1. Review income and deductions. The most fundamental year-end tax move is to adjust the timing of income and deductions. If your income is high, deferring receipt of more income at the end of the year can save taxes. If you’re close to the line on itemizing deductions, accelerating payment of deductible expenses might save taxes.
2. Postpone income. If you’re due a bonus, see if your employer will hold off writing the check until January. If you own a cash-basis business, you can time receipt of income by waiting until close to the end of the year to send your December billings.
You can’t defer taxes by simply not putting a check in the bank. If you have an unrestricted right to the money, it is income in the year it is available—whether or not you choose to receive the funds.
3. Bunch your payments. Some taxpayers find they have almost enough deductions to exceed the standard deduction. If this is your situation, try bunching payments into one year to take advantage of itemizing. The next year use the standard deduction, and then bunch your payments again the following year. This way you’ll itemize every other year.
4. Pay deductible expenses before December 31. Paying your state income tax estimate before December 31 accelerates your federal deduction. You can also pay property taxes early, make an extra mortgage payment (the interest portion is deductible), pay your tax preparer for your year-end planning meetings, or opt to have dental work or elective surgery before the end of the year. Remember that the IRS doesn’t allow a deduction for payments made before the services are performed.
5. Be charitable. You can make cash contributions or charge them on your credit card and take a current deduction. If you give appreciated property to charity, you’ll get to deduct the full market value. You may need an appraisal to determine the value of the property.
6. Contribute to a deductible IRA if you qualify. You have until April 15 to open an IRA and make a deductible contribution for the prior year.
7. Contribute to your company’s 401(k). If you have a 401(k) plan at work, make as large a contribution as you’re allowed to make.
8. Set up a Keogh plan before December 31. If you’re self-employed and you want to make a contribution to a Keogh retirement plan, the plan must be adopted before year-end, even though you have until April 15 (or later if you get a filing extension) to make a deductible contribution for the previous year.
9. If necessary, adjust your income tax withholding before year-end to avoid underpayment penalties. Withheld taxes are considered paid in equal amounts during the year regardless of when the tax is withheld. Therefore, a year-end adjustment to your withholding could help you avoid a penalty.
10. Consider your marital status. If planning a wedding or divorce, be aware that your marital status as of December 31 determines your tax status for the whole year. Changing the dates of a year-end event may save taxes.
11. Offset capital gains. Review your investment portfolio to determine whether you should sell some losers before year-end in order to offset capital gains you’ve already realized. Capital losses are first netted with capital gains and then are deductible against ordinary income (limited to $3,000 a year).
12. Check exposure to the AMT. If you have tax preference items, do an alternative minimum tax (AMT) computation when you do your regular tax estimate. If the AMT will apply to you, you may still be able to shift income or deductions to avoid or reduce the tax.
13. Plan for losses. Check your basis in any S corporation in which you are a shareholder and where you expect a loss this year. Be sure you have sufficient basis to enable you to take the loss on your tax return.
A word of caution about year-end tax-cutting maneuvers: don’t rush into transactions which you hope will reduce your tax bill. Do not enter into transactions solely for the tax benefits. All investments should be economically sound. There are those who will sell you so-called “tax” solutions. Analyze such options carefully.
Khorshed Alam is a practicing CPA and Business Valuation Analyst. Check out http://alamcpatax.com or call 1 408 445 1120.