Planning for Taxes

While taxes may be a certainty, you can minimize yours with a little planning before you sit down to file your taxes on April 15th.

Q.: What should I know about tax planning?

A.: Keep in mind the following tips:

1. Keep good records.  Good record-keeping will help you remember all of your deductions. These records help you substantiate your deductions, which you may be required to do if yours is the lucky return chosen for audit.

2. Time income and expenses to your advantage.  If you have control over income and expenses, time them to your advantage.  If you expect you will be in a lower tax bracket next year, you may want to defer some income until next year or accelerate some expenses into this year.  For example, you could prepay the second installment of your property taxes, pay the fourth quarter installment of state income taxes in December instead of January, or buy some needed business supplies.

3. Examine your investments.  Did you sell any assets this year?  If so, did you have a gain or a loss?  You may want to offset the earlier transaction with an opposite one.  For example, if you had a gain, you may want to harvest a loss to lower your taxes.  Remember, also, capital losses exceeding capital gains can be used to offset up to $3,000 of ordinary income (normally taxed at a higher rate).

4. While you are examining investments, do you have any mutual funds?  Each fund has a “distribution date” upon which it makes distributions of gains and losses.  If you do not own the fund on the distribution date, you do not get saddled with the income for tax purposes.  If you plan to sell the fund, it may be wise to do so before that distribution date, depending upon what income you expect will be distributed.  Similarly, by buying a fund right before its distribution date, you may be paying taxes on income earned by the fund before you owned it.

5. Contribute to retirement accounts.  You have until year-end to fund 401(k) and similar retirement plans with tax-deferred dollars.  You can contribute to IRAs and Roth IRAs until April 15th of the year after the year in question.  However, if you want to convert from a regular IRA to a Roth IRA, you must do so by December 31.  While Roth IRAs do not save on your current tax bill, the assets grow tax-free rather than just tax-deferred like a regular IRA.

6. Be sure to take any minimum required distributions from retirement accounts.  After you have reached age 70-1/2, almost all retirement plans have minimum required distributions.  Take at least that distribution or you could be slapped with a significant penalty.

7. Flexible spending accounts.  If you have a flexible spending account at work, typically you have until the end of the year to use it or lose it.  Therefore, to take advantage of any remaining funds in your account, you may want to schedule whatever medical appointments you can before the year ends. 

8. Charitable contributions.  Typically, it is best to make charitable contributions before year-end to get the current-year deduction in.  However, if you expect to be in a much higher tax bracket next year, it may be better to defer the contribution until it can help you more.

9. Bunching deductions.  Consider bunching deductions that are subject to floors.  For example, medical expenses must exceed 7.5 percent of your adjusted gross income before they are deductible.  If you can bunch any elective surgery, stock up on supplies, etc., you may be able to time the expenses so they exceed that threshold and make some of them deductible.

10. Traps for the unwary.  Do not forget the impact of deduction floors, deduction haircuts due to higher income, alternative minimum taxes, state taxes, etc.  Some deductions are subject to a minimum level before being deductible.  Most deductions are subject to reduction if you make too much money.  Alternative minimum taxes can kick in if you have a great many deductions.  Talk with your tax  professional about the impact of these items or use tax preparation software to look at the tax obligation for each scenario.

The information contained herein is general and should not be applied to specific legal problems without first consulting with one of our attorneys.

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