Editors' pick: Originally published Nov. 1.
Well, it's the fourth quarter -- which makes your 2016 tax bill look a lot less abstract and a lot more imminent.
We know that New Year's Day is still two months down the calendar, but financial advisors want to remind you that it's coming up a lot sooner than you think. That said, this is a great time to make year-end tax moves and reduce what you owe the folks at the Internal Revenue Service. If it can put more money in your pocket, why not give it a shot?
"As we enter the end of the year, taxes are on many of our clients' minds," says Mike Lynch, vice president of strategic markets at Hartford Funds. "We encourage reps and clients to think about this all year long, so that we aren't scrambling at the end of the year by discussing being tax diversified."
Rebecca Pavese, a certified public accountant, financial planner and portfolio manager with Palisades Hudson Financial Group's office in Atlanta says that calculating your income, tax payments and deductions to date, and estimating your totals for 2016 is a good start.
"You need this baseline information before making any moves," she says.
Once you've done that, the easiest way to save is by reducing your taxable income. Bankrate.com's Kay Bell notes that boosting your retirement savings can be particularly helpful. If you haven't made your maximum $18,000 contribution to your 401(k) ($24,000 for people age 50 or older) or $5,500 contribution for an IRA ($6,500 for people age 50+), now is the time.
"If your employer permits you to make extra contributions to your 401(k), put in as much as you can afford," says Bill Ringham, vice president and senior wealth strategist at RBC Wealth Management. "You typically contribute pretax dollars, so the more you invest, the lower your taxable income. Your earnings also grow on a tax-deferred basis."
If your per-paycheck contributions are not enough to hit the contribution limit for the year, Pavese says you can ask your employer to deduct a one-time lump sum for your 401(k) or IRA to catch up. At a minimum, 401(k) plan participants should contribute enough to take full advantage of any company matching.
You're basically trying to reduce your adjusted gross income (AGI) -- taxable income -- by any means necessary. That makes it a good idea to increase up your "above the line" deductions across the board. Those include IRA and 401(k) contributions, but also health savings account contributions. For that reason, if you haven't taken advantage of your flexible spending account for health care, now is a great time to schedule doctor's appointments or buy eligible supplies ranging from glasses to knee braces to cold medicine.
Why? Well, if you can hold your adjusted gross income to $74,900 for a married couple filing jointly or $37,450 for a single filer, you will pay 0% tax on sales of assets you've held longer than one year and 0% on dividends. Even if you can't get your AGI that low, you may be able to step down to the next lowest capital gains tax rate. Since many deductions are calculated by your adjusted gross income, knocking it down can make those less daunting.
"Unreimbursed medical expenses can only be deducted if they exceed 10% of AGI, for example," Pavese says. "On the other hand, if you expect to be in a higher tax bracket next year than you are this year, deferring deductions where possible can potentially help you pay less tax in the long run."
In fact, there are a whole lot of work-related moves you can make beyond your company's retirement plan. Pavese notes that even the amount you're paying the IRS throughout the year requires routine maintenance. Even if you've adjusted your withholding for 2016, just make make sure the IRS is getting a big enough cut to keep them from looking for more.
"If you adjusted your tax withholding during the year in order to keep a cash buffer on hand, make sure you haven't fallen short of meeting your obligations for the year," Pavese says. "If necessary, adjust your December withholding, which may help eliminate the prospect of estimated tax penalties and interest. You can adjust your withholding by submitting a new W-4 form to your employer."
Beyond that, your broader investment portfolio may hold some savings. The Hartford Fund's Lynch notes that selling out of a fund or stock by the year's end can help diversify holdings and, at the very least, can give you a loss to deduct.
"Is this a long-term investment or something I might be better off without and no longer fits my long-term needs?" he says. "Can I take advantage of a loss, or do I already have a prior loss in something that I can take advantage of? These exact questions should be covered with both tax and financial professionals."
Those losses can eventually add up to big savings. If you're attentive enough to recognize your losses on a yearly basis, loss selling can help you whittle down future tax hits even if you're not particularly worried about this year's numbers.
