Taxpayers are always on the hunt looking for ways to reduce their tax bills.  Even with the looming year-end tax legislation sessions that can result in tax provisions being changed, extended, extinguished, or reinstated, it is never too early to start year-end tax planning.  While some of the following suggestions may not be feasible for a taxpayer’s given tax situation, many can still be employed.

One thing many individual taxpayers look forward to every year is their expected annual year-end bonuses.  If asked, your employer may hold off paying it until January of the following year instead of December in the current year.  This way the additional pay will show on the following year income tax return.  This strategy is especially helpful when this added pay would push you into the next tax bracket.

Taxpayers are able to adjust their withholdings at any point during the year.  The ideal situation is for a taxpayer’s withholdings to be approximately the same as their tax bill for the year.  By not withholding enough money taxpayers often panic, unsure of where to come up with the money to pay their tax balance due.  By withholding too much, it means the government received a tax-free loan of your money that could have been invested by you sooner, earning you more money.  Identity theft with the filing of fraudulent returns has been at an all-time high so large refunds also represent a security risk.  For taxpayers that make estimated payments, an increase in withholdings can help to avoid underpayments penalties as the withholdings are deemed to have been made evenly throughout the year.   

It is probably certain that everyone’s favorite uncle is not the government’s Uncle Sam.  One of the easiest ways to put money into your own pocket, while lowering the amount of your current tax bill owed the government, is to put as much money into your company’s retirement plan as possible to help reach your retirement goals.  Most retirement plans allow for tax-free contributions that lower the taxable amount the government can touch (an exception is Roth 401(k) plans which utilize after-tax dollars).  The earnings are allowed to grow tax-free.  If you are a sole proprietor, you are allowed a deduction on your tax return for your self-employed retirement contributions.

If you do not already have one, another option may be to open a traditional Individual Retirement Account (IRA) that will allow earnings to grow tax-free until money is withdrawn from the account.  Whether you open one, or have an existing IRA, a portion of your contributions may be deductible subject to limits.  For taxpayers in lower income tax brackets, they may also be able to claim the Retirement Savings Contributions Credit for any current year contributions.  With IRA accounts, taxpayers need to be aware of the year in which required minimum distributions must begin as the penalties for failure to comply are high.

Roth IRA’s funded with after-tax dollars can be advantageous because withdrawals can be tax-free if you are at least 59 ½ years old.  There is a five year holding requirement on the initial contribution for the distributions to be completely tax–free.  Roth IRA conversions, or setting up a new one, make sense if it is anticipated that your tax rate will be going up in the future.

Now is the time to start reviewing your Flexible Spending Accounts (FSA), if you have one.  Money is contributed to FSA’s tax-free and money remaining in the account at year-end can be lost for good.  Recent IRS rules allow employers the choice of allowing their employees to carry over $500 in their FSA’s to the next year, but it is not required.  Some employers allow a grace period after year-end of a few months to allow for additional medical spending if too much money was put in the account.  Check with your plan administrator to see what your plan allows.  See IRS Publication 502 for a list of medical related deductions allowed to be paid through your FSA account as changes have recently been made to over-the-counter items.

If you would like to lower the amount in your estate while avoiding gift and estate taxes, you can gift up to $14,000 each year per person to an unlimited number of people.  The amount increases to $28,000 if you decide to split gifts with your spouse.  Gifts can include cash, stocks, bonds, vehicles, jewelry, real estate, and even ownership in companies.

Regular investment accounts (non-retirement ones) should be reviewed prior to year-end.  If capital gains are expected the investment portfolio should be scoured for non-performing investments that are no longer in tune with your investing strategy.  These could be sold for losses which will help offset your capital gains.    If capital losses exceed capital gains, up to $3,000 can be used to lower your income taxed at ordinary rates.  Any excess capital losses over $3,000 may be carried over indefinitely.  Capital losses can also help lower the income for high income taxpayers encountering the 3.8% Net Investment Income Tax.

