As commercial spaces all over North America are filled to the brim with Christmas paraphernalia one thing is clear - the New Year is nigh. We hope that you have already addressed the basics for preparing for your 2013 tax filing. If you did a good job of keeping (and organizing) records throughout the year, good for you. If not, once the New Year’s hangover wears off you might consider getting those records in order. But here are some other steps that you should consider before December 31st - since after the clock strikes midnight, it will be too late!
Reduce Your Taxable Income to Minimize Your Tax Exposure
The less income you have, the less Uncle Sam is entitled to take. On the face of it, that’s simple enough. Effective income deferral, however, is slightly more complicated. First, remember that taxes on any income you defer are delayed by a year, not eliminated. That means deferring income until 2014 only makes sense if you anticipate having less income, more deductions, or both next year
Second, income deferral has the greatest value when it keeps you from crossing into the next tax bracket. The highest rate of 39.6 percent, for example, kicks in at $400,000 if you are single, $450,000 if you are married and filing jointly, or $425,000 if you are a head of household. So if you are single and deferring income means the difference between a taxable income of $390,000 or $420,000, you’ll avoid paying the highest rate on that last $20,000. (The effect is the same at lower brackets.)
Maximize Your Available Tax-Deferred Contributions
Speaking of deferring income, there is one way that is simpler than deferring a bonus, delaying invoicing, or waiting until after January 1 to sell an asset, and that is to take advantage of tax-deferred retirement accounts. Whether that is a 401(k), a traditional IRA, a SIMPLE IRA, or some other version, consider funding your account to the maximum—and don’t forget that you are entitled to additional “catch-up” contribution amounts if you are 50 or older
Another means of deferring income is the flexible spending account (FSA). These funds can be used only for healthcare-related costs, of course, and in addition the Affordable Care Act established a $2,500 annual contribution limit. Watch those funds carefully, because the FSA is a use-it-or-lose-it proposition, and anything remaining in the account at year end goes away. There is now a provision to allow a carryover of up to $500 into the next year, but that applies only if your employer has revised its plan rules to adopt it—the change is not automatic.
Manage Your Investments to Reduce Capital Gains Taxes and Avoid the ACA Surtax
With the new year comes new laws, and another effect of the Affordable Care Act is a 3.8% surtax on unearned income called the Net Investment Income Tax. The surtax only kicks in at an adjusted gross income (AGI) of $200,000 for single and head of household filers or $250,000 for married joint filers, so it’s not exactly a concern for everyone. Keep in mind that it is preferable for capital gains to be taken on investments held more than one year, since the long-term capital gains rate is lower than the short-term rate. For losses, however, you may apply up to $3,000 in capital losses to offset capital gains, and carry any additional losses over to future tax years. So look at where your investments stand and plan appropriately for any you are willing to liquidate. (Remember, only realized losses and gains are taxable—paper gains and losses are meaningless.)
Take Advantage of Mortgage Interest, Property Tax, and Energy Efficiency Deductions and Credits
You probably already know that interest on the mortgage and property taxes for your primary residence are tax-deductible. However, there are also tax credits (not merely deductions) available for energy efficiency-enhancing upgrades provided they are made by December 31. How long these deductions will remain available is questionable, so if you plan to use them, better now than later.
Schedule Deductible Expenses Before Year-End to Maximize Your Tax Deductions
In addition to planning income, you may also want to plan expenses for the final weeks of the year. Some expense categories become deductible only when they reach a certain threshold, such as 10 percent for medical expenses or 2 percent for miscellaneous expenses. (Of course, if your medical insurance benefit year is based on the calendar year, once you meet your out-of-pocket maximum you will generate few if any additional medical expenses.)
Charitable donations are also subject to thresholds, so you may be interested to know that cash and household goods are not the only types of donations available. You can donate cars and boats, stock and other equities (as long as you have held them at least one year), and even the required minimum distribution from your IRA if you are 70-1/2 or older.
Some significant deductions and the American Opportunity (formerly Hope) tax credit are available for college education expenses. If you were unable to claim the maximum available amount in 2013, you can prepay tuition for 2014 and claim the payment on your 2013 taxes as long as the classes in question begin within the first three months of 2014.
Don’t Forget that Sales, State and Local Income Taxes are also Deductible
Conveniently enough with the holiday shopping season at hand, you should know that you have the option to deduct sales taxes. It is much more common to deduct state and local income taxes instead, but depending on your spending, if you live in a low-tax jurisdiction you might actually fare better come tax time to take the sales tax route instead. (Don’t think that you have to dig out every single receipt you’ve generated in 2013. The IRS helpfully provides tables that show the average sales tax paid in each state to simplify the process). Sales tax paid in foreign countries does not qualify for U.S. tax deduction.
Tweak Your Federal Income Tax Withholding Prior to the Year End to Avoid Penalties
Finally, it is important to remember that if you have significantly underpaid your 2013 taxes, you will incur a penalty and interest when you file. While this close to the end of the year it might mean a significant hit to a paycheck or two, you still have the option to adjust your withholding rate and even request that an additional amount be withheld from your pay.
Finding the right withholding level is important. While many people look forward to a large tax refund, the reality is that all such taxpayers have done is provide the federal government with an interest-free loan for the year. Reducing your withholding and socking the difference away in a savings account can put that money to work for you instead. (If you don’t think you have the discipline to save the money, have it automatically deducted from your paycheck or checking account and diverted to savings—you won’t miss it.) If you use tax preparation software, it will probably advise you on the appropriate withholding level for 2014 once you complete your 2013 tax filing.
The taxman cometh soon, and he can’t be avoided unless you fancy the idea of spending several years contemplating the interior of a federal prison cell. There’s a reason for the old saying comparing death and taxes, after all. But some planning and proactive efforts now can make the bite a little less painful come April (or June if you’re one of our clients) 15th.