For many Americans, year-end tax planning can be a tricky affair where they have to accomplish certain objectives in order to maximize their tax savings for the year. A tax-saving move done in the current year should never be done at the expense of a greater tax bill the following year. However, 2012 may stand as one of the hardest years ever in this regard, as Congress grapples with the fiscal cliff that America stands to hurtle over if it cannot reach an agreement to prevent it. However, there are still several things that you can do to at least partially prepare yourself for 2013, regardless of how things turn out.
Wait to Itemize
If taxes go up in 2013, then next year might be a better year to itemize than this year. If you are just on the edge of being able to itemize deductions, then it might be wise to wait to incur expenses that you can report until next year. For the moment, you should bunch up your year-end charitable donations and medical expenses and also have money set aside to pay your January mortgage costs and property taxes. That way you will be able to immediately pay those bills and make those donations this year if the new tax laws show that you will be better off doing so for 2012. Then you can wait and do it all in January if the laws show that you will save more by doing so next year, which will likely be the case for many filers.
Dump Those Winners
The Bush tax cuts are set to expire at midnight on Dec. 31, 2012. If you have stocks or other securities that have appreciated materially for more than a year, then this year will be the time to sell them if you are not planning on holding them for the long term. Many experts believe that the long-term capital gains tax rates are going to go up by at least 8% next year, regardless of any compromise that Congress may reach at the last minute. If this happens, then you can save money by selling any taxable holdings you have in your portfolio in the final trading days of the year. Of course, this doesn't mean that you should necessarily liquidate all of your long-term holdings for the sole purpose of paying a lower tax rate on the sale; this can deprive you of future gains that you may need for retirement or other expenses.
Contribute and Convert
Although Congress may reduce or eliminate some or all of the tax breaks that we get in our retirement plans, our previous contributions may be grandfathered in, depending upon how things turn out. You may therefore be wise to pack away additional contributions into your IRAs and employer-sponsored retirement plans before the end of the year, while the current contribution limits and deductions are still in effect. You may also want to consider converting any traditional IRAs or qualified plans into Roth accounts if you were planning to do so in the future if the new laws dictate that your tax rate will increase in 2013. This move has little risk for you, because if it turns out that you would have been better off without converting your assets, then the IRS will allow you to undo the conversion until Oct. 15, 2013.
Adjust Your Withholding
An astounding majority of Americans (over 75%) receive a refund when they file their income taxes each year. The average refund equals about $3,000, which is the equivalent of loaning the government $250 out of your pocket each month. Because withholding and other taxes may increase next year, you can help to preserve your budget by raising the number of allowances that you list on your W-4 form. This can help to offset the $3,500 tax increase that the Tax Academy study indicates the average family will face next year if America goes over the Fiscal Cliff.
The Bottom Line
These are just some of the strategies that may help you to save on taxes and prepare for the new tax laws and rates. For more information on how to prepare for the Fiscal Cliff and how you can prepare for it, visit the IRS website or consult your tax or financial advisor.