Tax planning is complicated. But here are some tips that could help, with the caveat that you should consult your advisor on your own situation:
1. Utilize income and deduction strategies
For individuals, income is taxable when it is received and expenses are deductible in the year that they are paid. It may make sense to accelerate or postpone income from year to year so the income is taxed in a lower tax bracket. One way to defer income includes waiting until after the end of the year to take discretionary distributions from IRAs. Whether you’re eligible depends on your age, so check first.
A common approach to income timing involves the sale of publicly traded securities. While the purchase or sale of a security should primarily be based on its investment value, the timing of the sale is important. In years in which you have recognized capital losses, it can be smart to harvest capital gains to offset losses.
Deduction timing is also an important part of year-end planning. In high income years, it may be advantageous to pay deductible expenses before the end of the year. If 2014 is a low income year, it might be better to defer those payments until they are due in 2015.
2. Time your charitable contributions
Donations can be timed to correspond with the level of income in any given year.
The actual deduction for the contribution is subject to myriad complex rules. Check with your tax preparer.
But generally, contributions can range from gifts of cash to transfers of stock and property directly to charity. Gifts of appreciated securities can be especially beneficial, as the transfer of appreciated securities avoids the recognition of any capital gains that would have been recognized if the stock had been sold and the proceeds given to charity.
A gift to charity made by check need only be mailed by year end. Remember to keep the required acknowledgement from the charity for gifts of $250 or more.
3. Maximize 401(k) retirement plan contributions
Take full advantage of employer-provided retirement benefits. Make sure you have contributed the minimum amount necessary to your 401(k) plan to receive any matching contributions from your employer.
4. Utilize annual exclusion gifts
The end of the year is a time when many focus on giving to family and friends. The most common method of tax-free giving is the annual exclusion gift. In 2014, each individual is permitted to make outright gifts of $14,000 in cash or property to an unlimited number of people without incurring gift taxes or using part of the lifetime gift tax exemption amount. The gift must be delivered to the recipient by the end of the year.
Individuals can also make direct payments of tuition to educational institutions and unreimbursed medical expenses to healthcare providers for any person without incurring any liability for gift taxes.
5. Consider 529 Plan contributions
The end of the year is also a good time to create 529 Education Plans for the “new additions” to the family during the year, or to fund existing plans. Income accumulated in a 529 Plan is not subject to federal income tax and will never be subject to income taxes so long as the funds are used for qualified education expenses of the plan beneficiary. Special rules even allow a donor to transfer five times the annual gift exclusion amount ($70,000 in 2014) to the 529 Plan.
6. Take advantage of low interest rates
Another strategy is one family member lending money to another family member. The minimum interest rate that a family member must charge another family member is significantly lower than commercial lending rates. The loan could be for any reason, including the purchase of a home or starting a new business.
7. Remember filing requirements for household staff
Someone providing household services to you may be your employee, depending on the type of services rendered and how much control you have over how the person performs the service. If you paid the employee more than $1,900 during the year, you are liable for the Social Security and Medicare taxes for that employee and must file a Form W-2 for the employee. The taxes are paid with your income tax return. Also, review your homeowners’ insurance policy to make sure a household employee is covered if there is an accident.
8. Plan for the Medicare Surtax on investment income
Review your portfolio to determine if losses should be harvested to offset capital gains.
9. Prepare for extension of IRA charitable rollover
Last week Congress extended the IRA Direct Charitable Distribution, sometimes called “rollover,” for this year. People age 70½ or older are permitted to transfer up to $100,000 directly from an IRA to qualified charities without recognizing income or taking a charitable deduction. The transfer also counts to satisfy all or part of the required minimum distribution for this year.
10. Review your estate plan annually
Everyone should have a plan in place that reflects their wealth distribution desires after they die. The tax exemption will increase to $5.4 million in 2015, which gives the opportunity to make additional gifts to family members or trusts for their benefit. You should periodically review your documents with your advisors to make sure they are up to date and your disposition plan is tax efficient.
There are other documents that need to be reviewed each year. Beneficiary designations for insurance, qualified retirement plans, and IRAs should be examined on a regular basis. The end of the year is also a good time to review your insurance coverage.
Donna Barwick is vice president of wealth management firm Wilmington Trust in Atlanta.
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