Education expenses offer another way to save.  Normally the spring semester’s tuition bill is not due until January.  Depending on your income level and ability to pay the tuition expenses, the spring bill could be paid by December 31.  The American Opportunity Credit can be as high as $2,500 for taxpayers with the opportunity for up to $1,000 as a refundable credit.  For New York residents, money may be contributed to a New York 529 college plan allowing a taxpayer up to a $5,000 deduction on their NYS tax return ($10,000 for married filing joint returns).  Amounts contributed to state 529 plans typically are removed from an estate.  Educational institutions also allow payments to be made directly to them with no gift tax consequences.

The majority of taxpayers make charitable contributions during the year.  Keep the receipts for every contribution that is made, not only those over $250.  Contributions can be made with cash, clothing, household goods, securities, and vehicles to name a few.  By donating securities you avoid the capital gains tax that you would have had to report for selling the securities, and get the benefit of being able to deduct the fair market value as a donation.  Donor advised funds are becoming more popular where taxpayers make a charitable contribution receiving an immediate tax benefit, and then get to recommend disbursements of the fund over time.  Another option is a charitable gift annuity where some of the money donated is allowed as a current year donation and you then get a fixed monthly income payment for life.

Another way to increase itemized deductions is to bunch deductions or accelerate payments.  Medical expenses subject to the 7.5% threshold, or 10% depending on your tax situation, can be consolidated and taken every other year as itemized deductions to try and get over the limitation (miscellaneous itemized deduction subject to the 2% threshold can be handled the same way).  Additional mortgage interest expense can be claimed if the January payment is paid by December 31.  The real estate tax bill due in the first few months of the following year can be paid by December 31.  Fourth quarter state estimated income tax payments due in January can also be paid by December 31.  If you are subject to the Alternative Minimum Tax (AMT) however, some of these deductions will be disallowed.                 

The AMT tax usually sneaks up on taxpayers unaware.  While the original goal of the AMT was to force high income taxpayers to pay some tax, the AMT now hits many middle-class taxpayers as well.  It is important to recognize some of the factors that can generate the AMT which include:

• Large capital gains
• Large state income tax deductions
• Interest from certain private activity municipal bonds
• Exercising incentive stock options
• Higher than average number of dependency exemptions

Here is a list of life events that sometimes a taxpayer inadvertently forgets to tell their accountant:

• Changes in filing status (marriage, divorce, death)
• Birth of a child
•  Daycare expenses for children and summer camps
• Changes in dependents (moved out, graduated college, disabled, death)
• Significant medical expenses (watch for nursing home expenses too as there may be a possible NY credit)
• Long-term care insurance premiums (possible Federal itemized deduction and a NY credit)
• Recent or anticipated large inheritances
• Bankruptcy or discharge of indebtedness
• Employment changes and related relocation
• Purchase of a new home or refinance

It is important not to forget the Affordable Care Act.  Individuals in 2014 risk facing a penalty if they do not carry minimum essential health insurance coverage.  Regarding employers, those with fewer than 50 full-time equivalent employees are exempt from having to offer employees health coverage.  Employers with 100 or more full-time equivalent employees are required to offer full-time employees minimum essential coverage starting 2015.  Employers with at least 50 and less than 100 full-time equivalent employees are required to offer full-time employees minimum essential coverage starting 2016.

The new tangible property regulations, required for tax years beginning on or after January 1, 2014, are very important for businesses.  De minimus regulations allow $500 per item or invoice for companies without an Applicable Financial Statement and $5,000 for those who do.  It is recommended that companies have a fixed asset capitalization policy on file spelling out the dollar threshold for which they will expense items under it instead of capitalizing.  Most companies will have to review their past fixed assets and depreciation methods to make sure allowed methods were being used.  Companies will need to correct improper prior depreciation and adopt the new repair regulations by filing Form 3115.

With December right around the corner there is no better time to start tax planning if none has been done to date.  The new tax year will be upon us before you know it and certain tax planning strategies will need to be complete by December 31.  Please feel free to contact your Dermody, Burke & Brown tax advisor to further discuss any questions you may have.

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.