Year-end tax planning helps examine your current financial status and set goals to help you achieve your financial objectives.
Check Your Earnings and Withholdings to Date
One of the first steps in yearly tax planning is to look at your current earned wages or other income and how much has been withheld for income taxes or what quarterly estimated taxes have been paid. Then, try to make a reasonable effort to estimate the earned income and withholdings for the remainder of the year. Add to this income your projection of other income (e.g., dividends, capital gains) for the entire year. Any approximation is better than doing nothing. At this point, you can see if you are likely to owe taxes for 2014 or get a refund. You may then need to consider adjusting your withholdings.
Will you itemize your deductions or take the standard deduction for 2014? How do you determine which to use? The standard deduction is determined annually and is a no-questions-asked allowance as a reduction of your income. For 2014 the amounts are:
- Single: $6,200
- Head of Household: $9,100
- Married Filing Jointly: $12,400
- Married Filing Separately: $6,200
Choosing to itemize deductions depends on how much you spent on certain items (this is not an exhaustive list of itemized deductions) such as the ones listed below. Compare this set of standard deductions to your itemized deductions for 2014:
- Medical expenses exceeding 10 percent of your adjusted gross (total) income.
- State taxes: income and real estate.
- Interest on home mortgages.
- Interest on debt to purchase or carry investments (limited to the amount of your investment income).
- Charitable contributions: cash and in-kind donations.
- Certain employee and investment expenses (to the extent they exceed 2 percent of AGI).
If the total amount spent is more than your standard deduction, it may be beneficial for you to itemize deductions. What if it looks like you won’t have enough of those to itemize in 2014? You may then want to defer as many of those expenses and pay them in 2015 and start the comparison again – in effect “bunch” your deductions.
Check Your Investments
Do you have any capital gains for this tax year? If you already have taxable gains from selling stock, real estate or others, see if you have some unrealized losses in other assets that you can sell before year-end to offset those gains. Although it’s not favorable to lose money on your investments, declaring capital losses can help offset capital gains and reduce your tax liability.
If you are thinking of selling stock, consider postponing the gain until January to avoid the tax in 2014. First, make the right decision from an economic or investment standpoint. Don’t let the tax tail wag the economic dog. Make sure the decision benefits your overall financial objectives.
One of the best tax planning opportunities is to maximize your retirement contributions. Make elective deferrals to your 401(k) account in addition to what your employer contributes. You can reduce your income by up to $17,500 ($23,000 if you are at least age 50) in some cases. Money you contribute to your 401(k) plan is excluded from your income, which helps lower your tax bill. This is a great long-term savings option.
If you work and are not covered by a retirement plan, you can make an IRA contribution in 2015 before you timely file your 2014 return. Those contributions are deductible in 2014. You have 15 months to contribute to an IRA for the current tax year. For example, you can make 2014 contributions any time from January 1, 2014, to April 15, 2015.
Education Savings Opportunities
Education savings plans are a good, long-term savings vehicle to provide for your children’s or grandchildren’s college expenses. While there are no current income tax deductions for contributions to these accounts (except for some possible state income tax deductions), this is a good option to put away money for college expenses. Income earned in these accounts is not taxed as long as the funds withdrawn go toward qualified education expenses.
Gift giving is a tradition during holiday season, and your generosity may pay off at tax time. For 2014, you can give up to $14,000 to a person without incurring any federal gift tax liability. If you’re married, you and your spouse can give up to $28,000 per recipient. However, in order to qualify for the annual gift exclusion, you must give the funds directly to the individual or put the funds into a trust with certain requirements. You do not get an income tax deduction for gifts to relatives.
Spend Your FSA Money
A flexible spending account (FSA) is a saving account offered by an employer that helps you put away tax-free money for qualified medical expenses. The Internal Revenue Service (IRS) changed the rules so that employers can allow employees to carryover up to $500 in their account to the next year.
If your FSA is still in the motto of “use it or lose it,” you’ll want to make sure to you use all of your funds by the end of the year. Spend down your FSA on qualified medical expenses to help maximize your tax savings. When you start your 2015 tax planning, evaluate the amount you spent in your FSA and adjust accordingly.
Your Unemployment Income Is Taxable
Did you know that unemployment benefits are subject to both federal and, depending on where you live, state taxes? That’s an important fact to keep in mind so that you stay within your budget and aren’t surprised by a larger-than-expected tax bill in April. You must report and pay taxes on any kind of unemployment income, including both state and federally funded benefits. If you request it, the federal government will withhold 10 percent of your unemployment income toward your taxes. This is worth considering, since it will help prevent you from spending money that should be set aside for taxes. It will also allow you to avoid the paperwork involved in determining and paying quarterly estimated taxes on your unemployment income. Companies have the option to allow participants to rollover unused funds, but are not required to do so.