Part 1: The Basics of Effective Year-End Tax Planning
As the calendar year winds down, taxpayers have a golden opportunity to evaluate their financial situation and implement strategies to reduce tax liabilities. Whether you are managing significant wealth or working toward financial stability, year-end tax planning is a critical step in ensuring your financial health. This article explores key considerations to lay a solid foundation for year-end tax planning success.
1. Understand Your Current Tax Situation
The first step in effective tax planning is understanding where you stand. Start with these essential tasks:
- Income Analysis: Calculate your total taxable income to determine your marginal tax bracket. Knowing your bracket can help you decide between strategies like deferring income to lower future tax burdens or accelerating deductions to take advantage of higher current-year rates.
- Tax Withholding and Payments: Evaluate your tax payments through paycheck withholding or estimated tax payments. Falling short could result in penalties, but you can avoid this by meeting the IRS’s “safe harbor” rule—paying at least 90% of this year’s tax liability or 100% of last year’s, whichever is lower.
Take time to review your most recent pay stubs, tax forms, and financial documents to gain clarity about your current obligations and potential opportunities.
2. Optimize Deductions and Credits
Deductions and credits can have a significant impact on your tax liability, but it’s important to use them strategically:
- Charitable Contributions: Giving to qualified charities can lower taxable income. Monetary donations are straightforward, but non-cash contributions, like clothing or household items, require proper valuation and detailed records. If you’re contributing securities, donating appreciated assets can avoid capital gains taxes while providing the full deduction for the fair market value.
- Bunching Deductions: If your itemized deductions, such as mortgage interest, medical expenses, or state and local taxes, fall just below the standard deduction, consider “bunching” them into a single year. For instance, paying property taxes early or scheduling elective medical procedures in December could help you exceed the threshold.
- Tax Credits: Unlike deductions, which reduce taxable income, credits provide a dollar-for-dollar reduction in tax owed. Investigate credits like the Child Tax Credit, Education Credits, or the Earned Income Tax Credit. Retirement savings credits, like the Saver’s Credit, can further reduce taxes while encouraging long-term savings.
3. Use Tax-Loss Harvesting
For those with investments, tax-loss harvesting can help offset taxable gains:
- Realize Losses: Selling investments at a loss can offset capital gains from other assets. If losses exceed gains, you can apply up to $3,000 annually against other income, with unused losses carrying forward indefinitely.
- Avoid the Wash-Sale Rule: Be cautious about the IRS’s wash-sale rule, which disallows claiming a loss if you repurchase the same or substantially identical investment within 30 days before or after the sale. Plan sales and repurchases carefully to comply with this rule.
Other Considerations
Keep an eye on deadlines, as most tax-saving opportunities must be completed by December 31. This includes making charitable contributions, completing tax-loss harvesting transactions, and ensuring your withholding aligns with your tax obligations.
By taking these foundational steps, you’ll better understand your financial situation and uncover potential savings opportunities. Part 2 of this series will dive into retirement contributions and income deferral strategies to further enhance your year-end tax planning.
Financial Enhancement Group is an SEC Registered Investment Advisor.
