Tax planning can be a year-round effort but certain activities have deadlines that coincide with New Year’s Eve. Others have deadlines in the first part of the new year but can still help reduce your tax liability for the previous year. Tax law changes made a couple years ago simplified planning for many individuals since a larger “Standard Deduction” was put in place and for most is beneficial compared to itemizing deductions like property taxes, mortgage interest, charitable contributions, etc. More on this later.
We have three learning objectives for this video:
To understand common actions that can be taken to reduce your federal tax liability
Know the deadlines for certain activities that can reduce your tax bill
Review your personal situation to identify future opportunities to legally keep your taxes as low as possible
There aren’t a lot of loopholes in the tax code compared to a few decades ago when you could put money in oil drilling partnerships or an exotic investment like an alpaca farm and generate some great write-offs with all the money you were most likely going to lose. Today’s options are generally simpler and you are less likely to lose money. Here’s some things to consider:
Contributions to Retirement Plans – Contributions made to employer sponsored plans by December 31st can reduce your taxable income, lowering your total tax liability. Some employers match contributions, typically in percentages ranging from 50 – 100 percent, up to a certain level where the match ends. This effectively provides an instant profit while you reduce what you owe to Uncle Sam by contributing out of your salary pre-tax. Of course, retirement plan contributions that reduce your tax now end up creating a tax liability in retirement when you take distributions as retirement income. But overall, using tax deferred retirement plans is a great idea.
For those investors contributing to Traditional IRAs, you have until the tax filing deadline date of the following year to make your contribution and still receive the tax deduction for the previous year. Self-employed business owners contributing to Simplified Employee Pension - IRAs, profit sharing plans or defined benefit plans have up to the tax filing deadline for their business structure, and sometimes even longer if a extension of filing time is granted by the IRS. We suggest discussing these deadlines with your financial advisor or tax preparer.
Roth IRAs are a great idea for reducing future tax liability after you are retired and taking distributions, but provide no deduction to reduce taxes at the time you make the contribution. In addition, Roth IRA contributions are limited to those making under a certain level of income, which is adjusted every couple years for inflation. Check with your advisor on the current income limitations.
For those whom a Roth would be advantageous, but whose household income is too high to make direct Roth IRA contributions, a strategy called a “back door” Roth conversion may work. This more complex strategy should be discussed with your qualified financial advisor.
Pay Business Bills Before December 31st – This concept is more for business owners than for most individuals. Bills for legitimate business expenses paid on or before December 31st can be deducted from business income for that year, reducing your tax liability. Of course a tax deduction taken now doesn’t help lower tax in the next year, but the idea here is that the time value of money is on our side. Paying lower taxes now is generally more beneficial than paying lower taxes later.
However, if you anticipate a large increase in taxable income next year compared to this year, it might be wise to postpone payment of business expenses into the new year where they might provide more benefit than paying them currently.
Itemizing Deductions – As mentioned in the beginning of this post, tax law changes that took effect in 2018 combined the old “personal exemption”, which was a deduction for you and each of your dependents, and the formerly lower standard deduction into one larger standardized deduction. These deduction levels are currently $12,400 for a single filer and $24,800 for a married couple filing jointly. Unless someone has a high level of combined mortgage interest, property tax, medical expenses and makes a lot of charitable contributions that will exceed the standard deductions, they will be better off utilizing the standard deduction.
For some though, lumping several years of expenses like charitable contributions into one year may create a tax benefit. You can make those contributions direct to the non-profit organizations or contribute to a donor-advised fund at a community foundation or financial institution where you can make the larger lump-sum contribution in one year and then make contributions out of the fund for several years following the one large gift that provides a tax benefit in the year of the donation.
Another common deductible expense which could work in conjunction with lumping charitable contributions is property taxes. Property taxes are deductible in the year paid, not the year assessed. So paying property tax after January 1st and then paying the next year’s assessment before December 31st of that same year would effectively provide a double deduction.
I recommend working with your tax preparer and financial advisor to develop a plan to keep your tax liability as low as possible within the rules of the tax code. Contact Integra Capital Advisors at 941-778-1900 or visit www.integracapitaladvisors.com today to schedule an introductory call on how we can help with your tax planning.