As we approach the end of another tax year, it is beneficial to consider certain actions that can not only result in a lower tax bill this year, but also in the years to come. Below are a number of strategies you may wish to utilize prior to December 31:
Take advantage of preferential capital gains rates – For those individuals whose income falls below $38,600 ($77,200 for married filing jointly), long-term capital gains are taxed at 0%. With this in mind, you may wish to consider realizing enough gains to “fill up” the bottom capital gains bracket and therefore pay no capital gains taxes on that income. However, be careful as an increase in Adjusted Gross Income (AGI) can affect taxability of Social Security, itemized deductions subject to thresholds, charitable deductions, credits, etc.
Harvest losses – If you anticipate having large capital gains this year, they can be offset by selling other positions at a loss. This can be especially beneficial in situations where the gains will be subject to the higher rate (20%) and/or the 3.8% Medicare Surtax. In addition to mitigating capital gain income, you can also offset up to $3,000 in ordinary income and carry the remaining balance forward for future tax years. Finally, reducing net gains will also reduce AGI which can have a positive effect on certain deductions. An important reminder when utilizing this strategy is to avoid the wash sale rules – this means that if you sell an investment at a loss, you must wait 30 days (either before or after) to purchase that same investment.
Convert your Traditional IRA – If you think you might be entering a higher tax bracket in the future, will be in a lower than normal bracket this year, or think tax rates will rise, it might make sense to convert your Traditional IRA to a Roth IRA. This will allow tax-free growth of your money and future qualified distributions will be tax-free (assuming you meet the necessary qualifications). This strategy can also be beneficial in situations where your account has lost money but will likely recover; a conversion will result in less taxes payable than otherwise would be due to the diminished balance. Consider pairing this strategy with a charitable donation (below) to at least partially offset taxes due on the conversion. Remember – the conversion of a Traditional IRA to a Roth IRA is irrevocable. You cannot undo the conversion once it is made.
Donate to charity – For those who itemize deductions (or plan to) and are charitably inclined, donating cash or property to a qualified organization can have a sizeable impact on your tax bill. In general, contributions to charity can be deducted by up to 60% of AGI, but a 30% limitation may apply to certain organizations. Now that the standard deductions are higher, it will be more important to bunch charitable contributions in the same year to be able to itemize. One way to do this is by utilizing a donor-advised fund. In addition, the IRS allows tax-free Qualified Charitable Distributions (QCDs) directly from your IRA to a charity of your choice in lieu of taking a traditional RMD. To utilize QCDs, taxpayers must be over 70½ and up to $100,000 can be transferred.
Increase retirement plan contributions – Even though it is the end of the year, there is still time to save! If you find yourself with extra income, make sure to contribute any excess to your retirement plan during the last few pay periods; if you receive a year-end bonus, you can also re-direct a portion of that to your retirement plan. Not to mention, you may qualify for a higher employer match.
Remember your RMDs – If you are older than 70½, make sure to take your Required Minimum Distribution from your retirement plans and inherited IRAs. While the IRS tends to be fairly lenient when it comes to missed RMDs, there is a chance that a potentially sizable penalty could be due (50% of shortfall) if the mistake is not forgiven.
DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firms judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.