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Year End Income Tax Planning

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Once you’ve reached the last month of the tax year, there aren’t a lot of things that can be done to minimize your income taxes.  But there are a few things that could be done.

For example, you could double up your real estate taxes by prepaying next year’s tax during December.  Doing this with, for example, a $3,000 per year real estate tax bill could result in a reduction of tax for the year of $750 if you’re in the 25% bracket.  Keep in mind though, that you’ll have forked out this money long before it is actually due in most cases, and for the next year you won’t have this deduction available if you used it in this year.

The same could be done with your charitable contributions – there’s no reason that you can’t make additional contributions to your favorite charities at the end of this year instead of waiting until next year.

You could also send your final estimated state income tax payment due in January of next year during December and claim that payment on this year’s itemized deductions as well.

Prepaying your January mortgage payment will credit that mortgage interest to this year as well, further increasing your itemized deductions.

Other itemized deductions could be “stacked” in one year, such as medical expenses (subject to the 7.5% floor) and miscellaneous deductions (subject to the 2% floor).

It’s important to keep in mind that the moves that you make this year might reduce your tax now – but you might have an adverse impact on next year’s income tax by doing so.  It will pay to run the calculations based on what you know about this year’s tax and next year’s tax to make sure that it is in your best interest to do this.

Here’s how it might play out: if you prepaid your next year’s real estate tax during this year, it might reduce your deductions below the Standard Deduction – which could be a good thing.  In doing this, you would get to use the Standard Deduction to increase your tax deductions on next year’s return when you specifically reduced your deductions for that year by prepaying the deductible real estate tax in during this year.  In this fashion you might be making the most of the standard deduction and your itemized deductions year after year – one year using the “stacked” deductions, the next using the standard deduction.

These prepayment options could have a negative affect if you are subject to the Alternative Minimum Tax (AMT).  Prepaying your state tax, mortgage interest and some medical expenses might trigger or cause an increase in AMT.

One tactic that you might consider is selling a taxable investment that has an inherent loss; this is especially useful if you’ve sold another investment at some point in the tax year that has resulted in a taxable gain.  Losses can be used to offset those capital gains dollar for dollar, and an additional $3,000 in capital losses can be used to reduce your ordinary income as well.

You can also make up for underpayment of estimated tax by taking a withdrawal from an IRA (especially if you’re over age 59½) and having tax withheld from the withdrawal.  This can also be accomplished by having more tax withheld from your paycheck if you’re still working, by filing a new W4.

Another move you can make includes the Qualified Charitable Distribution from your IRA – allowing you to bypass recognizing that income, including your RMD.  This can only be done if you’re at least age 70½ and subject to Required Minimum Distributions.

You can also delay your first RMD (if you reached age 70½ this year) until as late as April 1 of next year, although that will mean you have to take two RMDs next year.  But in some circumstances that may be the better option.

You can also make a deductible contribution to your IRA, if you qualify – but you don’t have to do that before the end of the year, you have until April 15 to do that.

This isn’t an exhaustive list of year-end tax moves, just several of the more prominent ones.  Hopefully you’ll find what you need here to help with your year-end tax plans.

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5 Comments

  1. Your readers may also be interested in what are called charitable remainder trusts. These trusts are used to place monies in trust for the benefit of the donor and the tax-exempt organization. Basically, the donor (and his wife if desired) can be paid an income from the trust for their lives or for a term of years. When this time frame ends the charity named as the residual beneficiary gets the balance in the trust. The advantage for the donor is that they reserve income to themselves and get a tax deduction in the year the trust is funded for the actuarial value of the residue going to charity. There are various types of charitable remainder trusts and the provisions can be fine tuned to meet various needs.
    Finally there is something called a charitable lead trust, that works in the opposite way; the charity is paid first and for a number of years and then the balance goes to family or other non-charitable remainder beneficiaries.

    1. jblankenship says:

      Thanks, Steven – the charitable remainder and lead trusts are very good options to consider.

      jb

  2. Chris says:

    The latter you wait the more limited you are for year end adjustments

    Chris
    Owner
    Cel Financial Services
    Please visit my website at Income Tax Fillmore for your tax needs.

  3. clydewolf says:

    I have one more item.

    For those that are in the RMD age range, and have a Tax Deferred 401k, 403b or IRA, we have until December 31, 2011 to make a Qualified Charitable Distribution QCD. We can make QCDs for a total value of $100,000. The money can be given to one or several organizations.

    The QCD does not show on our 2011 tax return as income. And we can not take a deduction for this charitable contribution. The QCD will lower the 2011 year end balance in our tax deferred account, and therefore will also lower our 2012 RMD, saving us tax dollars on our 2012 tax return.

    The charity, receives a donation. We can feel good about helping our favorite charity, And we help to lower our RMD and tax bill for 2012. This opportunity goes away on December 31, 2011. Under current law, the QCD option will not be available after that date.

    1. jblankenship says:

      Thanks for the addition, clydewolf!

      Since this is the last year (again) for the QCD it should be utilized by anyone who is in a position to do so.

      jb

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