Top Tax Tips for 2016
Many people think about taxes in the Spring (when they’re due) or in December (when it may be too late to do anything meaningful). If you believe you pay too much in taxes, now is the time to make changes to reduce what you owe.
At Sound Stewardship, we believe taxes are a symptom of provision. Struggling with a high bill to the IRS is a direct result of receiving a high income, which is certainly something to be thankful for. Taxes are a part of being a responsible citizen in a free society that offers us many benefits those in other countries do not experience.
However, when we ask people, “What area of your finances do you feel least content with?”, one of the most common responses is, “Taxes.” Because the government’s share increases as your income increases, this is especially true for those with higher incomes. Did you know that the top 20% of earners pay 84% of the taxes in the US?
Those who believe in honoring government and “rendering to Caesar his due” don’t necessarily intend to pay more than their fair share. If there’s a way they can effectively reduce their taxes with wise planning, they will.*
Below are our top 12 suggestions for reducing taxes now, before it is too late. Of course, these are general suggestions, so make sure you talk to a tax professional about your personal situation and applying them.
1.) Run a tax projection.
This time of year, we’re helping clients complete tax projections so they know what they’re on track to owe or receive on April 15. I’m amazed by how few people do this. Our tax code is certainly complicated, but it’s not a mystery. You can know ahead of time (almost to the dollar) what your taxes will be. Unless you do this, it will be challenging to put the next steps into action.
2.) Fill up your 401(k) or other retirement plan contributions to the maximum.
Most retirement plans allow you to contribute $18,000/year ($24,000 if over age 50). This is one of the largest deductions most people can get, and the great thing is that the money is still yours. Though you’re kicking the tax-can down the road into future years, you may also pick up an employer match and be able to reduce taxes in other ways during retirement.
3.) Pre-fund next year’s giving now.
Many clients tithe or do annual giving, and one way to dramatically decrease taxes is to dramatically increase this year’s charitable deduction by “pre-funding” next year’s giving. This is done by utilizing a Donor Advised Fund, which is essentially like your personal giving foundation. You get a deduction for whatever you place in the fund this year, and then you distribute it out in future years to charities just like you otherwise would have.
4.) Accelerate deductions like pre-paying mortgage payments.
For those who itemize, other deductions might be accelerated into this year as well. By pre-paying mortgage payments, you could increase your mortgage interest deductions. Make sure the bank knows what these extra payments are for so it does not apply them only to principal. Medical and miscellaneous deductions (like paying your CPA) are only applied if they amount to more than a percentage of income, so you may benefit more when grouping them into one year. If you need a medical procedure but have flexibility about what year it will take place, you may be able to time it for maximized tax treatment.*
5.) Accelerate business deductions, like purchasing new equipment, now.
Business owners can also boost deductions by accelerating necessary* expenditures into this year. If you have sizeable equipment purchases coming up, try to time them with your largest income years in order to maximize the benefit of the deduction or depreciation.
6.) Utilize state tax credits like the KS Community Service Tax Credit.
Most states offer special tax credits to incentivize spending in particular areas. Some of these credits are refundable, meaning you will get a check back from the state if the benefit is more than the actual tax you owed. For instance, Kansas taxpayers can utilize the KS Community Service Tax Credit by giving to specific charitable projects going on in the state. If you give $1,000 to one of these charities, you not only get a Federal deduction, you also receive a credit from KS equal to either $700 or $500, depending on the charity!
7.) Give appreciated assets (not cash) whenever possible.
Writing a check to charity is not an ideal way to do your giving. You may pick up a charitable deduction, but you lose out on other tax savings that are out there. The best way to give is using appreciated assets, like stock or mutual funds. If you hold these investments in a taxable account, you’re taxed on the growth when you sell them. On the other hand, if you’ve held them for more than a year and give them to charity you not only pick up the tax deduction for their value, you also never have to pay the gains tax you would have owed if you sold them. The Donor Advised Fund mentioned above is an easy way to do this.
8.) Tax-Loss Harvest with taxable investments.
If you should give your winners, you might want to sell your losers. Selling investments that have declined in value results in losses that can be used to offset other investment income and possibly even ordinary income. A savvy investment advisor will do this in a way that not only maximizes the tax treatment in your account, but maximizes the portfolio’s overall strategy (as opposed to intentionally investing in losers).
9.) Run college tuition payments through 529 Plans (state deductions only).
529 Plan accounts allow investments to grow tax-free as long as they’re used for college and graduate expenses. But in most states you can also receive some form of state tax deduction when you place the money in the 529 Plan. If you are making current year tuition payments, running them through the plan first could give you a state tax boost. Make sure you give yourself a couple of weeks for the money to move through the accounts, and you may want to take advantage of other education credits first, like the American Opportunity Tax Credit.
10.) Adjust withholding to smooth out or reduce payments through the end of the year.
Completing a tax projection now can also give you an opportunity to make withholding adjustments from now until the end of the year. If you’re on track for a refund, reducing tax withholding from your remaining paychecks will mean more money this year instead of a refund check next spring (just in time for Christmas!). If you’re on track to owe, increasing paycheck withholding could save you from having to write a big check at tax time (and maybe avoid underpayment penalties).
11.) Defer income into next year.
Business owners or consultants on a cash basis may have opportunities to defer December income into January. Sometimes these deferrals can make a big difference. One client of ours was able to save a significant amount in taxes simply by moving his official retirement date to January 1 instead of December 31.
12.) Give away Required Minimum Distributions as a Qualified Charitable Distribution.
Those who are over age 70 ½ with IRAs are required to distribute out a minimum amount from their IRA accounts each year. If that income isn’t needed, up to $100,000 of the account can be sent directly to charity instead. Because it skips your income altogether (and qualifies as your RMD), it’s better than the charitable deduction you would’ve received if you wrote your own check to the charity.
Now is the time! Talk to your CPA to get your tax projection done and start working on the tax savings strategies that fit you best.
* Minimizing taxes can be good, but it is not always beneficial for financial and overall health. Be careful not to let the “tax tail wag the dog.”< Back to Updates