It’s time once again to start giving some thought to paying taxes. Who’s excited?
Okay, even though it may feel like a chore it’s wise to do a little analysis at the end of the year to see if there are any year end tax planning moves you need to make.
Remember, corporate returns are due on March 15, 2016. Personal tax returns are due on Monday, April 15, 2016, the last day to file taxes. But you can file your taxes with the IRS as soon as you have them prepared and as soon as they are ready to start taking returns.
But before the year is through, here are some things you can think about doing to decrease the amount of taxes you’ll pay. In a general sense, I like to think about this topic in three ways:
3 Ways to Think About Year End Tax Planning
When it comes to the end of the year, it’s said that you should focus your tax-planning efforts on three main areas: deferring or accelerating revenue, deferring or accelerating expenses, and expiring tax provisions.
Let’s take a look at each one and I’ll follow that up by giving 7 specific examples that I find useful.
Category 1: Deferring (or Accelerating) Revenue
Generally speaking, the more revenue you have, the more taxable income you’ll have, and the more tax you pay. In most cases it doesn’t make sense to purposely reduce your revenue (“I want to earn less”, said no one ever!). But you may want to defer your revenue until next year.
It’s hard for a salaried employee to pull this off, because your employer has all of the control. But you could request that your boss pay you the end of year bonus in January.
If you have taxable investments that have seen positive gains, wait until the new year to sell any off.
If you are a contract employee, or if you have revenue from a small business, you may want to wait to invoice your clients until just before the new year. Doing so would likely delay payment until next year, and thus, reduce your revenue and overall taxes due this year.
Finally, if you’re in retirement and you can manage it, stop taking retirement plan withdrawals from now until January.
Keep in mind, once you start deferring revenue, you’ll have to keep this practice up from year to year, to keep pace (i.e. avoid having 13 months of revenue reported in one tax year).
Category 2: Accelerating (or Deferring) Expenses
Generally speaking, the more deductible expenses you have, the less taxable income you’ll have, and the less tax you will pay. In most cases it doesn’t make sense to increase your expenses just to avoid taxes. But it may make sense to accelerate your expenses (i.e. spend it now vs in the new year).
Remember, it can’t be just any type of expense. It should be tax-deductible expenses. Good examples include: medical expenses, mortgage interest, charitable donations, taxes (property, sales, state, local, etc.), education, job-related expenses, and childcare expenses. Take a look at this tax preparation checklist for more ideas. Don’t forget about taxable investing losses.
To accelerate these expenses, you would simply need to pay them before midnight on December 31. Like revenue, once you start accelerating expenses, you’ll need to keep up this practice from year to year.
Visiting with a tax pro is always wise to help you discover more ways to accelerate expenses.
Category 3: Expiring Provisions
Finally, there are the expiring tax provisions. Just like that last “for sale” item on the retail shelf, expiring tax provisions have a way of encouraging tax payers to act.
When it comes to this category we could be talking about tax rate changes (like we saw last year), changes in limits and deductions or credits, and changes as to what is considered income.
Rather than bore you will all of this year’s expiring tax provisions I’ll just point you to the Joint Committee on Taxation’s Expiring Provisions page.
Okay, so to sum all of this up, when you’re trying to do tax planning at the end of the year, it’s important to focus on three areas: revenue, expenses, and expiring provisions.
Be sure to ask yourself:
- Based on my current situation, is it beneficial and possible to defer or accelerate my revenue?
- Based on my current situation, is it beneficial and possible to defer or accelerate my expenses?
- Are there any expiring tax provisions that I need to take advantage of?
Without further delay, here are my seven specific year end tax strategies and moves you can make to maximize your tax season success.
1. Maxing Out 401K (or 403B) Contributions
This is probably the biggest single move anyone can make at the end of the year to help their tax situation.
Take a look at your last paycheck and see how much you’ve contributed. Compare that to the annual maximum allowable contribution. Make an adjustment to your contribution percentage so that you get as close to the max as you can.
Unlike the rest of these deductions, it doesn’t matter if you think we’ll have higher tax rates next year or not. You only get one shot at the annual maximum. Take advantage.
You should also strive to make maximum contributions to your other retirement (Traditional IRA) and health savings accounts (HSA). But the deadline for those isn’t 12/31. It’s April 15 next year, or your tax filing date. So maybe wait till later to make these contributions.
But remember you’ll need to have the HSA open before the end of the year to qualify for this year’s contributions.
The remainder of these personal deductions are going to depend on if you think tax rates will be higher next year, and/or if you think some deductions are going to go away (i.e. like a cap on charitable deductions).
That said, I do not expect taxes to go down on me anytime soon. The voters have shown they want a bigger entitlement state and there will continue to be pressure to increase taxes to keep up.
When looking at my personal situation, I’m taking as many deductions as I can this year. My business income isn’t guaranteed and it’s constantly fluctuating. I have no idea if I’ll make more or less next year than I did this year.
