In our current and uncertain tax and legislative environment, year-end tax planning is a must for individuals, public companies, and private companies. As the possibility for major tax reform becomes more of a reality, planning before year-end is not only smart, but can save on tax now and in the future.
Here are a few areas to consider and discuss with your tax professional before it is too late:
ACCELERATE DEDUCTIONS / DEFER INCOME
Increasing your deductions in years with higher tax rates (i.e. now), and deferring income to future years when tax rates are expected to be lower can save a substantial amount of taxes. You know your business and which expenses are controllable – strategize correctly and pay less to Uncle Sam. Also think about accelerating state and local taxes, interest payments, and real estate taxes.
USE ITEMIZED DEDUCTIONS
The current proposed tax bills may eliminate many itemized deductions (i.e. medical expenses, and state and local taxes). If possible, consider making these payments before year-end to take advantage of current tax laws.
LEVERAGE STATE AND LOCAL SALES TAX DEDUCTIONS
Don’t forget, you can elect to deduct state and local sales tax instead of state and local income tax. This can be beneficial for those living in a state without an income tax, or for those who may have made a large purchase in a state subject to sales tax (or will be making a large purchase before year-end).
CONSIDER CHARITABLE DEDUCTIONS
Although promises have been made to retain the charitable deduction, there still may be applicable limits. In addition, with the proposed doubling of the standard deduction, charitable deductions may not be as beneficial next year. Quite simply if the new standard deduction is larger than one’s itemized deductions, no charitable deduction will be allowed. Finally, your charitable deduction may have more value now when exposed to higher tax rates as opposed to the lower future tax rates on the horizon.
GET CHARITABLE DUCKS IN A ROW
Cash contributions must be documented to be deductible, charitable deductions of more than $500 in donated property must be accompanied by a Form 8283, and a donated automobile deduction of $250 or more must have a contemporaneous written acknowledgement from the charity that includes a description of the car. Bottom line, get your “ducks in a row” early to ensure the IRS accepts your claimed charitable deductions.
CORRECT TAX SHORTFALL WITH INCREASED WITHHOLDING
Since taxes are due throughout the year, don’t forget to check your withholding and estimated tax payments. Withholding is considered to have been paid ratably throughout the year, while a bigger estimated tax payment can leave some exposed to penalties for previous quarters. If you risk an underpayment penalty, think about increasing your withholding on your salary or bonus.
UTILIZE RETIREMENT ACCOUNT TAX SAVINGS
Traditional retirement accounts like a 401(k) or IRA still provide some of the best tax savings for individuals. Contributions to such accounts reduce taxable income when made and aren’t taxed until funds are taken out during retirement. It is not too late to increase your contributions before year-end, if possible.
DOCUMENT BUSINESS ACTIVITY
Taxpayers may not need to pay a 3.8% Medicare tax on business income if they participate enough in the business that they are not considered a “passive investor.” However, even if you are not considered a “passive investor,” you must document the business’ activities – the IRS will not allow ballpark estimates after the fact. Make sure you document your hours spent with calendar and appointment books, e-mails, and narrative summaries of work performed. (Note: “Participation” is defined as any work performed in a business as an owner, manager, or employee as long as it is not an investment activity.)
CONSIDER STATE RESIDENCY STATUS
If you are one of many who split your time in two different states throughout the year, consider which state provides the more advantageous tax consequences. If you are going to change your residency status this year, I would suggest tracking the number of days spent in each state. In general, if you reside in a state for 183 days or more, that state will assert residency and the ability to tax all your income.
USE CAUTION WITH ESTATE PLANNING
The potential repeal of the U.S. Estate Tax makes planning more complicated this year. While it still makes sense to utilize your annual $14,000 gift exclusion because the estate tax may not ultimately be repealed, you may want to avoid any giving strategies that involve paying gift tax until the legislative uncertainty is resolved.