New wrinkles in tax strategies could help smooth your year-end planning
As 2016 enters its final weeks, it’s a good time for year-end tax planning strategies — including some new wrinkles:
Plan for 2016-2017 together: Consider reducing your overall tax liability by shifting income and deductions across 2016 and 2017. Assuming similar income for both, you can accelerate various deduction items into 2016. For example, mail your state estimated tax payment, due in January, before year-end to make it tax deductible in 2016. Or pay your January mortgage payment now to make the interest deductible this year. You can also accelerate charitable deductions or medical expenses into 2016. The latter may be especially attractive for those 65 or older because the threshold for deductibility is scheduled to increase from 7.5 percent of adjusted gross income to 10 percent in 2017. For those under 65, the threshold is 10 percent.
Note that taxpayers subject to the Alternative Minimum Tax may not benefit from the above strategies because some deductions are eliminated under the calculation.
Minimize tax on capital assets: If you have unused capital losses from prior years, sell investments at a gain to make those losses work. You won’t be taxed on those gains, up to the amount of the losses.
If your income level is below $75,301 for married couples filing jointly, or $37,651 for singles, consider selling stock at a gain to benefit from the 0 percent tax rate. But be careful: the gain can reduce your itemized deductions or cause more of your Social Security benefit to be taxed.
You can also sell poorly performing equity investments to use the annual $3,000 ordinary income offset for capital losses and reduce your taxable income. However, remember the “wash sale rules.” If you want to harvest a loss but continue the same investment, you need to wait 31 days to reinvest or lose your loss deduction until you sell the repurchased investment.
Finally, be careful when buying a mutual fund. Make sure it will not pay a dividend after you buy it and before year-end. That would increase your taxable income and reduce the value of your investment by the same amount.
Going forward, consider steps to minimize or eliminate the 3.8 percent Medicare surcharge on investment gain for married couples filing jointly with income more than $250,000, and single filers with income more than $200,000. For example, try municipal bond investments. Tax-exempt interest doesn’t increase your income level for purposes of the above test.
You can also convert some or all of a traditional IRA to Roth IRA form. Although the conversion will create a tax liability on the underlying IRA asset in the conversion year, all future gains should be income-tax-free and future withdrawals from the Roth IRA should not count toward the income threshold that triggers the Medicare surcharge.
Required minimum distributions: If you are 70 1/2-years-old, you generally must take your RMD from each retirement asset, including 401(k)s, each year. Roth IRAs are not subject to RMD rules; Roth 401(k)s are. The amount you must withdraw is determined by an IRS table. The idea is to force out an increasing percentage each year so the retirement asset is used over your lifetime.
In the year you turn 70 1/2, you have an option to defer your first RMD to the following calendar year. Beware: this could increase your overall tax liability for the two years combined.
Charitable gift giving: For those over age 70 1/2, if you are charitably inclined, consider making your charitable gifts using RMD funds. By using some or all of your RMD amount, up to $100,000 a year, you can avoid inclusion of such otherwise taxable income. This is usually better than an outright gift to the charity, since the charitable deduction would probably not fully offset the income from the RMD due to limitations on deductions. Note that to qualify for this special rule the charitable gift must be made directly from your IRA to the charity. You cannot take the RMD amount and then write a check to the charity.
Roth IRA conversions: Is it the right time to convert some or all of a traditional IRA to a Roth IRA? Although that would trigger the gain on the traditional IRA amount being converted, there are numerous benefits from holding Roth IRA assets over the longer term. They serve as a hedge against increased tax rates, have no RMD requirement and can continue to grow without forced distributions. And, when needed, distributions from a Roth IRA don’t increase your taxable income for purposes of the 3.8 percent Medicare surcharge, calculating the taxable amount of your Social Security benefits or determining the Medicare Part B premium surcharge applicable to higher-income taxpayers.
Prudential Financial Inc. and its affiliates do not render tax or legal advice. Please consult your tax and legal advisors for advice concerning your particular circumstances.