The end of the year and the months before your tax return is due are when a little planning can save the most. You have to finish some steps by December 31. Others can wait until the filing deadline in the spring. Here is the year-end tax planning checklist we walk through with clients every year.
Year-End Tax Planning Before December 31
Check your withholding. Just as you see a doctor once a year, give your taxes a checkup before the year ends. Your employer may have withheld too little from your pay, or your estimated tax payments may fall short. If so, you may still have time to catch up and avoid an underpayment penalty. The IRS offers a free online Tax Withholding Estimator, and Connecticut publishes its own withholding guidance for state taxes.
Make the most of workplace retirement plans. Contributions to a 401(k) or similar employer plan generally have to come out of your paychecks by December 31 to count for the year. If you can afford to raise your contribution for the last few paychecks, it can lower this year’s taxable income. Contribution limits change most years, and people age 50 and over can usually contribute more. So check the current limits with your plan or the IRS.
Take required minimum distributions. If you must take a minimum distribution from an IRA or retirement plan, you generally have to take it by December 31. Missing it can mean a penalty. Also, if you give to charity and are old enough, a qualified charitable distribution from an IRA can help. It can satisfy some or all of the requirement without adding the amount to your taxable income.
Year-End Tax Planning for Investments and Gifts
Review gains and losses. Selling investments that have lost value can offset gains you have already realized, and up to a limited amount of ordinary income. If you plan to buy a similar investment back, watch the wash-sale rule. This rule disallows the loss if you buy a substantially identical investment within 30 days before or after the sale.
Plan gifts and charitable giving. Gifts to family under the annual gift tax exclusion count toward the year in which you make them. Charitable gifts generally need to be complete by December 31 for you to deduct them that year. Some people group several years of giving into one year, sometimes through a donor-advised fund. That way they can get more benefit from itemizing.
Consider a Roth conversion. A conversion counts toward the year you complete it. In a year when your income is lower than usual, converting part of a traditional IRA can mean paying tax at a lower rate. Our article on Roth IRA conversions explains how it works.
Before You File
Finish IRA and HSA contributions. Unlike 401(k) contributions, IRA and health savings account contributions have a later cutoff. You can generally make them for a given year up to the tax filing deadline the following spring. If you have not reached the limit, you may still be able to contribute for the prior year. However, Roth IRA contributions are subject to income limits.
Understand home office rules. Under current federal law, employees generally cannot deduct unreimbursed home office expenses, even if they work from home for their employer. If you are self-employed, though, you may be able to deduct the business use of your home.
Claim every deduction and credit. Gather your documents early. These include tax forms from employers, banks and brokerages, records of charitable gifts, and property tax and mortgage statements. Going through them often turns up deductions and credits that are easy to miss. In addition, it can prompt better decisions for the year ahead.
Know the deadline. Federal returns are usually due on April 15. When that date falls on a weekend or a holiday, such as Emancipation Day in Washington, D.C., the deadline moves to the next business day. State deadlines can differ.
Work With an Advisor Who Prepares Taxes
Many financial advisors tell clients to “consult a tax advisor.” At Toomey Investment Management, our advisors take part in preparing hundreds of tax returns every year. We also include tax planning in every client’s financial plan at no additional charge. That means we make your investment and tax decisions together, and year-end tax planning becomes part of the bigger picture. See our tax planning and tax preparation services, or call our Wallingford office at 203-949-1710.
This article is for general information only and is not individualized tax, investment or legal advice. Tax rules and limits change; confirm current figures with the IRS or a tax professional.