Max Out Your 401(k) or Contribute to an IRA
You’ve heard it before, but it’s worth repeating because it’s one of the easiest and most cost-effective ways of saving money for your retirement.
Many employers offer plans where you can elect to defer a portion of your salary and contribute it to a tax-deferred retirement account. For most companies, these are referred to as 401(k) plans. For many other employers, such as universities, a similar plan called a 403(b) is available. Check with your employer about the availability of such a plan and contribute as much as possible to defer income and accumulate retirement assets.
Tip: Some employers match a portion of employee contributions to such plans. If this is available, you should structure your contributions to receive the maximum employer matching contribution.
If you have income from wages or self-employment income, you can build tax-sheltered investments by contributing to a traditional (pre-tax contributions) or a Roth IRA (after-tax contributions). You may also be able to contribute to a spousal IRA even when your spouse has little or no earned income.
Tip: To get the most from IRA contributions, fund the IRA as early as possible in the year. Also, pay the IRA trustee out of separate funds, not out of the amount in the IRA. Following these two rules will ensure that you get the most tax-deferred earnings possible from your money.
If You Have Your Own Business, Set Up and Contribute to a Retirement Plan
Similarly, if you have your own business, consider setting up and contributing as much as possible to a retirement plan. These are allowed even for a sideline or moonlighting businesses. Several types of plans are available which minimize the paperwork involved in establishing and administering such a plan.
Use the Gift-Tax Exclusion to Shift Income
In 2016, you can give away $14,000 ($28,000 if joined by a spouse) per donee, per year without paying federal gift tax. And, you can give $14,000 to as many donees as you like. The income on these transfers will then be taxed at the donee’s tax rate, which is in many cases lower.
Note: Special rules apply to children under age 18. Also, if you directly pay the medical or educational expenses of the donee, such gifts will not be subject to gift tax.
For gift tax purposes, contributions to Qualified Tuition Programs (Section 529) are treated as completed gifts even though the account owner has the right to withdraw them. As such, they qualify for the up-to-$14,000 annual gift tax exclusion in 2016. One contributing more than $14,000 may elect to treat the gift as made in equal installments over the year of gift and the following four years so that up to $56,000 can be given tax-free in the first year.
Consider Tax-Exempt Municipal Bonds
Interest on state or local municipal bonds is generally exempt from federal income tax and from tax by the issuing state or locality. For that reason, interest paid on such bonds is somewhat less than that paid on commercial bonds of comparable quality. However, for individuals in higher brackets, the interest from municipal bonds will often be greater than from higher paying commercial bonds after reduction for taxes. Gain on sale of municipal bonds is taxable and loss is deductible. Tax-exempt interest is sometimes an element in the computation of other tax items. Interest on loans to buy or carry tax-exempts is non-deductible.
Give Appreciated Assets to Charity
If you’re planning to make a charitable gift, it generally makes more sense to give appreciated long-term capital assets to the charity, instead of selling the assets and giving the charity the after-tax proceeds. Donating the assets instead of the cash prevents your having to pay capital gains tax on the sale, which can result in considerable savings, depending on your tax bracket and the amount of tax that would be due on the sale. Additionally, you can obtain a tax deduction for the fair market value of the property.
Tip: Many taxpayers also give depreciated assets to charity. Deduction is for fair market value; no loss deduction is allowed for depreciation in value of a personal asset. Depending on the item donated, there may be strict valuation rules and deduction limits.
Tip: Taxpayers age 70 1/2 and older can take advantage of tax benefits associated with Qualified Charitable Distributions (QCDs)–IRA withdrawals that are transferred directly to a qualified charitable organization. See the article, Qualified Charitable Distributions from IRAs, below, for additional details.
Keep Track of Mileage Driven for Business, Medical or Charitable Purposes
If you drive your car for business, medical or charitable purposes, you may be entitled to a deduction for miles driven. For 2016, it’s 54 cents per mile for business, 19 cents for medical and moving purposes, and 14 cents for service for charitable organizations. You need to keep detailed daily records of the mileage driven for these purposes to substantiate the deduction.
Take Advantage of Employer Benefit Plans Such as Flexible Spending Accounts (FSAs) or Health Spending Accounts (HSAs)
Medical and dental expenses are generally only deductible to the extent they exceed 10 percent of your adjusted gross income (AGI). For most individuals, particularly those with high income, this eliminates the possibility for a deduction.
However, you can effectively get a deduction for these items if your employer offers a Flexible Spending Account (sometimes called a cafeteria plan). These plans permit you to redirect a portion of your salary to pay these types of expenses with pre-tax dollars. Another such arrangement is a Health Savings Account. Ask your employer if they provide either of these plans.
If Self-Employed, Take Advantage of Special Deductions
You may be able to expense up to $500,000 in 2016 for qualified equipment purchases for use in your business immediately instead of writing it off over many years. Additionally, self-employed individuals can deduct 100 percent of their health insurance premiums as business expenses. You may also be able to establish a Keogh, SEP or SIMPLE IRA plan, or a Health Savings Account, as mentioned above.
If You’re Self-Employed, Hire Your Child in the Business
If your child is under age 18, he or she is not subject to employment taxes such as FICA and federal unemployment taxes from your unincorporated business (income taxes still apply). In addition, your child may be able to contribute to an IRA using earned income. This will reduce your income for both income and employment tax purposes and shift assets to the child at the same time; however, you cannot hire your child if he or she in under the age of 8 years old.
Take Out a Home-Equity Loan
Most consumer-related interest expense, such as from car loans or credit cards, is not deductible. Interest on a home equity loan, however, can be deductible. It may be advisable to take out a home-equity loan to pay off other nondeductible obligations.
Bunch Your Itemized Deductions
Certain itemized deductions, such as medical or employment related expenses, are only deductible if they exceed a certain amount. It may be advantageous to delay payments in one year and prepay them in the next year to bunch the expenses in one year. This way you stand a better chance of getting a deduction.
A word about proper documentation…
Unfortunately, many taxpayers forgo worthwhile tax credits and deductions because they have neglected to keep proper receipts or records. Keeping adequate records is required by the IRS for employee business expenses, deductible travel and entertainment expenses, and charitable gifts and travel, and more.
But don’t do it just because the IRS says so. Neglecting to track these deductions can lead to overlooking them.
You also need to maintain records regarding your income. If your receive a large tax-free amount, such as a gift or inheritance, make certain to document the item so that the IRS does not later claim that you had unreported income.
It’s never too early to get started on tax planning for 2016 and beyond. Call the office today to speak with an accountant and find out how you can save money on your taxes this year.