With the end of the year fast approaching, you’re probably wondering what you might do to cut your taxes. If you wait until April to start thinking about this, it’s just too late. Here are some ideas to get you moving in the right direction now.
- Pay state income taxes before December 31.
Many people wait until April 15 to pay their state income taxes, since that’s when they file their state tax returns. However, if you pay your state income taxes in 2018, you can’t claim the deduction for those taxes until you file your 2018 income tax return in 2019. Thus, you have to wait an entire year before getting the tax benefit of the expense. By paying your state taxes now, you get a deduction for those taxes in 2017, one year sooner than you’d otherwise realize.
- Review your wage withholding or estimated payments.
Eighty-five percent of all taxpayers get a tax refund when they file their tax returns. The average refund is about $3,000. If you get a tax refund, it doesn’t mean the government got religion and decided to give you free money. It means you paid more than you owe. If you got a refund in 2017, you need to examine your withholding situation going into 2018 to make sure you don’t overpay.
Whether you’re an employee or a self-employed person, sit down now and do some preliminary calculations on your tax liability. Figure out if you’ve overpaid. If so, you need to adjust Form W-4 (for wage earners) or your estimated payments (for self-employed people).
Keep in mind that no law requires you to pay more taxes than you owe. For withholding purposes, you avoid under-withholding penalties if you pay either 100 of last year’s tax (2016) or 90 percent of this year’s tax (2017), whichever is less. Use that yardstick to guide you in adjusting your withholding for 2018.
- Count your money now.
Each year, millions of people are blindsided come April 15 with surprise tax liabilities they can’t pay. Don’t wait until March or April to start figuring your tax, especially if 2017 was a particularly good year.
It is important to sit down now and examine your 2017 financial situation. If there were substantial changes to your economic condition, that may increase your tax burden. If you don’t have the money to cover the tax, you’ll wind up as one of the millions facing enforced tax collection.
Get a good handle on what you’re going to owe. If you figure it out now, you have four and a half months to put a plan together to pay the tax. If you don’t, you could be hit over the head in April. In my experience, it’s that kind of shock that causes people to start making critical mistakes in how they handle their tax burdens. Often, it leads to years of hassle and harassment from the IRS.
- Review your financial portfolio.
One of the biggest problems with our tax system is the unfair treatment it affords to investment gains and losses. If you win with your investment, the IRS stands next to you with its hand out to get its “share” of your success. If you lose, you are, for the most part, on your own.
The reason is that capital gains are subject to tax in their entirety in the year realized. However, capital losses are subject to a $3,000 cap in a given year. For example, if you lose $15,000 in an investment, you can only deduct $3,000 at time. At that, it takes five years to fully write off your loss.
This is true unless you have both capital gains and capital losses in the same year. In that case, you offset your gains against your losses, plus you can take an extra $3,000 of loss. Suppose you have $10,000 of capital gains and $12,000 of losses. The first $10,000 of losses are offset against the gains. Then, you get the additional $2,000 of losses as a deduction that can offset other income.
In order to best utilize this rule, you should consider selling investments that are down in 2017 so that you can offset the loss against any investments that made money during 2017. This allows you to effectively increase the allowable capital loss deduction, thereby recovering your losses much faster than you otherwise would. Talk to your investment advisor about the merits of this strategy in your case.
- Consider making equipment purchases.
If you own a small business, now is the time to consider purchasing any equipment you might need. A special tax code section creates an advantage for such investments.
Code §179 allows you to claim a full deduction for the cost of business tools and equipment placed in service in the year purchased. Ordinarily, such cost must be depreciated over its useful life. For example, if you purchase a copier for $5,000, you would have to depreciate it over three years. In that case, you get a deduction of $1,667 for each of three years. But under §179, you can fully expense up to $510,000 of equipment in 2017.
Now is the time to take advantage of this deduction, especially if your income was unusually high in 2017. The best way to offset that income for tax purposes but still get the benefit of the money is buy equipment you need for your business.
- Fund a Health Savings Account.
One of the best-kept secrets in tax planning is the Health Savings Account. This allows you to set aside money earmarked to pay medical expenses not covered by insurance (other than the insurance policy itself). By placing the money in a specially designated savings account, the contribution to the account is tax deductible, up to certain limits.
It works much like an IRA or 401(k), except that you don’t have to pay taxes on the money when it’s distributed, provided you use it for medical expenses that are not covered by insurance. You can fund this account right up to December 31, 2017, and get a deduction for the money you put in, even if it’s not used for medical expenses in 2017. What’s more, any amounts left in the account at the end of the year carryover to 2018 and remain in your account, under your control. You don’t lose the money. It’s always available to you.
- Fund a retirement account.
An IRA, 401(k) or other retirement account can be funded anytime during 2017, and you get a deduction for the contribution (within limits) in 2017. In fact, for most retirement accounts, you have up to April 15 of the following year to contribute. You can get a deduction for the prior year simply by designating the contribution to apply to the prior year. That means a contribution made in 2018 can still apply to and be deductible in 2017.
- Consider restructuring your business.
There are millions of people operating small businesses in the form of sole proprietorships. And while this is probably the best way to start a new business, it may not be the best way to continue an existing business. Various forms of business entities are available, including a small business corporation or partnership. Depending on the nature of your business and non-tax considerations, one or more of the available entities might be a better idea than continuing as a sole proprietorship. January 1 is generally the most convenient time to change the structure of an existing business.
- Catch up on your charitable contributions.
If you make it a practice to give generously, make another contribution before December 31. This gives you further opportunity to cut taxable income and help those in need at the same time.
Note that you must have a contemporaneous acknowledgement from the donee organization for contributions of $250 or more. This applies to one-time contributions, not a total of contributions to a given organization over the year. If you don’t have the proper acknowledgement in hand by the time you file your tax return, the deduction is not allowed, even if you have your canceled check and even you get the statement later. That’s why they call it a “contemporaneous acknowledgement.”