You won’t start hearing tax preparation commercials on TV until next January. However, it will be too late for many of your best tax planning opportunities by then. Other than making some retirement contributions, most of your tax-affecting moves for 2016 need to be completed before December 31. So, sometime in the next month or so, take a few minutes to think about your tax situation for this year and consider these options.1. Defer income to next year
Consider opportunities to defer income to 2017, particularly if you think you may be in a lower tax bracket then. For example, you may be able to defer a year-end bonus or delay the collection of business debts, rents, and payments for services. Doing so may enable you to postpone payment of tax on the income until next year.
2. Accelerate deductions
You might also look for opportunities to accelerate deductions into the current tax year. If you itemize deductions, making payments for deductible expenses such as medical expenses, qualifying interest, and state taxes before the end of the year, instead of paying them in early 2017, could make a difference on your 2016 return.
3. Factor in the AMT
If you’re subject to the alternative minimum tax (AMT), traditional year-end maneuvers such as deferring income and accelerating deductions can have a negative effect. Essentially a separate federal income tax system with its own rates and rules, the AMT effectively disallows a number of itemized deductions. For example, if you’re subject to the AMT in 2016, prepaying 2017 state and local taxes probably won’t help your 2016 tax situation, but could hurt your 2017 bottom line. Taking the time to determine whether you may be subject to the AMT before you make any year-end moves could help save you from making a costly mistake.
4. Bump up withholding to cover a tax shortfall
If it looks as though you’re going to owe federal income tax for the year, especially if you think you may be subject to an estimated tax penalty, consider asking your employer (via Form W-4) to increase your withholding for the remainder of the year to cover the shortfall. The biggest advantage in doing so is that withholding is considered as having been paid evenly through the year instead of when the dollars are actually taken from your paycheck. This strategy can also be used to make up for low or missing quarterly estimated tax payments.
5. Maximize retirement savings
Deductible contributions to a traditional IRA and pretax contributions to an employer-sponsored retirement plan such as a 401(k) can reduce your 2016 taxable income. If you haven’t already contributed up to the maximum amount allowed, consider doing so by year-end.
6. Take any required distributions
Once you reach age 70½, you generally must start taking required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans (an exception may apply if you’re still working and participating in an employer-sponsored plan). Take any distributions by the date required–the end of the year for most individuals. The penalty for failing to do so is substantial: 50% of any amount that you failed to distribute as required.
In the first year you reach 70½, you have the option to wait until April 1 of the following year to take the distribution. However, we don’t generally recommend that approach because you then have two distributions in 1 year which can result in a higher tax rate.
Be aware that the opportunity to take your RMD as a direct charitable contribution is now permanent law. If you’re making charitable contributions anyway, it can save you more money on your taxes by making them directly from your IRA rather than taking them as an itemized deduction because the direct contribution also reduces your adjusted gross income.
7. Consider non-required IRA distributions
If you’re in your 60s, you’re at the point in life where there’s no penalty for IRA distributions, and they’re not required either. If you’re retired, it’s entirely possible that during this decade taking some voluntary IRA distributions in low tax brackets can save you significant taxes in the future. It makes sense to do some detailed retirement distribution planning to avoid missing out on this opportunity.
8. Consider Roth conversions
If this is a relatively low income year for you, you may wish to consider doing a partial Roth conversion. These conversions become particularly attractive when you’ve had a year with partial unemployment, career change, or early in retirement. Converting funds means you’ll pay taxes on the income today, and then benefit from tax-free growth in the future. Again, if you’re considering this, coordinate with your tax professional and us to make sure it’s helpful in your situation.
9. Consider harvesting capital gains or losses
It seems odd to consider harvesting gains and losses, but which is best all depends on your tax bracket. If you’re going to be in the 15% or lower tax bracket this year, the tax rate on long term capital gains is 0%. Selling investments at a gain to reset the cost basis higher at zero tax cost can create a big savings in the future. On the other hand, if you’re in a 25% or higher tax bracket, you may wish to sell positions at a loss to offset other gains for the year or to realize the up to $3,000 deduction against ordinary income. In either case, please coordinate with your tax professional and us to ensure that you’re seeing the big picture on implementing either of these strategies.
10. Beware the net investment income tax
Don’t forget to account for the 3.8% net investment income tax. This additional tax may apply to some or all of your net investment income if your modified AGI exceeds $200,000 ($250,000 if married filing jointly, $125,000 if married filing separately, $200,000 if head of household).
Parts of this article adapted with permission of Broadridge Forefield Investor Communications.