Many people start to worry about preparing their taxes shortly after the new year. In fact, the best time make plans to reduce your tax billis now, three months before the end of the year. This is the golden opportunity to make decisions that will effect your taxes for the current year. If you wait too late there will be little you can do to impact your taxes.
Lower Your Tax Burden for This Year
Here are three steps to consider as you look to lower your taxes this year.
Step One: Determine Your Future Income
Tax deductionHow you prepare for the end of the year depends heavily on where you predict your income will be next year. If you are about to retire, and expect your earnings to fall, you will want to take all possible deductions this year while deferring any expected income to next year. The same would be true if your household income is predicted to fall next year due to other circumstances, such as a member of the household leaving the workforce or the loss of other significant sources of income. Likewise, if your household income is expected to rise significantly you will want to postpone deductions until after the new year while accelerating earnings that can be claimed this year. For example, you would want to push as many deductions to next year as possible if you just received a new job that pays much better or if you or your spouse is returning to the workforce. Unfortunately, it is difficult to predict whether or not a household will experience income growth next year, and what affect it might have on future taxes. If all things are equal, it is better to defer your tax burden than to incur it during the present year. In fact, even if minor income growth is expected, most families are better off taking deductions before the new year and receiving income afterwards. This is due to several reasons. First, you can earn interest on your money for an additional year if you keep it out of the government’s coffers. Also, a minor increase or decrease in household income will not make a dramatic effect in your overall tax rates. Due to the nature of our marginal tax rate system, even if a small portion of your income is being taxed at a higher rate, the majority of it will still be taxed at the same rate as it was in previous years. Finally, the sad truth is that the odds of sudden income growth just aren’t as high as they are for some kind of income loss. We all want to believe we are on the verge of a windfall, but we are much closer to a layoff or some other type of income disruption.
Step Two: Take Simple Steps To Manage Your Income And Deduction Schedule
This step is so important it has been the subject of entire books. If you are an especially high income earner it can make sense to undergo extensive year end planning. But for most people, a few simple steps is all that is needed to reach the low hanging tax benefit fruit. For example, your January mortgage payment could be paid in December to realize the interest deduction in this calendar year, while you can request from your employer or clients that December payments, like a year end bonus, be sent out in January. This is also the time to schedule doctor’s appointments or to purchase medical supplies before year end to take advantage of leftover healthcare savings accounts such as an HSA and FSA. You will lose any money you don’t use in your FSA; your HSA funds are yours to keep forever.
Step Three: Assess Your Investments
It is likely you have seen both gains and losses in your portfolio this year. Depending on which retirement account you are using, you may be able to harvest your investment lossesfor a tax benefit. The IRS allows you to deduct up to $3,000 in losses against your regular income every year. If you have more losses than that, you can carry them forward to future years as well. Many people wait until the last week of the year to sell some of their “losers”, and repurchase the shares after a 30 day waiting period. If this stock or mutual fund price does not change significantly during the waiting period you can effectively take a tax benefit now on the losses, and repurchase the shares for the same price that you sold them at. This gives you a tax benefit today while providing the opportunity for the investment to regain its value in the future.
Final Thoughts on Saving on Taxes This Year
Once you understand the principals of scheduling income and deductions around the end of the year, the sky is the limit to your opportunities to better manage your tax liabilities. The key is to plan your strategy now, and not wait until after Christmas. Don’t ruin your holiday season by scrambling for tax advice. Make changes now and set up a plan for you to execute on when the time is right. Jason D. Steele is personal finance writer and a consumer advocate. He specializes in helping people eliminate credit card debt and maximize rewards. His work can be found at personal finance sites like Money Crashers, Ask Mr Credit Card, and at his home page.
Photo by J.K. Califf via Flickr