Minimize This Year’s Tax Bill
Christopher R. Wills, CPA, CFA, CFP®
Director of Wealth Management
Paying taxes is part of life in the United States. While there’s no way to completely avoid taxes, smart planning can help you minimize what you owe. Generally, there are two strategies for minimizing your tax bill: delaying income or increasing your deductions and credits. A good tax plan takes advantage of both methods. If you’re interested in minimizing this year’s tax bill, here are a few options to consider.
Maximize Retirement Contributions
One way to reduce your current income is to save more through your qualified retirement accounts, such as a 401(k) or an IRA. The IRS offers a tax deduction for contributions to many of these accounts. Doing this gives you a chance to both save money for the future while also reducing your taxable income for the year. The amount you can put away this year depends on what type of account you are using. Work-sponsored retirement plans use a set formula to determine exactly how much of your income you can save and deduct per year. If you don’t have a qualified plan at work, you could use a Traditional IRA. As of 2013, you can invest and deduct up to $5,500 a year for this account if you are younger than 50 and up to $6,500 if you are 50 or older. If you are married, your spouse can also contribute and deduct the same amount.
Contributing money to your retirement accounts can be a solid way to reduce your tax bill, but just be sure you won’t need the money until retirement. In exchange for this deduction, retirement accounts generally restrict access to this money until you turn 59 1/2.
The home mortgage interest tax deduction is very popular because it encourages home ownership across the United States. You can deduct the interest you pay on the mortgage for your personal residence for a loan up to $1 million. You are likely already taking advantage of this deduction, but you need to be careful that your final payment of the year goes through on time, especially if you pay near the end of the month. If the payment is delayed and doesn’t go through by December 31, you won’t be able to take the deduction for the payment this year.
Deduct Investment Expenses
Your investments might offer another way to reduce your taxes for the year. Take a look at the performance of your investments. Have any of your stocks or bonds lost value since you originally bought them? The IRS offers a tax deduction for capital losses when you sell an asset for a loss. When you take a capital loss, first you can take that loss as a deduction against your taxable investment gains. If you plan right, doing this can help you avoid paying too much in taxes on your investment portfolio. If you’ve lost more in the market this year than you made in gains, you can take up to $3,000 in losses as a deduction against your other income.
To claim a capital loss, you actually need to sell the asset that lost money; you can’t claim a deduction just because your portfolio has become less valuable. After you sell an asset, you can’t buy it back for at least 30 days to claim this deduction. This move makes sense if you no longer want to keep a losing investment, or you can buy a similar asset right away, such as a stock in the same industry. However, you generally don’t want to sell an asset for a loss if you think there’s a good chance it will gain value in the next month.
To help charities raise money, the IRS offers a tax deduction for charitable contributions, which applies when you give money as well as many goods to qualified charities. If you go through your closets this year and donate whatever you can to charity, you could get a surprisingly large deduction. You can’t donate the time you give to a charity though. For example, if you volunteer to build a new table for a charity, you can deduct the cost of any building materials you buy for the job but not the value of your labor. You’ll need to document everything you donate with a photo and an estimate of the current market value, but you don’t need a professional appraisal for an item unless you are donating something worth more than $5,000.
One other useful charitable deduction is the gift of appreciated stock. If you own shares that have gained in value, you can transfer them directly to the charity. This move helps increase your tax savings in two ways. You get a deduction for the full value of the shares but never have to pay taxes on the capital gains. If you sold the stock and donated cash, you would need to pay taxes on your gains first. The opposite strategy makes sense when you want to donate stock that lost money. It’s better to sell the shares, deduct the loss, and then give away the cash from the sale.
The IRS also offers a tax deduction for unreimbursed work expenses, which are out-of-pocket expenses you had to pay for your job that your employer never paid back. These expenses can include paying for licenses, necessary tools and supplies, liability insurance premiums, dues for professional societies, and travel and entertainment expenses.
The deduction for work expenses is part of a group of itemized deductions that are subject to a 2% limit. Tax preparation fees, investment adviser expenses, and expenses for a hobby that earned money are also part of this group. For these expenses to be deductible, they need to exceed 2% of your adjusted gross income. For example, if your adjusted gross income was $200,000 and you had $6,000 of these itemized deductions, your total deduction would be $2,000 ($6,000 ‒ 2% of $200,000 = $2,000).
Defer Income to the Future
If you have some control over when you receive your income, another strategy is to defer income to the following year so that it won’t apply to this year’s tax return. Doing this can work well if you are a business owner and are waiting on some large invoices. You could ask your clients if they would be willing to delay payment until the next year. If you sell services, you could also try to delay a few jobs by a few weeks at the end of the year so that they wouldn’t be part of this year’s tax return. You’ll still have to pay taxes on your income the following year, but this move at least helps reduce your current tax liability.
Work with an Advisor
One last way to minimize your tax bill is to work with a professional financial adviser. It’s tough to keep track of every tax law and deduction. If you try to file without help, you could overlook some ways to save money. A good adviser should have an organized checklist with every relevant deduction that the two of you can review. When you’ve gone through this process once, it will be much easier to file your taxes in the future.
The cost of your financial adviser can also be tax deductible. These expenses count toward the 2% limit of itemized deductions, so if the total of your other expenses is high enough, the cost of your adviser could also be deductible.
Don’t pay any more than you have to on this year’s tax return.
If you would like to discuss comprehensive financial planning with a Senior Wealth Advisor at R.W. Rogé & Company, please call 1-631-218-0077 or visit our website at www.rwroge.com.