It’s been a relatively quiet year in terms of tax legislation, but that doesn’t mean tax-planning opportunities don’t exist. There’s still time to adjust certain tax and gift strategies that can help you reduce your tax bill and ensure you’re well positioned for the year ahead. Take a few minutes to review this checklist. Then discuss it with your financial professional and tax advisor.
Carefully plan IRA rollovers. An unexpected ruling on tax law this year rescinds the long-standing “one rollover per IRA per year” rule and replaces it with a new rule (starting Jan. 1, 2015) that limits you to only one rollover in any 12-month period, regardless of how many IRAs you may have. Why is this important? The new rule effectively ends the ability to perform multiple rollovers from different IRAs. A rollover is defined as a withdrawal from your IRA and treated as a tax-free transaction if you redeposit the amount in the same or another IRA no later than 60 days after the date you received the funds. This new rule applies only to indirect rollovers; the one-year waiting period doesn’t apply in the case of “trustee-to-trustee” transfers directly from one IRA provider to another or direct rollovers from your employer-sponsored plan.
Update withholding. Check your current tax withholding and/or estimated tax payments to make sure they’re in line with your anticipated earnings. Update your withholding or estimated tax payments in light of any changes to your life, such as marriage, divorce, the birth of a child, or starting a new business. Overpaying your 2014 tax reduces your available cash flow all year long and offers the government an interest-free loan on your hard earned dollars, but underpaying can lead to penalties and interest.
Accelerate deductions. The top income tax rate is 39.6 percent for individuals with taxable income over $400,000 ($450,000 for joint filers). If you think your income will be near the threshold, consider strategies for reducing your taxable income and staying out of the top bracket. To do this, you might be able to defer income to a future year and/or consider accelerating deductible expenses to get a deduction on this year’s tax return, assuming that doing so doesn’t trigger the Alternative Minimum Tax (AMT). Other possible strategies include making 2015’s charitable deductions this year, making an extra mortgage payment in December, paying estimated tax installments and/or real estate taxes in December instead of January, and prepaying next spring’s college costs now if you qualify for education tax credits.
Keep an eye on investment income. This year, the capital gains rate for taxpayers in the top bracket is 20 percent. If you realized or expect to realize significant capital gains this year, consider selling some depreciated investments to generate losses you can use to offset those gains. It may be possible to repurchase those investments after 30 days to avoid the “wash sale” rule.
Also, keep in mind the 3.8 percent net investment income tax (NIIT), which applies to taxpayers with modified adjusted gross income (MAGI) over $200,000 ($250,000 for joint filers). The NIIT applies to your net investment income for the year or the excess of your MAGI over the threshold, whichever is less. This means you can lower your tax liability by reducing your MAGI, reducing net investment income, or both.
Plan for medical expenses. Beginning in 2013, the threshold for deducting medical expenses rose for a maximum 7.5 percent of adjusted gross income (AGI) to 10 percent unless you’re age 65 or older. One way to save on next year’s taxes even if your expenses don’t exceed this floor is to contribute to a tax-advantaged health care account, such as a Health Savings Account (HSA) or a Flexible Spending Account (FSA). Contributions are pre-tax or tax deductible, and withdrawals used to pay for qualified medical expenses are tax free. Rules and limits apply, however, so be sure to check your plan documents for more information.
When thinking about medical expenses that may be deductible, don’t forget to consider health insurance premiums (if not deducted from your wages pretax), long-term care insurance premiums (age-based limits apply), medical and dental services and prescription drugs that aren’t reimbursable by insurance or paid through a tax-advantaged account, and mileage driven for health care purposes.
Claim your dependent-care tax credit. If you work and pay for day care expenses for your young children or aging relatives, you may be eligible for a federal tax credit of up to 35 percent of the cost of day care.