Additionally, even if rates stay the same for me, some tax deductions may be capped based on my income. So I would want to take as many deductions as I can this year if they are going away for someone at my income level. It’s hard to know what will happen. So I’m following a “take what I can get” strategy.
2. Giving Extra to Your Church and Other Charities.
We try to be better givers throughout the year, but we often find ourselves playing catch-up at the end.
This is not so much the case for this year, but we have at least one more check to write our Church. More places to give: schools, colleges, foundations, charitable organizations, like Habitat for Humanity.
Charitable contributions are deductible if they are made to qualifying organizations. They are reported on the Schedule A.
3. Prepaying January Mortgage Payment
I’ve taken this approach for several years and it’s worked out nicely. The payment you make in January is actually for December interest, so it’s theoretically sound to deduct the interest from this payment in December, as long as you actually pay it then.
By paying it early, my lender should pick up on it and reflect this in my Form 1098, showing the amount of interest I paid for the year. Like property taxes, mortgage interest is deductible on Schedule A.
4. Paying Annual Property Taxes or Sales Taxes Early
These aren’t due until January. But I can pay property taxes now and I’ll be able to deduct them on this year’s return. Property taxes are big in Texas, where we have no state tax. So this is a nice deduction to add to my itemized list on Schedule A.
Here in Texas my property taxes aren’t due until January 31. However, these taxes can be deducted as an expense against your income on this year’s federal tax return, as long as you pay them this year. I plan to write a check for mine in the next few weeks.
If you escrow your property taxes (i.e. pay them with your mortgage payment) then consider making an extra payment or two prior to year end. This will decrease your taxes by increasing the amount you can deduct for mortgage interest expense and property taxes.
If your plan is to make a large consumer purchase (e.g. car, boat, etc.) within the next few weeks, consider making the purchase prior to year end. The sales taxes incurred on the transaction can be deducted from this year’s taxes.
A word of caution…don’t let the “tail wag the dog” here. Unless you were already planning a big purchase, don’t shoot for this deduction. Making a big consumer purchase is best when you’ve had time to evaluate your needs and create a plan to get the best deal. Don’t go buy something big just to get a little tax deduction.
Now let’s move to some ideas for those of you who run a small business. I run a couple of small businesses (this blog and FinCon), so I also look for ways that my business income and expense can help me have a happier tax season.
5. Spend Next Year’s Business Dollars Now
In the past I’ve chosen to reinvest some of my earnings from the year back into the business. Last year I actually already made a couple of these purchases: a new monitor and a wireless keyboard. Both have helped to make my home office a more productive place, and helped to reduce my taxable business income.
A few years ago I accelerated one business expense: rent. I prepaid three months rent at my new office. Think about your business expenses over the next couple of months. Is there anything you can purchase now that you absolutely know you’ll need next year? Doing so will increase your expenses and reduce your taxable income.
6. Delay Billing for Business Services
I use the cash basis of accounting, so I don’t count income unless I’ve received the payment. For some of my clients if I don’t want to receive payment, I simply don’t invoice them. By delaying income, you reduce your taxable income for the year and will pay fewer taxes.
7. Opening and Contributing to an Individual (Solo) 401K
Just like on the personal side, a tax-advantaged retirement account, like the Individual (or Solo) 401K can really help you rack up the deductions. I opened an Individual 401K for my business a while back. I contributed the maximum that I could afford before the end of the year. This reduced my current year tax burden by a significant sum. I plan to do the same for years to come.
Should You Seek Professional Year End Tax Planning Services?
The end of the year is traditionally a time for many people to assess their financial situation – often with the help of a tax expert – and make some decisions that can result in lower tax obligations. For example: making a contribution into an IRA before you file your taxes adds a tax benefit for that year and is often a strategy recommended by a tax professional.
But these past few years have been especially important far as tax planning services goes, so much so, that it makes sense for anyone except a person with no investments and the very simplest of tax returns to seek the advice of an expert to make the proper tax planning decisions before the end of the year.
Of course, if you simply can’t justify giving any money to a CPA, there is a free tax service available that can provide a lot of information about your tax situation and whether you are likely to owe any money to the government. One that comes to mind is the TurboTax free tool TaxCaster. A more expedient approach would be to just download the current version of TurboTax (or use TurboTax Online) and go through the “what if” scenarios.
As long as you have the information about your income, the software will estimate if you should expect a check back from the government. You can even run through scenarios in which you make charitable contributions or end-of-the-year payments to an IRA to see the impact it has on a potential tax refund.
If, however, you itemize your tax return, and especially if you took advantage of any credits or exemptions on last year’s tax return, it makes sense to seek tax planning services this year from a professional. He or she can help you decide whether it’s better to take advantage of all possible deductions before the end of this year, defer income into next year if possible, as well as other tax-planning strategies.
What tax planning moves are you making before the year is out? I’d love to hear your approach.