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Lower Your Tax Bill with Year-end Planning

As the end of the year draws near, the last thing anyone wants to think about is taxes. But if you are looking for ways to minimize your tax bill, there's no better time for tax planning than before year-end. That's because there are a number of tax-smart strategies you can implement now that will reduce your tax bill come April 15.

As the year begins to draw to a close, consider how the following strategies might help to lower your taxes.

Maximize Contributions to Tax-Advantaged Accounts

Contributing to your employer sponsored retirement plan such as 401(k)s and 403(b)s is one of the smartest tax moves you can make. For 2016 you can defer as much as $18,000 of pre-tax income towards your retirement, essentially, reducing your taxable income for the year.  If you are age 50 or older, you can shelter an additional $6,000 for a total income reduction of $24,000.  Additionally, the money in the account is allowed to grow tax deferred until you begin taking withdrawals, usually in retirement.1

If you are interested in supplementing your contributions to your employer's plan, consider funding a traditional IRA. You can contribute up to $5,500 in 2016, and an additional $1,000 catch-up contribution if you are 50 or older. Like 401(k)s, IRAs offer a "one-two punch" in tax savings: tax deferral on your investment until you start withdrawing money, along with a potential tax deduction on all or part of your annual contribution if you meet the IRS's eligibility rules.  However, keep in mind that IRA contribution deductions (tax benefits) are phased out above certain income levels, depending upon your filing status and if you or your spouse are covered by an employer-sponsored retirement plan. 

If you’re subject to a phase-out of tax deductions, consider directing your savings to a Roth IRA or a Roth 401(k), if offered by your employer. Although contributions to Roth retirement vehicles are made with after-tax dollars, the future withdrawals (including investment gains) are tax free, provided certain conditions are met. Keep in mind that those with higher annual household incomes may be unable to make a Roth IRA contribution, so check with your CPA.

Put Losses to Work

If you expect to realize either short- or long-term capital gains, the IRS allows you to offset these gains with capital losses.  This strategy of minimizing your exposure to capital gains tax is often referred to as tax-loss harvesting.  Short-term gains (gains on assets held less than a year) are taxed at ordinary rates, which range from 10% to 39.6%, and can be offset with short-term losses.  Long-term gains (gains on assets held longer than a year) are taxed at a top rate of 20% and can be reduced by long-term capital losses.2  To the extent that losses exceed gains, you can deduct up to $3,000 in capital losses against ordinary income on that year's tax return and carry forward any unused losses for future years.

Given these rules, there are several actions you should consider:

  • Avoid short-term capital gains when possible, as these are taxed at higher ordinary rates. Unless you have short-term capital losses to offset them, try holding the assets for at least one year.

  • Take a good look at your portfolio before year-end and estimate your gains and losses to date. Strategize with your financial advisor how you can offset gains and losses to minimize your capital gains tax.

  • Consider taking capital losses before capital gains, since unused losses may be carried forward for use in future years, while gains must be taken in the year they are realized.

When evaluating whether or not to sell a given investment, keep in mind that a few down periods don't mean you should sell simply to realize a loss.  Stocks in particular are long-term investments subject to ups and downs.  Moreover, taxes should only be one consideration in any decision to sell or hold an investment.  If you are considering employing this strategy, evaluate carefully the investments you may select for sale, then discuss your plan with a trusted financial advisor.

Consider a Qualified Charitable Distribution (QCD)

An important year-end consideration for older IRA holders is whether or not they have taken required minimum distributions (RMDs). The IRS requires account holders aged 70½ or older to withdraw specified amounts from their traditional IRA each year. These amounts vary depending on your age, increasing as you grow older.

Some retirees have a steady income stream from Social Security or a pension plan and don’t actually spend their RMDs to cover daily living expenses.  However, meeting the IRS requirement of taking an annual IRA distribution can increase your adjusted gross income (AGI).  This can increase your taxable income, push you into a higher income tax bracket, increase your Medical premium rates (based on annual income), etc. 

For those with high income sensitivity, a strategy of direct gifting your RMD to a non-profit organization might be the key.  A Qualified Charitable Distribution (QCD) is a nontaxable distribution made directly from your IRA to an organization eligible to receive tax-deductible contributions.  You must be at least age 70 ½ when the distribution is made. The QCDs count towards your IRA required minimum distribution.

A QCD is generally nontaxable to you, the donor, up to a maximum annual exclusion limit.  This allows you to stretch your dollars because you can gift pre-tax money directly to a charity that is eligible to receive the gift without paying taxes on the funds.  In other words, your AGI can be unaffected and your Required Minimum Distribution has been met, a win-win.

Regardless of what Congress does in the future, there are many steps you can take today to help lighten your tax burden. Work with a Certified Financial Planner and CPA to see what you can do now to reduce your tax bill in April. 

Source/Disclaimer:

1Withdrawals from traditional IRAs are taxed at then-current income tax rates. Withdrawals prior to age 59½ may be subject to an additional federal tax.

2Under certain circumstances, the IRS permits you to offset long-term gains with net short-term capital losses. See IRS Publication 550, Investment Income and Expenses.

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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