Greg Rosica, CPA, CFP, a partner with the accounting firm Ernst & Young who specializes in private client services and tax consulting, New York City. EY.com
Now is a great time of year to find tax savings. Enough of the year has passed to evaluate your tax position for the full year…and enough time remains to take actions that will reduce your taxes.
Planning now can reduce your tax bill for 2015 outright and—if you have overpaid income tax so far this year and are employed—let you scale back your wage withholding for the rest of the year instead of continuing to overpay and then waiting for a refund.
Estimating your year-end tax bill now is especially important because 2015’s volatile investment markets could complicate the calculation of gains…the Affordable Care Act could add surprising charges to your tax bill…and the recent increases of the top capital gains rate to 20% and ordinary tax rate to 39.6% can make mistakes in tax projections extra costly.
Helpful: Use your 2014 tax return as your guide. It will remind you of items to focus on and may contain information that affects your 2015 planning. For instance, if you applied an overpayment in 2014 to this year’s taxes, add it to your wage withholding and estimated taxes when figuring out whether you have already paid enough tax for 2015 so that you don’t overpay again.
Special planning areas…
The up-and-down investment markets of 2015 create potential tax savings in the form of unrealized gains and losses. Here’s how to use them…
First, add up all your “realized” capital gains and losses—those that you’ve taken by cashing in investments this year or that your mutual funds have declared. Then look at the investment holdings still in your portfolio to find capital gains and losses that you could still take, which are “unrealized.” Consider realizing additional losses before year-end to offset more of your taxable gains. Moreover, a net capital loss of up to $3,000 is deductible against ordinary income, such as wages.
Helpful: Under “wash-sale” rules, if you want to sell a stock or fund at a loss to offset investment gains and then buy the same stock or fund again, you must wait until at least 30 days pass. Or you can buy very similar but not identical securities at anytime. Also, because short-term gains and losses are fully counted in income, while tax-favored long-term gains and losses (on investments held over one year) are only partially counted, it is most efficient to take long-term losses to offset long-term gains and short-term losses against short-term gains. For more information on how the rules apply to particular investments, see IRS Publication 550, Investment Income and Expenses.
Compare your tax bracket for this year with what you expect it to be next year. If your 2015 tax bracket will be higher or the two will be about the same, take as many deductions as possible this year while deferring income until after year-end.
If instead you expect your 2015 tax bracket to be significantly lower than that for 2016, consider the reverse—accelerating income into this year at the lower tax rate and saving some deductions for later when they will be more valuable.
Examples of timing possibilities…
• Voluntary taxable withdrawals from IRAs and other retirement plans can be taken before or after year-end.
• Stock options, US Savings Bonds and other investments can be cashed in before or after year-end.
• State and local income and property taxes are deductible in the year that they are paid. You can choose whether to make the payments that you still owe for 2015 before or after year-end, picking the year that’s best for your federal return. Some states also allow you to prepay property taxes owed for 2016 during 2015. Check your state’s rules.
• If you have your own small business that you report on your personal tax return, you can time billing and sending out invoices to receive income in the most opportune year…while timing payments made for supplies, equipment and various other expenses before or after year-end to deduct them in the best year.
• Charitable contributions can be made before or after year-end.
Medical expenses are deductible only to the extent that they exceed 10% of adjusted gross income (AGI) or 7.5% on a return filed by a taxpayer age 65 or older, while miscellaneous itemized deductions are allowed only to the extent that their total exceeds 2% of AGI. (These include employee business expenses, investment expenses, legal fees and various other items.) Look at your total for each to see if it will be over the AGI threshold in 2015. If so, accelerate deductible expense payments into 2015. If not, defer as many as possible to help you get over the threshold in 2016.
Also, many employers offer medical benefit flexible spending accounts with “use it or lose it” provisions, meaning that the tax-favored contributions to the account are forfeited if the money is not spent by year-end. Some allow grace periods into the following year. Check with your plan’s administrator.
Under this law, if you fail to obtain required health-care insurance coverage, the penalty doubles in 2015 to 2% of household income or $325 per person, whichever is higher.
If you received a subsidy for health insurance that was too large because your final income in 2015 is more than you expected when obtaining insurance, you will have to make up the difference on your 2015 tax return.