Tax planning is a year-round endeavor, but several year end strategies might reduce your 2015 tax bill. Here are five to consider:
1. Defer income, accelerate deductions. You may be able to lower your 2015 income taxes by deferring income to 2016 or accelerating deductions into 2015. To defer income, for example, ask your employer to pay your year end bonus in early 2016. Keep in mind that the bonus must be paid by March 15 to avoid running afoul of deferred compensation rules.
To accelerate deductions, prepay your property taxes, state income taxes or January mortgage payment in December.The most effective way to accelerate deductions is to make contributions to an IRA or other retirement plan, provided you haven’t already reached the 2015 limit.Depending on the type of plan, your contributions may be due by December 31, whereas for others you may be able to make 2015 contributions as late as your filing deadline, with extensions. For traditional IRAs, the filing deadline is the due date of the return without extension.
Deferring income and accelerating deductions isn’t right for everyone. So, if you expect to be in a higher tax bracket next year, you may be better off accelerating income into 2015, when your marginal tax rate is lower, and deferring deductions to 2016, when they’ll do more good. Certain deductions are more valuable if you bunch them together in a single year. Medical expenses, for example, are deductible only to the extent they exceed 10% of your adjusted gross income (AGI) (7.5% if you or your spouse is 65 or older). If you won’t reach that level this year, consider putting off optional medical care until next year, when you stand a better chance of exceeding the AGI threshold.2.
2. “Harvest” investment losses. This year, long-term capital gains are taxed at rates as high as 20% at the federal level — 23.8% if you’re subject to the net investment income tax (NIIT). If you recognized capital gains this year you may be able to reduce your capital gains tax and the NIIT by selling poor-performing investments at a loss. You can use those losses to offset capital gains, and up to $3,000 in ordinary income. Any losses in excess of the $3,000 allowable amount are “carried forward” for you to use in subsequent years.
3. Avoid estimated tax penalties. If you’re behind on estimated tax payments, you may be able to catch up and avoid penalties on your 2015 return by increasing withholdings on your remaining wages and retirement distributions — or, if you file jointly, on your spouse’s remaining wages — for the year. Unlike estimated tax payments, taxes withheld from wages are treated as if they were paid throughout the year, regardless of when they’re actually withheld.
4. Donate to charity. Making charitable donations before year end can reduce your 2015 tax bill. An effective strategy is to donate appreciated stock or other securities that you plan to sell anyway. That way, you’ll enjoy a charitable tax deduction for the security’s full market value (subject to certain limitations), while avoiding capital gains tax and the NIIT on its appreciation in value. Or, if you’re considering donating securities that have lost value, you’re better off selling them and donating the cash to charity. Otherwise, you’ll miss out on the chance to deduct the capital loss.
5. Watch out for deduction limitations. Note that deduction limitations for high-income taxpayers may reduce the effectiveness of certain strategies. Many itemized deductions are phased out, for example, once your AGI reaches a certain threshold. In 2015, the threshold is $258,250 for single filers and $309,900 for joint filers. If you might be subject to the alternative minimum tax (AMT) this year or next, consider the potential impact of itemized deduction strategies on your AMT liability.
How to get started
To plan for year end, estimate your income, deductions, credits and other tax items for this year and next. Armed with this information and your tax advisor, you can determine which strategies will have the greatest impact on your overall financial situation.
Year end tax strategies for business owners
If you own a business, here are several strategies that might reduce your 2015 tax bill:
- Accelerate deductions or defer income — your ability to do so may depend on your accounting method.
- Re-evaluate your accounting method and consider switching from cash to accrual or vice versa if it would help lower your tax bill.
- If your business receives advance payments for performing services or delivering goods, see if you can defer the tax on these payments.
- Make planned purchases of equipment or other depreciable property this year to take advantage of accelerated depreciation deductions — the enhanced Section 179 expensing election and 50% bonus depreciation expired at the end of 2014, but, based on what’s happened in the recent past, Congress might extend both of those benefits retroactively to January 1, 2015. Monitor the developments, as the answer may have an impact on your business.
- Review the tangible property regulations — known as the “repair” regulations — to ensure you maximize tax benefits allowed by the regulations.
- Keep an eye on Congress: Lawmakers might extend important tax breaks that expired at the end of 2014, including the R&D credit, depreciation-related tax breaks and the deduction for energy-efficient commercial buildings.