Retirement and Education Accounts
Boost your retirement plan contributions. Make sure you’re on track to contribute the maximum amount your retirement at work allows. Deductible contributions reduce your taxable income, and thus your income taxes, for the current year. They also reduce your AGI and MAGI, which can minimize or eliminate your exposure to NIIT. For 2014, the maximum you can contribute to a 401(k), 403(b) or 457 plan is $17,500. But if you’re 50 or older this year, you can make an additional catch-up contribution of $5,500 to a 401(k) or 403(b) plan.
Maximize your IRAs. If you haven’t already fully funded your Roth or Traditional IRA, you may want to do so before Dec. 31. For 2014, the maximum contribution amount is $5,500. If you’re 50 or older, an additional catch-up contribution of $1,000 is allowed.
Contribute to a 529 plan. Contributions to a 529 education plan aren’t tax deductible. However, if you’re currently setting aside money for a child’s college expenses in a taxable account, you could realize tax savings by opening a 529 plan instead. That’s because earnings on plan assets are not subject to federal tax and are generally not subject to state tax when withdrawals are used for qualified education expenses.
Plan for required minimum distributions. If you’re age 70 ½ or older and have a Traditional IRA, Simplified Employee Pension (SEP) plan or Saving Incentive Match Plan for Employees (SIMPLE) IRA, remember to take your Required Minimum Distribution (RMD) for 2014. If you’re already taking RMDs, consider using tax-efficient investing strategies to help reduce the tax on the income you earn on the distributed amount.
Estate Planning and Gifts
Review your gifting options. Gifting can be a good way to reduce your taxable estate and may be an important element of your estate plan. For 2014, the unified credit for estate and gift taxes was raised so that the tax applies only to estates greater than $5.34 million ($10.68 million for married couples). If you used the 2013 lifetime gift exemption of $5.25 million last year, you can add an additional $90,000 in 2014 to that exemption.
The annual gift-tax exclusion remains at $14,000 per person. If you’re married, this means you can gift up to $28,000 per recipient this year without any federal gift-tax ramifications by using the gift-splitting rules.
Give the gift of education. Gifting to a 529 plan can help fund a loved one’s higher education at the same time it helps reduce your income and/or future estate taxes. For 2014, you can make an accelerated gift of up to $70,000 ($140,000 if married) per beneficiary and have that gift treated as being made over five years for gift-tax purposes—all without using any of your lifetime gift-tax credit.1
Benefit a charity. There are no income thresholds when it comes to deducting charitable donations. If you give cash to an IRS-qualified organization within the tax year, you can usually claim the gift as an itemized deduction and deduct the full amount given.2 If you have securities that have appreciated in value, consider gifting the shares to charity.3 By transferring long-term appreciated stock rather than selling it first and gifting the proceeds, you’ll avoid having to pay income taxes on any capital gains. This means your gift will be able to do more for the charitable organization you choose.
And Don’t Forget to …
Spend your benefit dollars. If you have a flexible spending account (FSA) at work, make sure you know the deadline for claiming benefits. Up until this year, employers had the option to provide FSA participants a grace period that gave them until March 15 of a new plan year to incur enough expenses to use up their balance from the previous year. However, starting in 2014, the IRS is now offering employers an additional choice: the ability to allow participants to carry over up to $500 of any unused balance from one plan year into the next. Contact your employee benefits department to check your plan rules; they may impact your deadline for spending any remaining balance from this year and last. When estimating your contributions for next year, consider the increasing cost of uncovered medical expenses and any changes in your company’s medical insurance plan.
Review your portfolio. Over time, an investor’s portfolio asset-allocation policy can get disturbed by market ups and downs. Rebalancing is an essential account management tool that helps ensure your investment portfolio aligns with your personal circumstances. Ask your wealth management advisor for an end-of-year review to help ensure your portfolio continues to reflect your personal circumstances, including your goals, time frame and tolerance for risk.
Organize recordkeeping. Make sure your paperwork is in order to preserve your deductions. The tax law requires a contemporaneous written acknowledgement from the charity for gifts of $250 or more. Tax breaks that may be disallowed if you can’t provide proof include charitable contributions, vehicle costs, and travel and entertainment expenses, among others.
Source: Northwestern Mutual