11 end-of-year tax questions to ask yourself now
Making some early preparations can reduce stress and save you money at tax time.
Beware the ides of April.
That's when many of us procrastinators find ourselves in a frenzy, trying to cram a year's worth of tax planning into the span of a few days. But the act of paying Uncle Sam shouldn't be treated like finals. After all, it's not just a letter grade that's at stake anymore -- it's your time, your peace of mind and, most important, your money.
To clue you in on the tax moves that could lower your overall bill for the year -- and help you avoid an all-nighter come April 14 -- we've put together some of the most important questions you should ask yourself now. It may seem like a pain to gather the records and receipts that you'll need to answer some of them, but you'll thank yourself later.
No. 1: Do I need an accountant?
Before you do anything, you should decide whether you need the help of a professional. This is especially important to consider if your financial situation became more complicated this year. If you went through a big life change -- like getting married, having a baby, buying a home or starting your own business -- or if you exercised stock options, you should probably hire an accountant.
No. 2: Should I contribute more to my retirement funds?
The short answer: yes, if you're not already maxing out your contributions. Tax considerations aside, the more you can save now, the better off you'll be in retirement. For 2013, you can put away up to $5,500 ($6,500 if you are 50 or older) into your traditional or Roth IRA, and you can contribute up to $17,500 ($23,000 if you are 50 or older) pre-tax to your 401k. There are also some limits to how much you can contribute based on other factors, such as your income.
The longer answer: Your age and your overall progress toward retirement should factor into your decision to up your contributions.
Additionally, if you'd like to contribute more than the limits set by the I.R.S., including what's known as a nondeductible IRA, you have options -- but you won't see current year tax benefits.
No. 3: Should I convert from a traditional IRA to a Roth IRA?
There are some basics to consider first. For one, the main difference between a traditional and a Roth IRA is not whether you pay taxes, but when you pay them. "If you do a traditional IRA, you get an immediate tax deduction, but when you take that money out later, it's all taxed," explains Fred Freifeld, a CPA in Davie, Florida. "If you contribute to a Roth IRA, you are taxed on the contributions right away, but the advantage is that you won't be taxed on it forever more."
Bottom line: If you convert your traditional IRA to a Roth, you'll pay income taxes on those funds now. So why make a move that means you have to pay more in taxes this year? Because a little pain now could mean a lot less of it later. "If you're younger, and you're in a lower income bracket right now," adds Freifeld, "then it won't really hurt you." And you don't need to convert the whole thing, he adds. If converting your whole traditional IRA to a Roth would push you into a higher tax bracket, or if you don't think you'll have enough money set aside to pay taxes on the entire amount, just do a portion.
No. 4: Should I sell any of my investments?
Freifeld warns against just considering taxes when making big financial decisions. "Don't let the tax tail wag the dog," he says. However, all other things being equal, there are some tax considerations that may inform your decision to either hold onto or sell investments, such as stocks, mutual funds or real estate. For starters, if you've held an investment for less than a year and you sell it, you'll be taxed at a higher rate on any capital gains -- the profit -- you made on that investment. So if you can, hold off on selling for a little longer.
Also, if you have investments that have tanked since you bought them, you may consider selling. Those losses can be deducted to offset your capital gains and up to $3,000 of ordinary income. If you have no interest in keeping them in your portfolio, you could sell the investments permanently. But if you think that the investments will eventually go up in value, you could sell them, and then buy them back after 31 days (the I.R.S. won't allow the tax deduction if you do so under the 31-day time frame).
Just remember that this is still a gamble: It's possible that you could sell your investment, and then watch it skyrocket over the next 30 days. To combat this, some financial advisers suggest that you sell the loser and reinvest the proceeds in an index fund or similar stock that might have the same potential for gain without being so similar that it would be disallowed by the I.R.S.
No. 5: Are there charitable contributions I haven't made yet?
You should know that you can't deduct charitable donations if you're taking the standard deduction in lieu of itemizing your deductions. So making big donations now won't help you tax-wise -- although it is good for the soul.
If you're itemizing this year, and think that the food pantry in your community could use some help, or you want to donate to a charity in a loved one's name for the holidays, then upping your giving at the end of the year is something to consider. But keep in mind that a deduction is used to offset the amount of income on which you're paying taxes. So "if you're in a very low tax bracket this year, and may be in a higher tax bracket next year," you may want to hold off on donating until after the New Year, says Gail Rosen, a CPA who owns a New Jersey accounting firm.
No. 6:. Will I get better tax benefits if I donate in ways other than cash?
Let's say that you're thinking about giving $1,000 to a charity. You could write a check for $1,000 or you could give $1,000 worth of stock. "(Donating) is a way to give and get," Rosen says. "If you donate appreciated stock," which is stock that has gone up in value since you bought it, "you get the deduction at the fair market value of the stock, and you avoid paying taxes on the capital gains." It's kind of like getting a 10 percent to 39.6 percent discount, depending on your tax bracket, on your charitable gift! (Just don't give away stock that has done poorly since you bought it. You'll probably want to sell it, as covered in question No. 4.)
