How to Prepare for Year End Tax Planning


What is Year End Tax Planning?

tax-planningYear-end tax planning involves doing specific things right before the end of the year that can result in minimizing your tax liability overall when it comes time to do your taxes in April.  There are many things that you can do to prepare for the year end taxes. It’s always better to plan ahead rather than waiting so we have put together some valuable tips and information that you can use to make sure you’re ready.

Why Prepare Early?

No one likes to think about taxes, but there is a definite benefit to planning ahead and thinking about it early. When you are prepared, you have plenty of time for those last minute actions to be completed before the end of the year. You don’t want to start trying to get things set up December 31st because the likelihood of being able to use those actions for your upcoming taxes is very slim. Start now so you can plan your timing accordingly.

By doing many of the steps listed below before the end of the tax year, December 31st, you will be able to legally and rightfully claim many of those steps you took on your upcoming taxes. The more deductions you can take, the lower your tax bill will be and who doesn’t want that?

Why is Organization Important?

organizedBe prepared may be the Boy Scout’s motto but it also has a lot of merit in year-end tax planning as well. Nothing makes for an easier tax time than being organized. If you’ve been laid back in your organization there is still plenty of time to tighten the reins and get things set up for when you need to sit down and get your taxes done.

The more organized you are, the easier and faster doing your taxes will be. That is beneficial for your accountant for starters, but it also makes it much easier to keep track of all the deductions you are eligible for.  If your accountant has to try and sort through a lot of unorganized record keeping and receipts, it’s much easier for them to miss something.

The Benefit of Doing Early Projections

One of the most important things you can do when the end of the year is getting close is to do an early projection of your financial situation. This will give you a good idea of what your tax liability is going to be so you can make some good decisions and choices that can help that tax liability go down.

By getting this done early, you will have allowed yourself plenty of time to make some changes and take care of anything that is glaring at you before it’s too late. The best way to do these early projections is to use last year’s tax returns with your current pay stubs and financial accounts. There are even some websites that offer tools that can be used for this process to make it easier to get that snapshot you need to plan your end of the year strategy.

Beneficial Year End Moves You Can Take

These actions below are things that you can do to increase the potential deductions you are eligible for come tax time.

Make Donations to Charities

Many people love to give at holiday time, but it can have another benefit as well when it comes to your taxes.  There are a few things to remember when it comes to charitable contributions. If you’re cleaning out the garage or basement and donating the items to charity, you will be able to claim the value of those items on your tax return ONLY if you itemize.

Valuing household items and clothing can be complicated but many tax preparation sites have tools that help you figure the value of those items if you are not sure. Receipts are crucial and all receipts you get from charitable organizations need to be kept.

If you are donating an item such as a vehicle, there are a few rules that will apply, such as your deduction being limited to the amount the charity sells the car for. Your deduction will be able to be larger if the charity keeps the car and uses it for the charity’s work or gives the car to a needy family.

There is a special form that you will attach to your taxes that specifies either the vehicle’s price when sold or the higher exception is allowed if they keep the car for business purposes. Your accountant will have this form and it will need to be filled out by the charity you donated the car to.

You MUST keep impeccable records when it comes to donating cars and noncash items because this has been abused in the past. Your deductions could attract some IRS attention but as long as you have the legitimate records and receipts to back up your deductions, you’ll be fine.

Donating cash is the simplest way, since the value of the contribution will be the face value of the cash.  If you donate over $250 dollars get a letter of acknowledgement from the organization that you donated to for your records stating the donation date and amount. In addition, hang onto the cancelled check, credit card slip or money order receipt as additional proof and protection.

Another less known type of donation is if you have stock that has appreciated. If you haven’t sold the stock so you can hold off on paying the taxes on it, you can legally donate the stock itself to charity and take the gains the stock receives as a deduction. This also enables donators to not have to pay the 3.8% or more tax on net investment income which is a plus as well.

Increase Your Withholdings Now

tax-withholdingsIf you have projected that you will have a high tax bill due when it’s time to file your return, and you are employed through someone else, you can increase your federal income tax withholding amounts to help offset the amount you will owe. This is best done throughout the year, but if you start the additional withholding early enough, it can be a help in lowering your tax bill.

Ideally you want your withholding to be as close to accurate as possible so you are not paying too little and will owe a huge tax bill at tax time, or paying way too much and giving the IRS what amounts to an interest free loan with money that could be benefitting you throughout the year.

By making sure that the withholding amounts are good and adjusting them accordingly in plenty of time, you can help that tax amount that will be due at the end of year.

Pay Certain Bills Early

If you owe any money for your state taxes, owe any medical bills or property taxes you have the option of paying them early even if they aren’t due until next year.  Paying them before December 31st means you can claim them on the current return. This will benefit you by adding to the deductions that you can claim.

The one reason this would not be a good idea is if you already know that you will be in a higher tax bracket next year. If this is going to be the case, you will want to save them to deduct next year to help offset the higher tax bracket you will be in.

