Don't Forget These Year-End Must-Dos

In this week's Financials edition of Industry Focus, Motley Fool analyst Gaby Lapera talks with Fool director of investment planning Dan Caplinger about some tasks you need to take care of before Dec. 31. With ideas including tax-loss harvesting, making sure you don't lose any of your flex account money, and maximizing your deductible expenses, you can put yourself in the best possible position to start off the new year on the right foot.

A full transcript follows the video.

This podcast was recorded on Nov. 28, 2016.

Gaby Lapera: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You are listening to the Financials edition, taped today on Monday, Nov. 28, 2016. My name is Gaby Lapera, and joining me over Skype is Dan Caplinger, a Motley Fool personal finance guru. Hey, Dan! It's nice to have you. How was your Thanksgiving?

Dan Caplinger: I had a pretty good time, Gaby. How about yourself?

Lapera: It was great, we had stuffing, and my mom's mashed potatoes, which are the best mashed potatoes because she looks at the recipe and she goes, "Haha, I'm not going to put a quarter cup of milk, I'm going to put a whole cup of heavy whipping cream in it," and it's delicious.

Caplinger: There you go. We had good luck with the potatoes this year, pretty much every kind of cheese that you can imagine in there, worked like a charm.

Lapera: Oooh, that sounds so good. Listeners, if you don't know this about me, I absolutely love food. If you have any recipes you would like me to make and eat myself -- because I'm not going to send it to you, let's be real, that would be unsanitary and disgusting -- I would love to have them. You can contact us at [email protected]. Now that Thanksgiving is done, we are heading into December. It's almost the end of the year, which I can't believe. We thought it would be really good to talk about some year-end housekeeping things you should think about doing for your taxes, specifically for legally saving money on your taxes. Who doesn't like saving money? Dan, I figured we should start with tax-loss harvesting.

Caplinger: You bet. That's the obvious place to start. It hasn't actually been a huge problem for a lot of investors over the past several years because we haven't had that many losses, the stock market has pretty much been shooting straight up. But most people will find even if you have a successful Investment portfolio, you can't escape having at least some stocks lose ground. And that's where tax-loss harvesting can really help, by selling off those stocks, taking those losses, and you're able to use them to offset either capital gains or, in some cases, other types of income to reduce your eventual tax bill.

Lapera: Yeah, this is really interesting. A lot of people don't realize that you have to pay taxes on capital gains. They think it's just free money. But it's income, so you have to pay taxes on that. Tax-loss harvesting, just like Dan said, is a great way to offset that. Another thing to keep in mind is -- I hadn't thought about this until today -- if you own index funds, a lot of them pay out dividends, and that also counts toward something you need to pay taxes for. So, keep that in mind. I just want to say that right now, because I totally almost forgot about that when I was thinking about which TurboTax program to buy.

Caplinger: Gaby, just to jump in there -- a lot of mutual fund investors, especially this year, now that the stock market has been going up for so long, sometimes they're going to get distributions toward the end of the year that are really big, and they're going to wonder, what the heck is going on here? The fact is, most mutual funds pay out a distribution. Some of it is just the dividend income that they accumulate over the course of the year. That's usually pretty modest. But if a fund has been successful, sometimes they'll make a really big distribution, and that's all the capital gains that all of their successful investments that they've decided to sell off during the year, it's those gains getting passed out to their fund holders. That's one reason why tax-loss harvesting can be smart, because you can use the losses that you harvest in order to offset those capital gains distributions that those mutual funds pay out to.

Lapera: Yeah, absolutely. Just a reminder to our listeners, there is a difference between short-term and long-term capital gains taxes. Short-term capital gains tax depends on your income, but I believe ... do you have the number off the top of your head, Dan?

Caplinger: It's a year or less, if you own something for one year or a shorter period of time, then you have to pay taxes on whatever your ordinary tax bracket is. That goes as high as 39.6%, depending on what your income is. Long-term capital gains, on the other hand, that's for stocks or other investments that you hold for longer than a year -- so, a year plus one day, or longer -- those get a preferential tax rate, and that depends on your tax bracket. For those who are in the lowest two tax brackets, those long-term capital gains are tax free, it's 0%. For everybody else, it's 15%, unless you're in the highest possible tax bracket, then it goes up to 20%. But that's still just barely half of what the ordinary income tax rate is at that point. So, it's a big tax savings, gives you an incentive to hold on to those stocks longer than a year if you have gains on them.

Lapera: Absolutely. So, definitely keep that in mind. That's one of the other benefits of following The Motley Fool's philosophy of being a long-term investor. Not to get too much like I'm drinking the Kool-Aid, but I totally am. The next thing I figured we would talk about would be charitable donations -- when giving back gives back to you, haha. OK, I'm not as funny as I thought I was. That's fine.

Caplinger: (laughs) 

Lapera: You can give gifts of appreciated stock.