For those who are able to donate a fairly significant amount, another option is what's known as a donor-advised fund or DAF. It's like a mutual fund for money that you want to give to charity, and it can be nationally or locally focused. "You can put the money in now, and get a deduction for it now, even if you may not give it to a charity until the future," Freifeld says. Some financial services firms, like Vanguard and Fidelity, have launched independent charitable arms that run DAF programs.
A DAF can come in handy if you haven't yet decided on a chosen charity. It also works well if you find yourself with a high income this year and want a deduction now, but you also want to spread out your donations over several years. And since DAFs are managed by public charities, they will handle the paperwork. Just check the minimum amount required to start a DAF (they vary by fund), and that the charity you want to give money to can handle this sort of donation -- many small ones cannot.
No. 7: Do I have HSA or FSA money that I still need to use before the end of the year?
A Health Savings Account allows you to drop money into it pretax to pay for medical expenses. You need to have an eligible health care plan to have an HSA, but the good news is that you don't have to use all of the money -- it rolls over indefinitely. Actually, if you have spare money, and you've topped out your retirement savings contributions, you could consider putting more in a HSA before the end of the year -- it's almost like another retirement plan, but for medical expenses.
However, if you have a Flexible Spending Account (FSA), which you can use for medical expenses, day care and other qualified expenses, you could lose any money you have left in there after December 31. In 2013 your employer is allowed (but not obligated) to either let you roll over $500 or offer you a two-and-a-half-month extension. Double-check with HR to see if your company is taking advantage of either option.
No. 8: Is it a good idea to make moves that either lower or raise my income this year?
It depends on whether you expect your tax situation to change much between this year and next. If you work a salaried, nine-to-five job, and you expect to stay in that job, you don't really need to stress over this question.
But if you are self-employed, there are times when it could make sense to accelerate or defer your income. Accelerating means moving some of your income from next year into this year. So, for instance, if you are a consultant, you can bill clients now for future work, and deposit those checks before the New Year, instead of waiting until 2014.
"It would only make sense to accelerate income if you are in a lower tax bracket this year," Rosen says. "So if you got fired, and you have a new job for 2014, you might do that." Another opportunity, say Freifeld, is if you're anticipating moving from a low-tax state to a high-tax area in 2014 -- say, Florida to New York City -- and want to take advantage of the lower tax rate that you have now.
Likewise, it only makes sense to defer income if you anticipate being in a lower tax bracket next year. For example, if you know that you'll get an unusually large year-end bonus that could result in a high tax bill for you this year, you could ask your employer not to cut that check until January.
As you can tell, accelerating or deferring income requires a lot of guesswork (not to mention staying abreast of whatever changes Congress is pondering for the tax code), so it's a good idea to consult a professional about either strategy.
No. 9: Am I overlooking any deductions?
There could be a few lesser-known deductions that you can take advantage of, such as charity miles or medical miles, Rosen says. If you're driving around town in your car doing things for a 501(c)(3) nonprofit, you can deduct 14 cents per mile. If you are driving to and from medical appointments, you can deduct 24 cents a mile. You can also deduct expenses that you incur on behalf of a charity, if you're not getting reimbursed.
For teachers, Freifeld points out that the educator expense deduction, which lets you deduct up to $250 of classroom supplies -- even if you're not itemizing -- is expiring in 2013. So buy any school supplies before the end of the year.
If you refinanced your home, look at the HUD form that came with the paperwork. You may be able to deduct some of the taxes or closing points you paid. And Rosen adds that if you're thinking about energy-efficient improvements to your home, like replacing your windows, do it before the end of the year because those tax credits may expire -- there's no guarantee Congress will extend them.
And if you expect mortgage debt on your home to be forgiven (because of a foreclosure or short sale, for example), complete the process now. In 2014, you will be taxed on that forgiven debt, which is considered income to the debtor.
Did you start your own business this year? Even if you sold just a $3 trinket, it means you have to report your income and expenses. So keep track of everything that you spent and earned. In the first year, it's quite possible you realized a loss anyway, which means lower taxes. And if you hired an independent contractor to do work for your business, like designing your website, make sure to send them a W-9 form. Any business-related employee compensation and professional fees are deductible.
No. 10: Do my same-sex partner and I need to redo our taxes from last year?
The IRS now treats same-sex couples who were married legally as married for federal tax purposes, even if they live in a state that does not recognize same-sex marriage. So if you're based in North Carolina and got married in New York, you can still file jointly, like any other married couple. (Registered domestic partners don't count.) Freifeld says that you can also refile your tax returns as far back as the 2010 return that you filed in 2011, if you previously filed separately. Ask your preparer to run the numbers and see if that would ultimately save you money.
No. 11: Should I gift money to family members?
These days it's not uncommon for parents to give a little bit (or a lot) to their kids right out of school. But be careful: If you give any single person more than $14,000 a year (without expecting to be paid back), you'll create more work for yourself and have to file a gift tax return, says Freifeld. You won't be penalized financially, but that generosity will count against the total amount you can give over your lifetime without incurring the gift tax. For 2013, that lifetime total is $5.25 million.
More from LearnVest:
- 10 tax filing mistakes to avoid
- What is the AMT? The alternative minimum tax, explained
- Got a tax refund? 3 big reasons you don't want one
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