"Simply put, tax loss selling is a strategy to minimize capital gains on one asset by realizing a loss to offset it," Pavese says. "You can also carry tax losses forward indefinitely, so if you don't end up needing to offset capital gains right away, you can use the loss to offset a gain in a future year."
That makes this a great time to assess your 2016 investments and pick out the losers that can minimize or eliminate capital gains on various assets through dollar-to-dollar offsets. For example, if you've had $5,000 of capital gains on one asset and $5,000 of capital losses on another, that can wipe out your tax hit completely.
The best part is that you can carry those tax losses forward indefinitely. If you don't need those losses to offset capital gains right away, you can use the excess loss to offset gains in a future year. That's particularly helpful since net capital losses (capital losses minus capital gains) can only be deducted up to a maximum of $3,000 in a given tax year. Any losses beyond $3,000 must be carried over, which also makes it worth your while to consider putting off selling some of your "winners" until next year."
"Capital gains can increase your adjusted gross income — and, consequently, your tax bill," Ringham says. "So if you are considering selling an asset that has increased in value, such as a stock, you may want to wait until January so the gain will be realized next year."
If you're in a really desperate situation, there's also a chance you can just give some of those investments away. Highly appreciated stocks or mutual funds you've owned for more than one year can go directly to a charity, so if you've purchased shares for $1,000 and they are now worth $10,000, giving those share to a qualified charity would give someone in the 28% tax bracket a $2,800 tax deduction, based on the current market value of the donated shares.
"You benefit three ways," Pavese says. "First, you're doing good. Second, you won't pay the capital gains tax you'd owe if you sold the security instead. And third, you'll get a deduction if you itemize."
Other charitable donations can help offset your gains as well, but keep in mind that just about everyone has this idea and waits until about December to do something about it. Taking care of it earlier is far wiser. Lynch notes that many of his clients wait until this time of year to make their charitable donations, but that it pays to consider who you want to donate to early on -- and where to keep the documentation once you've made those donations.
"Keeping inventory of donations should ideally be done throughout the year, but for those of us that may have given goods or money early in the year, tracking the receipts can be difficult," Lynch says. "Now might be time to look at the junk drawer, that drawer in the corner of the kitchen where old receipts go to die. Make a folder and start putting those receipts in it."
Also, if you're over 70.5 years old and have an IRA account, you're going to have to make your required minimum distribution before the end of the year to avoid penalties. However, if that's going to put you in straits with the IRS, Lynch says you may want to see if you can give your required minimum distribution directly to the charity of your choice. If you're out of charitable options however, just remember that some gifts to your family can be just as beneficial to your taxes as a charitable donation.
"We like to remind clients of the gift tax exclusion: You can give $14,000 per donor without incurring a gift tax," says Mike Greenwald, partner at Friedman, LLP. "If you want to give money to your kids or you're fortunate enough to have rich kids who want to give money to their parents, you want to make sure you don't miss that at the end of the year because you can't use this year's exclusion next year."
That's not the only way to make your children's welfare work in your favor. Ringham also notes that 529 plan contributions are tax deductible in several states, so contributing to your kid's college fund will allow your earnings grow tax-free, provided they are used for qualified higher education expenses. Just make sure it's going toward college, however, as distributions not used for qualified expenses may be subject to income tax and a 10% penalty.
When your holiday gift and charity list is complete, start looking for deductions under your own roof. Bankrate's Bell suggests homeowners submit January mortgage payment and property taxes by December 31 so they can deduct the interest in 2016. If that still can't prevent you from taking a hit in 2016, now is the time to start banking deductions for 2017. Pavese suggests that, instead of paying your estimated quarterly state income tax by December 31 and deducting it on your 2016 return, you can pay it between January 1 and 15 and get a 2017 deduction. Also, if an additional deduction would trigger alternative minimum tax (AMT), pay your fourth-quarter state income tax and/or real estate tax installment in January."If your bracket will go up next year, consider deferring certain deductions, such as state taxes and real estate taxes," Pavese says. "The higher your bracket, the more the same deduction can save you."