Caplinger: Yeah. Just to give the general gist of this, just about anything that you give to charity is tax deductible, if you itemize your deductions, and if it's given without you getting something back in return. A lot of people ask questions like, "If I participate in some sort of charitable auction or something, and I make a $100 gift and in exchange I get a $100 gift certificate to my favorite restaurant," you're not going to be able to deduct that, because that gift certificate is worth exactly what -- you essentially paid for it. It's not a charitable deduction, even if you bought it at a charity silent auction or something like that. But, if you make gifts at year-end -- and a lot of people do their charitable giving toward the end of the year -- gifts of cash, you write a check, you make a gift by credit card, all of that you will generally be able to deduct, as long as you're itemizing your deductions. 

What Gaby was saying before about appreciated stock, that's actually a really great way to give to charity, because it not only gets you, potentially, that tax deduction for the charitable gift, but it also helps you avoid what would ordinarily be a big tax bill for you. For instance, say that you own a stock that has gone up in value from $1,000 to $2,000. If you sold that stock, you would have a capital gain, and you would have to pay tax on that capital gain. But if you give that stock directly to a charity, you get a full deduction for the current $2,000 value, and you don't have to pay the capital gains. The charity will be the one to sell it, they're a tax-exempt organization so they don't have to pay tax on it. Everybody ends up a winner. That's one reason why making gifts of stocks that have gone up in value a lot in your portfolio can be really big tax savers for you.

Lapera: Absolutely. And just to throw in a word about charitable giving, always make sure you check out the charity before you give them anything. You can check charities at Charity Navigator, or CharityWatch. Both of those websites give insight into how charities actually spend your money, so you can make sure that it's actually going toward a worthwhile cause -- or, your gifts of appreciated stock.

Caplinger: The other thing to keep in mind, if you are going to go to stock route, you don't want to wait until the last day of the year to get moving on that. With a check, you just write a check and it's done. But with stock, you really have to work with your broker in order to get the shares that you own in your brokerage account over to your charity. That can take days, or even a couple of weeks. A lot of brokers will tell you, "If you're going to do this, let me know early in December so that we can get everything moving in the right direction, and there's no question later on that you got it done before year-end." If the important activity involved in getting those shares moved out of your account doesn't happen until 2017, the IRS can come back and tell you, "You don't get to claim that on your 2016 tax return. You're going to have to wait until 2017 to get it," which is not what you want. You want to get it done now so you can claim that deduction now.

Lapera: Absolutely. So, now, people. Think about it right now. Moving on to our next topic, there are all sorts of other itemized deductions that you can double-up on -- so, you can pay two years' worth of the expenses at year-end to max out the deduction for this year. Do you have any comments on what sort of deductions those would be?

Caplinger: One thing you can do is double up on your charitable deductions, since we were just talking about charitable deduction. If you have the cash to do it, and if you're in the habit of making a particularly sized gift every year, you can, instead of making one gift now and waiting until January, or even worse, this time next year to do it, if you go ahead and give your two years worth of gifts now, you can basically double up the deduction. Now, it's true that next year you won't get a deduction for that, because you double it up. But here's the thing: A lot of people are really close to that line between whether they should itemize their deductions or just go ahead and take the standard deduction. A lot of the time, doubling up can really make the difference between it being smart to do the itemized deductions, or to take the standard deductions. Over the course of time, some people find -- and check the math to see if it's right for your situation -- that if you double up on those deductions, it lets you get more in total deductions over the long run than you would get if you just said, "I have one year's worth of deductions, we'll just claim them year-in and year-out one by one."

Lapera: I have a question. If you double up on your charitable donations for 2016, does that mean you can't take the same deduction in 2017? Or does it just mean that you would have less, that potentially you would just be giving less in 2017?

Caplinger: It has to do with what you do with the money. Just to throw an example out there, say you give some organization $100 every year. You can keep doing that, and then you'll be able to deduct $100 every year. If you double up and say, "I'm going to give my $100 for 2016 and my $100 for 2017, I'm just going to go ahead and get that out of the way now, I'm going to write a check for $200," then you get to deduct the $200 this year, you don't get to deduct anything for next year because you don't pay it next year, you're paying it this year. If you go ahead and make another -- if you decide to be incredibly generous and say, "I know I said I already made my gift, but I'm going to go ahead and give another gift later in 2017," then that's fine, you've actually given more money, so you can take that deduction again. But there are a lot of situations where, you can think about it in terms of pre-paying what you wouldn't necessarily have to pay until later. Another example that comes in with a lot of people is property taxes. A lot of places will charge you half of your annual property tax every six months. You always have the option of paying it all upfront in the earlier year. If you do that, you get to deduct it all up in the earlier year. If you don't, then you just claim half this year and half next year. Again, depending on the situation you have with your standard deduction, with other types of itemized deductions, sometimes it makes more sense to do it one way, sometimes it makes more sense to do with the other way, and sometimes it doesn't make any difference. But it's something to think about, especially this year, because a lot of people are thinking in terms of, "I want to maximize deductions for 2016 in the hopes that a new administration might be bringing us lower tax rates next year, so those tax deductions might be worth more in 2016 than they will in 2017 and in the future."

