As another year draws to a close, taxpayers everywhere need to take stock of their income, deductions and credits for the year and take the necessary steps to minimize their tax bills for 2018. Here is a list of things you can do before you ring in the New Year to reduce the amount you owe Uncle Sam and pump up your refund.
Before You Start
Get a rough sense of where you're going to be next year, by estimating what you expect your taxable income to be. Think about wages, investment income, side gigs and any pensions or other payments you expect to receive.
Next, figure out whether you can itemize your deductions this year. Note that the Tax Cuts and Jobs Act has massively changed the math about whether itemizing makes sense. Starting with tax year 2018 – the taxes you're about to file – the standard deduction virtually doubles to $12,000 for individual filers (from $6,500), $18,000 for heads of household (from $9,550) and $24,000 (from $13,000) for married filing jointly and surviving spouses. In high-tax states, the non-itemizing trend will likely be enhanced because the amount you can deduct for state and local taxes (SALT) has been capped at $10,000 (it was previously whatever those taxes were).
Once you have decided whether you'll itemize, review the following list and see if any of these strategies will help you minimize what you owe.
1. Get Deductions in Writing
If you have made any type of charitable contribution this year, get a written receipt from the receiving organization for your records (to deduct donations of more than $250, a receipt is required by the IRS). The IRS now requires filers to break down their contributions on Schedule A and be able to furnish proof that their contributions – and deductions – are genuine.
If your noncash gifts, such as clothing or other tangible property exceed $500 in total value, you will now have to include Form 8323 with your return in order to claim the deduction. The amount that you can claim must equal the proceeds paid to the charity when your item or items are sold. The charity will furnish you with a Form 1098-C when this happens. However, if your donations are not sold before the end of the year, you will have to wait until they are before you can deduct them. For more, see the IRS information on substantiating non-cash contributions.
2. Defer If You Can't Itemize
If it looks like you won’t be able to itemize your deductions this year, consider deferring substantial year-end charitable contributions until next year if you think you may have a better chance of being able to write them off. This could, for example, enable to double next year's contribution, making it large enough to give you a better chance of qualifying for itemization.
This also goes for unreimbursed medical expenses and other types of deductible transactions or expenses over which you can control the timing. (Note that this year, unreimbursed medical expenses in excess of 7.5% of adjusted gross income are deductible for all taxpayers – not just those aged 65 or older. Starting next year, the threshold reverts to 10%, as under the previous law.)
Remember that if you make a charitable gift in December with your credit card and then pay it off later, it will be deductible for the month/year in which it was purchased.
Conversely, if you can itemize this year, but it looks like you won’t be able to do so next year, consider paying expenses that you could deduct next year now, such as charitable contributions, estimated quarterly state tax payments, medical expenses and property taxes. This could beef up your refund for this year with no corresponding reduction the following year, given that you probably won't be able to itemize them anyway.
3. Time Your Gains and Losses
Work with your tax planner and investment advisor to determine when and how to sell any appreciated or depreciated securities so that you can minimize gains and maximize losses. To deduct losses, you must be able to write them off against gains. Generally, you must be able to write off losses from selling securities you held long-term (for more than a year) against gains you made from selling other long-term securities. Winners and losers you held short-term (one year or less) must be treated the same way. You will then compute your net long- or short-term gains and losses against each other to arrive at a final net short- or long-term gain or loss.
If you are simply selling losers to write off against winners for 2018, be sure to place all your trades by the last business day of December at the latest in order to have them count for this year. There's a $3,000 limit on how much you can write off in one year on stock losses against your ordinary income; if you lost more, you may be able to deduct the remaining balance on your 2019 taxes.
One strategy it's too late to employ: selling securities that lost money, then buying them back before year-end, in order to realize the loss. The IRS Wash Sale Rule requires sellers to wait for at least 31 days to buy back losing holdings.
4. Choose Your Cost Basis Carefully
There are several different ways to compute your cost basis, but the method you choose from one year to another can sometimes make a big difference in your taxes.
For example, if you sell a lot of shares at a very large profit and must declare this income, you may have the option of choosing to use an identical number of shares that were purchased at a higher price as the basis if they have not been used already. (The rules for this can be complicated in some cases and may require professional assistance.)
If you don’t have any lots that you can use for basis at a decent price, consider simply donating some or all of your appreciated shares to charity. You can take a deduction for the full fair market value up to certain limits and escape capital gains taxes altogether as long as you have owned the securities for more than a year. This can be done in lieu of a cash donation, which may ease your holiday budget. Calculating and reporting cost basis will be easier from now on, as financial firms have been required by law to supply this information for all of your buy and sell transaction each year.
5. Realize Income, If Necessary
If your income this year turned out to be substantially less than you had anticipated, then you may be wise to sell appreciated securities or convert a traditional IRA or retirement plan into a Roth account. This can allow you to use up tax credits, deductions and exemptions that you might otherwise miss out on.
For example, if you were laid off in February and couldn’t find another job until Thanksgiving, your combined exemptions, deductions and credit may well exceed your income for the year. You can use this opportunity to effectively reduce or eliminate your tax bill on your appreciated securities or Roth conversion by doing it now and crediting your deductions against it.
6. Make or Increase Retirement Plan Contributions
You can make IRA contributions for 2018 until the filing deadline next April, but your 401(k) or 403(b) contributions must go in by December 31, 2018. If you're 50 or older, remember that you can make catch-up contributions to most plans that will increase your tax deduction.
7. Buy for Next Year, Deduct This Year
If you're a business owner or have professional expenses that you can deduct, make upcoming necessary purchases or expenditures by the end of 2018. This will allow you to write them off for 2018 instead of next year, and thus reduce your income. This can make an especially large difference if you are buying a major item for which the purchase price can be expensed in 2018.
As already noted, the new tax laws have made significant changes starting in tax year 2018. Be sure to check the fate of the tax breaks that apply to you – and make whichever end-of-year accommodations could help you when you file your taxes. You may not be able to itemize this year because of the new higher standard deductions, and personal exemptions have also been eliminated.
The Bottom Line
Don’t be one of those unlucky tax filers who end up asking, when they file several weeks from now, “Why didn’t I do that in December?” Except for IRAs, now is your last chance to take action to reduce your tax bill for 2018, so don’t wait any longer. For more information on how you can reduce your taxes, consult your tax planner or financial advisor. If you're self-employed, also check into additional benefits for your tax situation.