As the end of the year approaches, individuals and businesses have an opportunity to review their financial situation and take steps that could impact their tax obligations. Proactive tax planning before the new year can help you optimize your deductions, adjust your income strategies, and prepare for the upcoming tax season. By considering key tax moves before the year closes, you might be able to manage your financial position more effectively.
Reviewing Income and Deductions
One of the first steps in end-of-year tax planning is assessing your taxable income and deductions. Taxpayers who anticipate changes in their income levels may consider strategies such as:
- Deferring Income: If expecting a lower tax rate in the following year, delaying bonuses, freelance payments, or business income until January could reduce the current year’s taxable income.
- Accelerating Deductions: Making deductible payments before year-end, such as mortgage interest, medical expenses, or state and local taxes (subject to limitations), could increase deductions for the current year.
Making Contributions to Retirement Accounts
Contributing to retirement accounts before the end of the year can have tax advantages. Some options include:
- 401(k) Contributions: Employees may contribute up to the annual limit, potentially reducing taxable income.
- Traditional IRA Contributions: Contributions made by the tax filing deadline may be deductible, depending on income level and participation in employer-sponsored plans.
- Roth Conversions: Converting a traditional IRA to a Roth IRA before year-end could lock in the current tax rate, though it will generate taxable income for the year.
Reviewing Investment Gains and Losses
Tax-loss harvesting1 is a strategy that involves selling investments at a loss to offset gains and potentially reduce taxable income. Key considerations include:
- Offsetting Capital Gains: Selling underperforming assets may potentially help offset taxable capital gains from other investments.
- Avoiding the Wash-Sale Rule: Investors planning to repurchase the same or similar security within 30 days should be aware that doing so may disqualify the loss for tax purposes.
- Rebalancing Portfolios: Adjusting investment allocations before year-end can align with financial goals while also addressing potential tax implications.
Taking Advantage of Charitable Giving
Charitable contributions made before December 31 may be deductible for those who itemize deductions. If that applies to you, consider:
- Donating Cash or Appreciated Assets: Contributions to qualified charities may provide a deduction based on the donation’s value.
- Using a Donor-Advised Fund: A lump-sum contribution to a donor-advised fund2 allows taxpayers to claim a deduction in the current year while distributing funds to charities over time.
- Qualified Charitable Distributions (QCDs): Individuals age 70½ or older may direct distributions from an IRA to a charity, which can count toward required minimum distributions (RMDs) without increasing taxable income.
Addressing Required Minimum Distributions (RMDs)
If you have reached the required age for RMDs from your retirement accounts, failing to withdraw the necessary amount by year-end could result in penalties. Steps to consider include:
- Calculating RMDs Accurately: Reviewing account balances and withdrawal requirements can help avoid penalties.
- Exploring Distribution Timing: Taking RMDs earlier or later in the year may align with overall tax strategies.
Reviewing Business Year-End Tax Planning Strategies
Business owners can take various end-of-year actions to adjust their taxable income, including:
- Purchasing Equipment: Buying necessary business equipment before year-end could qualify for deductions under Section 1793 or bonus depreciation rules.
- Deferring or Accelerating Income and Expenses: Depending on cash flow and projected tax rates, shifting revenue or expenses between years could influence tax liability.
- Funding Retirement Plans: Business owners may contribute to retirement accounts, such as SEP IRAs or Solo 401(k)s, to reduce taxable income.
Considering Health Savings Account (HSA) Contributions
Contributions to HSAs offer tax advantages, including potential deductions and tax-free withdrawals for qualified medical expenses. You can:
- Make Contributions Before Year-End: Depositing funds into an HSA up to the annual contribution limit may provide tax benefits.
- Use HSA Funds Strategically: Withdrawals for eligible expenses remain tax-free, while unused funds roll over to future years.
Evaluating Tax Withholding and Estimated Payments
If you have experienced income changes during the year, reviewing tax withholding and estimated payments can help prevent underpayment penalties. Steps to take include:
- Adjusting W-4 Withholding: Employees who have had a change in income, deductions, or family status may need to update their W-4 form.
- Making Estimated Tax Payments: Self-employed individuals or those with significant non-wage income may consider making a final estimated tax payment before the year ends to avoid penalties.
Keeping Records and Planning for the Next Year
Organizing financial documents before year-end can make tax filing smoother. Considerations include:
- Gathering Deduction and Credit Documentation: Keeping receipts and records of deductible expenses, charitable contributions, and business expenses can simplify tax preparation.
- Reviewing Changes in Tax Laws: Staying informed about new tax regulations may help in planning future tax strategies.
- Setting Financial Goals for the Upcoming Year: Reflecting on financial progress and adjusting tax-related strategies can contribute to long-term planning.
Year-End Tax Planning Strategies: The Bottom Line
End-of-year tax planning gives you an opportunity to review financial decisions and make any adjustments that could impact your tax liability. By considering strategies such as adjusting income and deductions, contributing to retirement and health savings accounts, reviewing investment positions, and addressing business tax opportunities, you can take proactive steps before the new year.
Sources:
- [1] https://www.nerdwallet.com/article/taxes/tax-loss-harvesting
- [2] https://www.investopedia.com/articles/managing-wealth/080216/donoradvised-funds-benefits-and-drawbacks.asp
- [3] https://www.nerdwallet.com/article/taxes/section-179-deduction
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Megan Jones joined the ILG Financial team in 2020 as marketing director. Megan and her husband live in Fredericksburg, VA with their German Short Haired Pointer, Gus. Megan is a graduate of Longwood University and holds a degree in communications. Megan is the oldest of Dave Lopez’s three children and not only enjoys working alongside her father, but also with her cousin, Chase, who joined the ILG Financial team in 2020 as an advisor. Megan is also a fully licensed Life, Health, and Annuity agent. When not at work, Megan enjoys sitting on the back porch with family and friends enjoying food and music.
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Chase Lopez joined the ILG Financial team in 2020 as an advisor. Chase is a 2016 James Madison University graduate with a degree in management. Chase has been trained under the tutelage of Dave Lopez, who is not only the founder and managing member of ILG Financial, but also is Chase’s uncle and godfather. He also enjoys working alongside his cousin, Megan, who is Dave’s daughter.