With all the major 2015 tax deadlines behind us, and "tax season" still several months away, tax planning may be the furthest thing from your mind right now. However, smart tax planning is a year-long process, and the moves you make now could save you lots of money when it comes time to file your tax return in 2017. With that in mind, here are four things you might want to do before 2016 comes to an end.
1. Maximize your retirement accounts
If you contribute to an IRA, you technically have until the April 15 tax deadline to make your contributions for the 2016 tax year. However, if you max out your contributions by the end of this year, you'll give yourself more time to focus on making your 2017 contributions next year.
For both the 2016 and 2017 tax years, the maximum allowable contribution to a Roth or traditional IRA is $5,500, with an additional $1,000 catch-up contribution allowed if you're over age 50. If you don't want to be scrambling to get your contributions in next year, the maximum contribution translates to $458.33 per month ($514.66 if you're over 50) spread out over an entire year.
If you have self-employment income, then you could be eligible for additional types of retirement savings, such as a SIMPLE IRA, SEP-IRA, or Solo 401(k), all of which have significantly higher contribution limits than standard IRAs.
If you haven't started investing in an IRA yet, or have questions about what to do with your money after you contribute, then check out The Motley Fool's IRA center.
2. If you're over age 70-1/2, make sure you've withdrawn enough
After you reach 70-1/2 years of age, you have to start taking required minimum distributions (RMDs) from your pre-tax retirement accounts, including traditional IRAs and most 401(k) and similar retirement accounts.
The amount you need to withdraw each year depends on your account balance at the end of the previous calendar year, as well as your and your spouse's ages. Most retirees can find their expected distribution period on the IRS' Uniform Lifetime Table, and there is another table for cases where the account's sole beneficiary is a spouse more than 10 years younger than the account owner.
For example, let's say you had a combined balance of $1 million in pre-tax retirement accounts as of the end of 2015, and you and your spouse are both 75 years old. Per the Uniform Lifetime Table, you have an expected distribution period of 22.9 years, so you would divide your account's balance by this factor, which yields an RMD of $43,668.
You don't need to take it all at once, but make sure you've taken enough by the end of the year, as the penalties for not doing so are severe. If you fail to take your entire RMD, the IRS can assess a penalty of 50% of the amount you didn't withdraw.
As a final note, you have until April 1 of the calendar year following the year in which you turn 70-1/2 to take your first RMD. However, if you wait until the last minute, you'll need to take your first two RMDs within the same calendar year, which could have major tax consequences.
3. Donate to charity
Charitable donations can make excellent tax deductions, but they absolutely must be made before the end of the calendar year to qualify.
You can deduct donations of cash or property to qualified organizations, which include, but are not limited to:
- Federal, state, or local government organizations, if the donation is to be used for public purposes
- Churches, synagogues, or other religious organizations
- Non-profit organizations created for charitable, educational, religious, literary, or scientific purposes
- War veterans' organizations
- Volunteer fire departments
- Civil defense organizations
You can deduct the actual dollar amount of most cash donations. If you received an item of value in exchange for the donation, then you can deduct the difference between the item's value and your donation. For example, if you pay $50 to attend a fundraising dinner held by a qualifying organization, and the dinner would have reasonably cost $20 elsewhere, then you can deduct the $30 difference.
When it comes to donated property, it's a little more complicated. The IRS allows you to deduct the "fair market value" of donated items, which, to be clear, does not mean their retail value. Many popular organizations, such as Goodwill, provide valuation guidelines for donated items. For large items, such as automobiles, the appraised value or blue book price is fine, and for other items, use your best judgement. Used-item websites like eBay can be a good place to find out what your items might sell for.
Whatever you donate, be sure you can adequately document it. The IRS has different rules that depend on the type of donation (cash or property) and the monetary value. Here's a guide to the documentation requirements, as well as a more thorough discussion of charitable deductions.
4. Get your paperwork together
As a final tip, one thing you should do before the end of the year is make sure you get your tax paperwork in order. Did you pay tuition? Make a big donation? Spend money on child care? These are all lucrative tax breaks, but you'd better be able to back them up if you're asked to do so.
TaxAudit.com's experts suggest that you make separate folders for each type of documentation, such as charitable donations, child care expenses, and tuition and education costs.
I know it can be a pain to collect and organize a whole year's worth of receipts, but it's better to do it now than to be running around trying to get everything together on April 14 of next year.