Year-end tax planning: Don't wait for year-end
Let’s face it, things get hectic as the year-end approaches. So it’s better to not wait too long to focus on financial transactions you can do now that will result in lowering your tax liability for 2016.
And this year’s tax planning should be at least a little easier. For the first time in several years, taxpayers won’t have to wait for Congress to act to approve the end-of-year “tax extenders” to know if certain popular tax breaks are still available. The PATH Act of 2015 made several provisions permanent and extended others for a few more years.
- For more tips on budgeting and spending for the festive season, see our Holiday Financial Guide
The main objective is to identify some specific transactions (save, pay, donate, sell, buy, etc.) that are worth making before Dec. 31. Typically, you’ll want to look for ways to delay taxation of income until next year and to increase deductible expenses you’ll pay this year. Done correctly, you’ll have more deductions, less income and, thus, pay less income tax on your 2016 tax return.
The first thing to know is your marginal tax rate -- that’s the rate that applies to your last dollar of taxable income. Say you’re married, and your household taxable income last year was about $250,000 and you expect it to be about the same in 2016. In that case, your last dollar of taxable income is taxed at a 33 percent rate in 2016. Reducing that income or gaining an additional $1,000 in deductions would result in a tax savings of approximately $330.
Here are a few ways to reduce your taxable income:
Increase the pretax contributions you make to an employer’s retirement plan, such a 401(k). The contribution limit this year is $18,000, but those age 50 or older this year can contribute an additional $6,000.
If you’re self-employed, hold off on sending any invoices to your clients and customers until January. That way, the payments you’ll receive will be included in your 2017 income, not in this year’s.
But before you do, figure out if your income will be higher this year or in 2017. If you expect significantly higher income next year (making your last dollar of income taxed at the highest 39.6 percent tax rate in 2017), it may be best to do the opposite: Send invoices to your clients now and ask that they pay their bills this year to ensure that income gets taxed at a lower tax rate.
Deductible expenses that you can pay now include:
State income tax payments. You can ask your employer to increase the withholding for state income tax from your remaining paychecks in 2016. If you pay estimated taxes each quarter, make the final fourth-quarter payment before the end of this year (it’s normally due Jan. 15, 2017).
Real estate taxes. Pay your home tax bills that are normally due in early 2017 now. This will not only increase your deductible expenses but some towns and school districts offer a small discount if you pay early.
Charitable contributions. Any donations you pay by check or charge to your credit card before year-end will count as a 2016 deduction.
We’ll look at more tax-planning strategies in coming weeks for homeowners, the self-employed and investors.
