Effective planning requires that you have a good understanding of your current tax situation, as well as a reasonable estimate of how your circumstances might change next year. There’s a real opportunity for tax savings when you can assess whether you’ll be paying taxes at a lower rate in one year than in the other.
One of the easiest ways to lower your taxes is to reduce your taxable income. Pretax contributions to a traditional IRA or an employer-sponsored retirement plan such as a 401(k) reduce your taxable income. (Remember that this does not apply to Roth IRA contributions.) You may also be able to lower your 2014 income by deferring a year-end bonus or by delaying the collection of business debts, rents and payments for services.
As you think about deferring income, be careful once you reach age 70½ when you generally must start taking required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans. Be sure to take any distributions by the date required (the end of the year for most individuals). The penalty for failing to do so is 50% of the amount that should have been distributed.
Properly timed deductions can help to reduce your taxes too. Relevant deductions include medical expenses, qualifying interest and state taxes. Another factor is your expected adjusted gross income (AGI). If your AGI exceeds specified values ($254,200 if single, $305,050 if married filing jointly, $152,525 if married filing separately and $279,650 if filing as head of household), your personal and dependent exemptions may be phased out and your itemized deductions may be limited.
And, of course, there’s alternative minimum tax (AMT). This is essentially a separate federal income tax system with its own rates and rules. If you’re subject to the AMT, traditional year-end maneuvers such as deferring income and accelerating deductions can actually have a negative effect. For example, if you’re subject to the AMT in 2014, prepaying 2015 state and local taxes probably won’t help your 2014 tax situation, but could hurt your 2015 bottom line.
A host of popular tax provisions, commonly referred to as “tax extenders,” expired at the end of 2013. These include deducting state and local sales taxes in lieu of state and local income taxes; the above-the-line deduction for qualified higher-education expenses; qualified charitable distributions (QCDs) from IRAs; and increased business expense and “bonus” depreciation rules. Also, it’s important to be aware of late-in-the-year tax legislation. In short, it normally pays to discuss your tax situation with a tax professional and a financial planner. Guidepost Financial Planning would be pleased to review your tax situation with you. Please visit our website or give us a call at 970.419.8212 so that we can discuss your financial goals in a no-charge, no-obligation initial meeting.
This article is for informational purposes only. This website does not provide tax or investment advice, nor is it an offer or solicitation of any kind to buy or sell any investment products. Please consult your tax or investment advisor for specific advice.