Personal Income Tax Guide: Moves To Make Before December 31
By Ken Clark
When it comes to the best tax tricks and tips out there, few dates matter more than December 31. That's because, for the most part, the return that you file on April 15 only measures what you did between January 1 and December 31 of the previous year. A couple weeks before you file your return would be too late to be figuring out that you should've contributed more to your favorite charity or accelerated your medical expenses.
Timing Your Year-End Income and Expenses
One of the most basic, but effective, tax strategies is the timing of year-end expenses and income. By controlling which side of December 31 otherwise normal expenses and income fall on, you can save yourself thousands.
Behind this strategy is the idea that many Americans are in different tax brackets in different years - some years are filled with big paychecks, while others are filled with big write-offs. This means that everything that falls on one side of December 31 might be taxed (or deducted) at a much lower or higher bracket than what falls on the other side of the New Year.
So, if you expect to have two back-to-back years in which you find yourself in very different brackets, you'll want to push all the income you can into the lower tax bracket year. Likewise, you'll want to push all the expenses you can into the higher tax bracket year. Doing so is a completely legal way to minimize the amount of taxes you'll pay on your income and maximize the after-tax value on your tax deductions.
Let's look at an example:
On December 1, Sara is informed that she will be getting a large promotion at work and will be making $30,000 more annually starting January 1. Upon doing the math, Sara realizes that most of this $30,000 raise will fall in the next highest tax bracket (25%) instead of her current tax bracket (15%).
In an effort to maximize her tax savings over the next couple of years, Sara makes a couple of very smart moves. First, she sends out the invoices for a consulting business that she runs on the side sooner than expected. She does this, because any money she receives in the current year will likely be taxed at a lower rate than if she waited to bill her clients in the New Year.
Second, she decides to hold off until after January 1 on some of her big year-end expenses such as her charitable donations and non-emergency medical procedures. By doing so she, she is ensuring that these costs are deducted against income that will be taxed at a 25% rate instead of 15%, saving herself more tax dollars in the process. (For more help on saving, see Money-Saving Year-End Tax Tips.)
According to the Generosity Index, the average American household donated approximately $3,000-4,000 per year to charitable causes over the last decade. Of course, one of the things that makes it easier to show that kind of generosity is that Uncle Sam allows taxpayers who itemize their deductions to subtract their donations from their taxable income. To encourage this generosity, which takes the pressure of the government to support valuable programs, the IRS even allows deductions for things like charitable mileage and the donation of household goods.
Of course, as with many deductions, the IRS only allows you to deduct on April 15 what you donated during the previous calendar year (January 1 to December 31). This means that if you are hoping to help yourself by helping others, you've got to make sure donations are completed by midnight on New Year's Eve.
One of the biggest planning opportunities in the area of charitable giving that doesn't matter when it is given is the donation of certain appreciated investments. The IRS allows taxpayers who have investments such as a stock, bond, or mutual fund that has gone up in value, to gift the investment to a charity while taking the write-off for the entire value. This essentially allows the taxpayer to avoid paying tax on their gains, while still taking a write-off for the full amount of the donation. This is far more favorable than making a cash gift in the same amount, while keeping the investment and eventually paying capital gains tax on the growth. (For more information, read Deducting Your Donations.)
There are few IRS penalties as brutal as the one for failing to withdraw the correct required minimum distribution (RMD) from your IRA. The penalty, set at 50% of the under-withdrawn amount, makes your RMD something you cannot afford to be wrong about. Sadly, many people get confused and assume that the withdrawal deadline (December 31) is the same as the contribution deadline (April 15).
While some younger taxpayers might be quick to dismiss this tip as something that applies only to those that have reached age 70.5 (the required age for starting distributions), the RMD rule can also apply to younger individuals who have inherited an IRA from someone else. In either case, be sure to read through IRS Publication 590 or check with your tax advisor to make sure you don't get smacked with this pricey penalty. (To learn more, see Tax Treatment of Roth IRA Distributions.)
Section 179 Deductions for Small Business Owners
One of the juiciest, but most overlooked, deductions is the Section 179 deduction for small business owners. This deduction allows small business owners (which include people running home-based business, consulting practices, etc.) to deduct the entire cost of new machinery and equipment in the year of purchase. With a six-figure limit on the size of this deduction, there is plenty of room for a small business owner to offset a large portion of the net taxable income.
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