Why ruin your day by thinking about taxes in December when you can put the subject off until next spring? As unpleasant as it may be, doing some advance work before the end of the year can save you money when tax time does arrive next year. Consider the following ways that you may be able to save.
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- Time Your Cash Flow – Try to time your income and expenses for tax-savings by deferring income from December until after the first of the year, and vice versa for expenses. By doing so, you can reduce your adjusted gross income (AGI) for 2015 and reduce your tax bill for next April.
On the income side, you could ask your employer to hold off on any year-end or holiday bonuses until after December 31st (although for the same tax reasoning they would prefer to give it to you early). The self-employed should consider billing late in December to avoid receiving payments until the new year (assuming payments are not electronic and instantaneous). Remember that if you do receive paper checks before December 31st they are considered 2015 income even though you may not deposit or cash them until January.
Take the reverse strategy toward moving your expenses. If you can, move up any tax-deductible purchases or expenses such as your January mortgage payment into December. Make your charitable contributions (don't forget the receipt) and pay any deductible property taxes before the end of the year to maximize your 2015 tax advantage.
This strategy could change if your AGI approaches the phase-out income for itemized expenses. For the 2015 tax year, the phase-out begins at $258,250 in individual income or $309,900 for married filing jointly. If your AGI is approaching the threshold, you may want to take the opposite strategy and delay deductible expense payments into January. You may be able to stay below the threshold and preserve this year's deductions while using the deferred payments for deductions in the 2016 tax year.
- Check Alternative Minimum Tax (AMT) Exposure – The AMT is a completely different method for calculating taxes that affects moderately high earners and above. Adjustments to your taxable income are made for certain items. The 2015 tax year AMT exemption amount is $53,600, or $83,400 for married couples filing jointly. You must calculate your taxes both ways and pay the higher of the two amounts.
Do some early calculations to see if your income may trigger an AMT calculation. If so, see if you can make changes before the end of the year to your deductions, exclusions, or exemptions to avoid AMT altogether. Timing of items like your state income taxes may be critical — pre-pay them before December 31st if it's to your advantage. Seek the help of a qualified professional such as a CPA if necessary.
- Make Additional Retirement Plan Contributions – Following this strategy brings dual benefits — your tax bill for 2015 goes down and your retirement savings go up. Any 401(k) contributions made before the end of the year reduces your taxable income. For 2015, you can contribute up to $18,000, or $24,000 if you are age fifty or older.
With a traditional IRA, remember that you can wait until next April 15th and still make a tax-deductible contribution that applies to the 2015 tax year. For the self-employed who have a SEP-IRA, you can make tax-deductible contributions and apply them to the 2015 tax year until your 2015 return is due (including extensions to the due date).
- Watch ACA Taxes – The Affordable Care Act (ACA) instituted two taxes on higher earners to help with funding. If your modified AGI is greater than $200,000 if single or $250,000 if married filing jointly, you will be subject to the additional Medicare tax and the Net Investment Income Tax (NIIT). Both are flat taxes.
NIIT is a 3.8% tax that high earners must pay on various investment incomes, including interest, dividends, royalties, annuities, capital gains, rents, and pass-through income generated by partnerships and S-corporations. NIIT is applied over and above regular income taxes. The additional Medicare tax of 0.9% is applied straightaway to earned income, whether traditional wages or income from self-employment.
You may be able to avoid these taxes by shifting investments that derive income into tax-deferred retirement plans such as IRA's and 401(k)s to drop below the threshold. Interest income from municipal bonds is NIIT-exempt, so switching to munis from taxable bonds may help. You can also try the strategy of deferring salary and/or advancing expenses as outlined above.
- Monitor Federal/State Withholdings and Estimated Tax Payments – Avoid penalties for underpayment by making sure that you have enough in taxes withheld from your monthly paycheck, or paid via estimated taxes. Check it now while you have time to adjust withholding and make a difference.
- If your 2015 income is greater than 2014 income, you can use the safe harbor rule. By paying at least 110% of the 2014 federal tax amount on time, you can pay the rest of 2015's bill on April 15th without incurring penalties or interest.
We understand that taxes are not one of your favorite things to think about as winter arrives. However, investing some time now to investigate your year-end tax options could bring you a springtime full of blossoming financial returns to enjoy along with your flowers.