Sell Investments that You Will Take a Loss On

It’s never enjoyable to have investments that you will lose money on, but there is a silver lining.  By taking the loss before the end of the year you can put that loss on your current tax return.  Your losses will help offset any gains that you realized throughout the year.

This is good to do on any investments that you know you are going to lose money on. Your losses will offset your gains equally which means if you gained $100 for example, and lost $100, the $100 loss offsets the $100 gain.

If what you lose is greater than what you gain you can use as much as $3000 of additional losses to reduce other types of income.  You can carry any additional losses of over $3000 to the next year and that will help offset gains from the next tax year as well as up to $3000 of other income. You can carry your losses over to the next year indefinitely.

Take Advantage of the “Gift” Exception

tax-giftThe gift exception allows individuals to give gifts of as much as $14,000 to as many people as you want to and have money for.  This step reduces the amount of your estate value and can reduce and/or avoid any federal gift or estate taxes.  These gifts can take the form of cash, bonds, parts of real estate, and stocks too.

If the gifts you gift are above $14,000 it is possible that they will be subject to gift taxes so be sure to keep the amount to under $14,000 per person and keep track of WHO you have already given gifts to.  Another option is to make a payment or gift directly to a school or college. You will not have to pay gift taxes on the money given directly to the educational establishment.

Deferring Income

If you already know that you will either be in a lower tax bracket next year or will be the same as this year, another option that you could consider is deferring income.  Of course if you are employed for someone else, this isn’t generally an option but for those who are self employed or freelancers, this is a definite option that has some benefits and appeal.

One of the ways you can do this is to wait to collect money owed to you by sending out year-end bills late in December so the money won’t come in until January.

If you are not self employed there are a couple of potential options you may be able to use.  One is to defer compensation of some of your end of the year wages until the next year if your employer allows this.

Another option is to ask your employer if you can get your year-end bonus until early the next year. (If you get a year-end bonus of course)  As long as you receive the bonus within 2.5 months from the end of the year, your employer can still deduct it for the current year and you won’t have to claim it on this year’s taxes.

If you are a regular investor, a way to defer income is to pull savings out of your money market funds, bank accounts and similar funds and purchasing a T-Bill or CD that doesn’t mature or pay you any interest until after the last day of the year.

Do You Have a Vacation Home?

Some people have vacation homes that they keep but don’t rent out.  You may not realize that if you rent the vacation home out less than 15 days per year, that rental income is  not only tax free but you may deduct real estate taxes, interest from the mortgage on the vacation home and casualty losses as well.  You can’t deduct any expenses you incur from maintenance and repairs UNLESS you rent the home for MORE than 14 days per year.

While the rental income now comes into play as taxable, you may also be able to deduct more expenses in regard to the vacation home including those repairs and maintenance costs.  Your accountant can help you decide which way is the better route for you to lower you taxes for the next year.

Contributing to Your Retirement Accounts

401k-contibutionIf you have a 401K or similar employer-based retirement plan you can add extra money to them as long as they are not a Roth. All of those extra contributions will be deducted from your overall income. That will result in a lower tax bill. You can do this with the last few paychecks of the year or even put your year-end bonus into your 401K if it isn’t going to be deferred to the next year.

With traditional IRAs all of the contributions you make are tax deductible but you will owe taxes on any amount that you withdrawal from that IRA. It is a bit different with a Roth IRA in that you can invest the money after the taxes have been deducted but any withdrawals you make from the Roth are tax free.

Timing is Everything

With all of the steps that have been suggested above you will be able to successfully lower your tax bill if you take these steps before the end of the year.  No one wants to pay a high tax bill and early planning and action will help reduce the overall tax you owe.

Paying attention to the time you have left, knowing what your projected tax liability is ahead of time and taking the right steps with that time you have left will all help make a difference on that bottom line that you have to pay.

Record Keeping is Paramount

One of the most important things you can do to make everything go much smoother at tax filing time is to have the proper records and documents that your accountant will need to file your return. We have provided a list of these tax-related records that you should keep track of.

  1. All W-2 Forms
  2. All of your paystubs for the year (for you and your spouse if you’re filing jointly)
  3. Your mortgage payment receipts
  4. The home purchase closing statement if you have purchased a home during the year
  5. ALL receipts from anything that you will be claiming or even think you will be claiming as a deduction.
  6. Your tax returns from the previous year (very helpful for comparisons and referencing)
  7. Your business mileage for your car if you use it for business
  8. Travel expense receipts including hotels, airline tickets, food
  9. Cancelled checks for IRA contributions
  10. Bank statements
  11. Credit card statements
  12. Receipts from charities you have contributed to
  13. Medical bills that have been paid (do they exceed 7.5% of your income?)
  14. Mobile phone bills if the phone is used for business

There may be some other forms or documents you may need if you have gotten married, gotten divorced, had a baby, sold a home, gone to school or sent a child to school and so on.  Your account will have that information but your main job is to make sure that you have the receipts and documents necessary to back up any and all deductions you make, including the year-end steps you choose to make.