deduction than claiming state and local income taxes.
If you do not have the cash available to pay for deductible items that you have scheduled as part of your year-end tax plan you can use a credit card and still claim a deduction in 2013. Allowable expenses charged to a credit card are deductible in the year charged, and not in the year that you actually pay for the charge.
The timing of deductions is especially important when it comes to medical expenses and miscellaneous job-related and investment expenses. You are allowed to deduct medical expenses only if they exceed 10% of your Adjusted Gross Income (AGI), 7.5% for taxpayers age 65 and older, and most miscellaneous deductions are only deductible when the total exceeds 2% of AGI.
If you anticipate an AGI of $70,000 you must exclude the first $7,000 of medical expenses. If your medical expenses to date are close to or more than $7,000 and you will be able to itemize this year, pay any outstanding medical bills and schedule (and pay for) check-ups, doctor visits and needed dental work in November and December. If your medical payments to date are substantially less than $7,000, put off paying any more medical bills until 2014. The same concept applies for miscellaneous deductions.
CAPITAL GAINS AND LOSSES
When preparing your projected return you should review the performance of your investment portfolio for the year. Add up all of your realized gains and losses from actual sales for the first 10 months of the year, with separate net totals for short-term (held one year or less) and long-term (held more than one year) activity. Gains and losses from the sale of inherited property are considered long-term, as are any "capital gain distributions" from mutual funds.
Do a similar calculation for unrealized "paper" gains and losses on the investments you still hold. You may want to sell something before the end of the year at a loss to wipe out year-to-date gains, or at a profit to offset year-to-date losses in excess of the $3,000 maximum you are allowed to claim.
Be aware of the wash sale rule. You cannot claim a current loss for the sale of an investment if you purchase the same, or "substantially identical," investment within 30 days before or after the date of the sale. This does not apply if the sale results in a gain.
The deduction and credits for post-secondary education costs are based on expenses paid in 2013 for courses taken this year or that will begin during the first three months of next year. You can prepay the Spring 2014 tuition and fees before the end this year and use the payment toward a 2013 deduction or credit.
The expense and other limitations and the AGI thresholds differ for each education tax benefit. If qualified expenses paid in 2013 already exceed the $4,000 or $10,000 maximums you may want to wait until January 2014 to pay for the Spring 2014 semester. You also may want to wait until next year to pay the Spring 2014 semester charges if the qualifying student will be graduating in 2014 so you can get a tax benefit on the 2014 return.
FYI, the above-the-line deduction for tuition and fees is another of the temporary tax benefits that will expire on December 31, 2013.
See my MainStreet.com article "Your College Expenses Can Pay a Little Back" to review the various deductions and credits for college costs.
ENERGY SAVING PURCHASES
The $500 lifetime maximum credit for qualified energy efficient improvements to a taxpayer's principal residence is also scheduled to expire on December 31, 2013. If you have not claimed the maximum credit in prior years you should consider making improvements or purchases in November or December.
See my MainStreet.com article "The Energy Credit is Still Here for 2013."
--Written by Robert D. Flach for MainStreet