While the deadline for filing annual tax returns runs until April 15 of the following year, there are certain tasks you should complete before December 31. Following a few year-end tax planning tips can help you increase savings and avoid penalties before the end of the year.
While these tips are generally applicable to taxpayers, you should always consult a tax professional for more individualized guidance.
Income deferrals can prevent you from paying taxes on certain income until next year, allowing you to keep that money in your accounts longer and earn more interest. This can also be a helpful year-end tax planning tip if you think you might be in a lower tax bracket next year.
As the end of December draws closer, consider how you can defer certain income until January. Perhaps you can avoid billing for freelance work until the first of the year or defer a year-end bonus until next year, if your employer allows you to.
If you are 73 or older, you generally must take required minimum distributions (RMDs) from a tax-deferred retirement account before the end of each calendar year. Missing this deadline could leave you with a steep penalty: 25% of the portion of the RMD you didn’t withdraw.
The main exception to this deadline applies to those taking their first distribution; they would have until April 1 of the following year. If you don’t want to increase your taxable income by taking RMDs, you can consider making qualified charitable distributions from certain accounts directly to a public charity.
If you can afford to, maximizing your retirement account contributions can be beneficial, especially for employer-sponsored plans. Plans like 401(k)s and IRAs have monetary contribution limits for each calendar year.
Maxing out your contributions to a 401(k) can reduce your taxable income for the current year, which may be a good strategy if you believe your tax rate will be reduced in retirement. Remember that you need to make 401(k) contributions by December 31 each year.
Even if you do not have an employer-sponsored plan, making the maximum contributions to any retirement plan can be wise if you want to maximize compound interest and returns.
Another important year-end tax planning tip involves maximizing your deductions before the end of the calendar year. For example, making qualified charitable contributions now can increase your deductions for this tax year, reducing your tax liability.
You can generally deduct cash donations made to qualified charities worth up to 60% of your adjusted gross income. Talk to a tax professional about strategies that can make these contributions even more tax-efficient; for example, you might consider donating appreciated long-term investments to avoid having to recognize capital gains.
The end of the calendar year is also a good time to assess your investment portfolio. Tax-loss harvesting involves selling investments at a loss to reduce or eliminate capital gains, effectively lowering your tax liability.
For example, you might calculate your capital gains for the calendar year and then cash out capital losses equal to that amount. Just make sure not to purchase the same or a similar security within 30 days to avoid violating the wash-sale rule.
Need help implementing these and other year-end tax planning tips while adhering to tax law and avoiding penalties? Contact Levy & Associates, Inc., today at 800-829-5389 or fill out our contact form for professional guidance.
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