Every year around this time, we hear about the same old things we should do by December 31 to save money on our taxes the following April. In this article, we'll provide some lesser-known tips and strategies for last-minute tax savings. We'll also share some arguments against taking commonly recommended measures like paying property taxes and the January mortgage bill in December. (For more suggestions, read 10 Money-Saving Year-End Tax Tips.)
TUTORIAL: Personal Income Tax Guide
Bunch Related Expenses into One Year
Some deductions aren't available unless your expenses in that category exceed a certain percentage of your adjusted gross income (AGI). For medical expenses, it's the amount that's more than 10% (7.5% if you or your spouse is 65 or older, through Dec. 31, 2016). For job expenses and certain miscellaneous deductions, it's 2%.
Here's an example of how this system works. If your AGI is $50,000 and you have $7,000 in qualified medical and dental expenses, you don't get to deduct $7,000 from your taxable income; you only get to deduct the expenses that exceed 10% of your income. Since 10% of $50,000 is $5,000, you can deduct $7,000 - $5,000, or $2,000.
It's better to be able claim something than to miss out on this deduction entirely. So, November and December is a good time to look at your actual medical expenses for 2015 and your anticipated medical expenses for 2016.
If you're close to crossing the 10% (or 7.5%) threshold for the current tax year, move your purchases of eyeglasses, dentist and doctor visits, surgical procedures and other medical and dental expenses to December to gain a tax deduction, advises Scott M. Estill, author of the book "Tax This! An Insider's Guide To Standing Up To The IRS" and a former senior trial attorney for the IRS. Likewise, if you have few medical and dental expenses for the current tax year, defer your purchases until the next one.
Numerous medical costs are tax-deductible, including LASIK eye surgery, doctor-prescribed weight loss programs, smoking cessation programs (but not patches or gum) and capital expenses for ramps, railings and other features installed in a home to accommodate disabilities, says John T. Hewitt, founder and CEO of Liberty Tax Service. (For related reading, check out Tax Deductions You May Be Missing.)
"Don't overlook medical mileage to and from doctors, hospitals and the pharmacy," he adds. Since January 1, 2014, the standard rate for medical mileage has been 23.5 cents/mile.
As for bunching your expenses, "The same idea works for miscellaneous itemized deductions, including investment advice, tax preparation costs, certain legal fees, safe deposit box rentals and so on," says Estill.
Consider Next Year's Tax Brackets
Before bunching expenses together, taxpayers should consider their overall tax brackets for this tax year and next year, Estill says.
"For instance, if I know my income will go up next year and thus I will be in a higher tax bracket, it may make sense to wait until next year to take the deduction because it will be worth more to me as a percentage of my income," he says.
If you jump from the 15% bracket in 2015 to the 28% bracket in 2016, your deductions will be worth 13% more in 2016, for example. A major tax bracket change might apply to you if your spouse was unemployed for most of 2015 but recently got a new job, or if you were a student in 2015 but will start working full time in 2016, among other possible scenarios.
"Likewise, if my income is expected to go down next year, it may make sense to try to accelerate the purchases into the current tax year," Estill adds.
Beware the Alternative Minimum Tax
The common advice to shift expenses from January to December to get the tax deduction a year earlier can backfire if you end up being subject to the alternative minimum tax (AMT).
What is the AMT? According to the IRS, "The tax laws provide tax benefits for certain kinds of income and allow special deductions and credits for certain kinds of expenses. The alternative minimum tax (AMT) attempts to ensure that anyone who benefits from these tax advantages pays at least a minimum amount of tax. The AMT is a separately figured tax that eliminates many deductions and credits, thus increasing tax liability for an individual who would otherwise pay less tax." (To learn more, read How To Cut Your Alternative Minimum Tax.)
Determining if the AMT applies to you is tricky and may require professional tax assistance. If the AMT does apply to you, you'll need to rethink your tax minimization strategy. "If you are subject to AMT, the benefit of being able to deduct property taxes disappears. It may be more advantageous to wait until next year to make the payment. Make sure you consult with a tax professional before you assume prepayment will result in income tax savings," he adds.
The same is true of state income taxes for the fourth quarter of the current tax year that you might elect to pay in December instead of January, says Estill.
The Bottom Line
Year-end tax planning isn't as simple as it seems. Rather than scrambling to reduce your taxes in December, a better strategy is to consult with a tax professional to develop an ongoing plan that you can implement over the course of the entire year, and change along the way if your income or expenses don't meet your predictions.