It's too early to prepare your tax return for 2016, but it's not too late to reduce the taxes you'll owe. There are many things you can do throughout each year and at the end of each year that can shrink your tax bill. Here are 10 tax moves you might consider.
- Take your Required Minimum Distribution (RMD). Once you hit age 70 1/2, some retirement accounts such as traditional IRAs and 401(k)s require you to withdraw certain amounts each year. The deadline to take your distribution is Dec. 30, unless you turned 70 1/2 in 2016. If so, then you have until April 1, 2017, to take it. (It can be better to take it before the end of December regardless, though, lest you end up taxed on two distributions in one year. You'll face penalties if you forget to take your RMD, so consider asking your account's administrator to automatically send it to you each year.
- Donate to charity. Considering that billions of people live on just a few dollars a day (or less!), most of us are quite fortunate, no matter how much better off we'd like to be. If you make donations before the end of the month to qualifying organizations, you may be able to include them in your itemized deductions. The more you donate, the more you can deduct -- it's win-win! (Be sure to keep documentation of your donations. The IRS requires receipts for donations of $250 or more.) Note, too, that if your donations won't be enough to make itemizing your deductions worth it, you might wait and make them in early 2017. Then make your regular 2017 donations later in the year. At the end of 2017, you'll have two years' worth of donations, which will make it easier to clear the hurdle.
- Bunch and defer. Moving two sets of payments into one year is called bunching and you can do it with a variety of expenses, such as mortgage interest. Make your January payment early, in December, and you'll get more mortgage interest to deduct this year. Meanwhile, you may be able to shift some income to arrive early or late, depending on whether you want to reduce your income in one year or another. If you're billing a customer, you might delay doing so -- or do so early. If you're expecting a bonus at work, see if you can delay receiving it if that makes strategic sense.
- Contribute to retirement accounts. Sure, you have until Dec. 31 to contribute to some and until April 15 to contribute to others, but why wait? The sooner you make your IRA and/or your 401(k) contributions, the sooner that money can begin working for you. Contribute generously, too. Your workplace might be deducting a small percentage of your earnings for your 401(k), but you'll have a much more comfortable retirement if you aim to contribute 10% or more of your income. For 2016, the contribution limits are $5,500 and $18,000 for IRAs and 401(k)s, respectively, with extra "catch-up" contributions of $1,000 and $6,000 allowed, respectively, for those 50 or older.
- Improve your retirement-account investing. Speaking of your retirement accounts, are they growing at a good clip? Be sure you've made savvy investment choices with those accounts. For example, if you're still decades from retirement, it makes sense to be heavily weighted in stocks, not bonds. If you're approaching retirement, you might want more stable stocks and more bonds. If you've chosen individual stocks or managed stock mutual funds, see whether you're outpacing the benchmark index, If you're not, consider simply investing in inexpensive index funds. They're hard to beat.
- Offset your gains with losses. If you know you'll be facing taxes on capital gains you realized throughout the year, such as via stocks sold at a profit, you may be able to reduce or wipe out the taxes owed on that by offsetting the gains. If you have $6,000 in gains and you sell enough holdings to generate a loss of $5,000, you can pay taxes on only $1,000 in gains. If you have way more losses than gains, you can wipe out your gains entirely, then shrink your taxable income with up to $3,000 of your losses, and then carry over any leftover losses into the next year. Losses can sting, but they do offer a silver lining. (If you plan to buy back any of the losers you sold, be sure to wait at least 31 days, lest you end up with a "wash sale" that doesn't count.)
- Think about your holding periods. If you're thinking of selling some stocks in the near future, consider how long you've held them. Don't base your decision solely on taxes, but know that as of now, most of us face long-term capital gains tax rates (for qualifying assets that were held at least a year and a day) of 15%. Short-term capital gains face your ordinary income tax rate, which could be close to twice as high. So if you've held a stock you want to sell for 11 months, consider hanging on for another month (and a day!).
- Open a Health Savings Account (HSA). If you have a qualifying high-deductible health insurance plan, you may be able to take advantage of HSAs. You fund an HSA with pre-tax money, lowering your tax bill just as you would with a contribution to a traditional IRA or 401(k). That money can be used tax-free for qualifying healthcare expenses. The money in the account can accumulate over years, too, invested and growing. Once you turn 65, you can withdraw money from an HSA for any purpose, paying ordinary income tax rates on withdrawals. An HSA is actually a bit of a healthcare-expense/retirement hybrid.
- Open a Flexible Spending Account (FSA). This is another account that accepts pre-tax dollars and lets you spend them tax-free on healthcare expenses. It's not quite as wonderful, though, as you need to use most of your contribution each year, or you lose it. Still, if you plan well, this can save you a lot in taxes.
- Contribute to a 529 plan. 529 plans are designed to help you sock away a lot for college expenses. Money in them grows tax-free and distributions taken to pay for qualified education expenses are not taxed, either. Better still, many states offer tax breaks for their residents who sock money away in the state 529 plan – and some states offer tax breaks for money saved in another state's plan (which might be more attractive than you own state's plans). 529 plans sport generous contribution limits of up to several hundred thousand dollars per beneficiary.
The above tips can be powerful, alone or together. You may be able to do even better, though, by hiring a tax professional to strategize with you and perhaps prepare your return. Pros know the tax code far more than you do, and they know many tax-reducing strategies, too. Don't just hire anyone, though -- ask for references from friends or look for "Enrolled Agent," a tax pro licensed by the IRS who is authorized to represent you before the IRS if need be. You might find one through the National Association of Enrolled Agents website.
Act now, and you may be able to shave hundreds or thousands of dollars off your tax bill.