Lapera: Yeah, we'll see what happens with that. The final thing we wanted to talk about is kind of tax-related, which is the flex spending account. Your FSA is for healthcare. A lot of employers have this. One of the things you're going to do is check to see if your employer has a grace period or a rollover. By law, I believe you are allowed to rollover $500 from year to year.

Caplinger: That's true, but only if your employer activates that option. It's really important to go to your employer and find out what your choices are, because each employer can differ. There's a couple basic different ways that this works. A lot of employers will take either one or the other of these two things. The first one is, a lot of employers will give you a grace period. What you can do then is incur health-related expenses through March 15th of the following year and still count them against the money that you put into your flex account for the previous year. Say right now you have $500 left in your flex account. You don't foresee needing any medical expenses between now and the end of the year. Ordinarily, that money would be gone. You would forfeit it, because again, the way these flexible spending accounts work is, you pick a number upfront that you're going to take out of your paycheck and put into these accounts but if you don't use it, you lose it. But the IRS figured out this wasn't entirely fair. So if your employer offers that two-and-a-half month grace period, then you'll still have January, February, and the first half of March to incur medical expenses, in order to use up that remaining amount.

Now, the second option that employers have is exactly what you just said. They can let you take up to $500 from your previous year and carry it forward into the next year. If your employer picks that then, under the example I just gave, you wouldn't have to do anything. You would just carry forward your $500, and then whenever you spend it next year, you could go ahead and do that. The key to remember is, your employer would have to pick one or the other. The IRS doesn't let employers offer both the grace period and the carry-forward. In addition, the IRS does not require employers to offer either one of those. If you don't have either one of those working for you, you have to make sure you get that money spent down by Dec. 31, or you'll lose it. But it's worth making a call or taking a visit to whoever handles payroll and HR stuff at your company to find out exactly how your flex spending account works, and to make sure you don't lose any money in the process.

Lapera: Yeah. And the other thing is, you want to be careful that you make sure you're using your flex spending account correctly. For example -- this happened to me earlier today, I almost illegally used my FSA. I got a dental bill, I went to a dentist out of network, so my dental insurance covered half of the payment, by sending the check to me, and I needed to pay the dentist in full, and I almost accidentally paid the dentist in full off of my FSA, which is illegal, because you can't use your FSA to pay for something that you have already been reimbursed for. You can only pay for the stuff that has not been reimbursed.

Caplinger: Right. The half that they didn't pay, you would have been OK with. But the half that the insurance had reimbursed, you're right, that would have been a no-go.

Lapera: Yeah, so make sure you check the rules online, there's the IRS and a few other organizations that have pretty clear rules that you can read. Other things that you can use it for are any qualified medical expense, so, something that requires a prescription is pretty much definitely going to be covered. That includes stuff like medicine, and I think eyeglasses, correct?

Caplinger: Yeah, that's right.

Lapera: Yeah. So, those are easy ways to spend it. I don't really know, I don't know what else you might want to spend it on. Some employers have an online store that you can peruse and use your FSA in, and it has all FSA-approved items in it. I've never done it, but I've also never had any extra, because I don't put a lot into it, I only put enough into it to pay for my dentist. But yeah, just, things to think about so that you can get the most out of your money. And also, during open enrollment, you can change the amount that you put into your FSA. So, consider what your medical expenses were this year, and what you imagine they might be next year, and adjust accordingly.

Caplinger: That's right. If you have a big balance at the end of this year, think about ramping it down for next year so you don't have the same challenge. But you're absolutely right. I see any number of ads from these outfits that sell eyeglasses and contact lenses and that kind of thing. I think end of year is their best season precisely because of this, people have money they need to use up.

Lapera: Yeah. And, of course, you can also spend your FSA on spouses and dependents, but there's rules surrounding that as well, so make sure you read them before you spend. I think that's it, unless you have anything else to say to our listeners.

Caplinger: Just don't wait too long, guys. I know that it says you have until Dec. 31 to get all these things done, but believe you me, there's a lot more interesting things you want to be doing on Dec. 29, 30, and 31 than worrying about these last-minute tax moves. Take the next few weeks, learn what you need to learn, start getting the ball moving, and that way you can enjoy New Year's Eve without having to have the tax burden on your shoulders.

Lapera: Very wise words. Also, happy holidays, everyone. I can't believe it's almost December. (laughs) Thank you very much for joining us, Dan. It's always a pleasure to have you. As usual, people on the program may have interests in the stocks that they talk about, or don't talk about, in this case, and The Motley Fool may have recommendations for or against, so don't buy or sell anything based solely on what you hear. Additionally, please make sure you consult a tax professional before taking tax advice from a disembodied voice on the internet. This is just a starting point, people. Contact us at [email protected], or by tweeting us @MFIndustryFocus. Thank you to Anne Henry, today's producer. I have no idea where Austin went, but I'm sure he's having fun wherever he is. And thank you to you all for joining us. Everyone have a great week!