This time of year, it’s easy to get wrapped up in the holidays and push unpleasant things like tax planning into January, but believe me — a few tax tips will actually come in handy sooner than later.
For some tax decisions — such as how much to contribute to an IRA or Roth IRA — waiting is perfectly fine. You until have April 15 of next year to make your 2013 contributions. However, you should start your planning now, and we have plenty of tax tips for you to use before year’s end.
Changes to the tax code are scheduled to be minor in 2014, so you don’t need to do anything too drastic. But it still makes sense to pull as many tax breaks into your 2013 tax return as possible.
Uncle Sam doesn’t pay you interest on any refund due, after all, and effective tax rates are slightly higher in tax year 2013 than 2014 due to inflation adjustments that will raise the income levels in each tax bracket. For example, in 2013, the 28% tax bracket starts at incomes of $87,851 for an individual. In 2014, it starts at incomes of $89,351. So if you can lower your tax bill this year, it certainly makes sense to do so.
Today, we’re going to look at seven tax tips that will help you do exactly that:
Tax Tip #1: Max out your 401k contribution
In both 2013 and 2014, the maximum personal contribution you can make to a 401k, 403b or 457 plan is $17,500. And if you’re 50 or older, you can toss in an additional $5,500 for a total of $23,000.
Remember, this is only the portion of your salary that you contribute yourself; your employer also may match up to a certain percentage of your salary.
If you’ve fallen behind in your 401k contributions, there is one quick way to catch up. If your plan will allow it, you can put up to 100% of your December paychecks into your 401k plan. This assumes that you have enough money socked away to effectively forgo a month’s worth of pay — and a month that happens to include the busiest shopping season of the year.
But if you can afford to do it, you should. You’ll pay less in taxes this year and give yourself a head start in your 2014 financial goals.
Tax Tip #2: Contribute to an IRA or to a Roth IRA
In 2014, you can contribute $5,500 to an IRA or Roth IRA and $6,500 to either if you are age 50 or older. These contribution limits are unchanged from 2013, but there are a few changes you should know about concerning income limits. This is one area where the IRS really punishes success, and that is a shame.
In 2013, if you earn $59,000 and have a 401k or similar workplace retirement plan, your IRA contribution tax deduction starts to get phased out, and at $69,000 it gets eliminated altogether. In 2014, these amounts get raised to $60,000 to $70,000, respectively, but this means that plenty of Americans are still denied a fantastic tax break due to their earnings “too much money.”
If you don’t have a workplace retirement plan but your spouse does, you still can contribute to an IRA and get a tax break. But it starts to get phased out $178,000 in combined income for the couple and is eliminated altogether at $188,000. In 2014 these limits get raised to $181,000 and $191,000, respectively.
Roth IRAs are also getting higher income cutoffs in 2014. The AGI phase-out range for Roth IRA contributions will be $114,000 to $129,000 for individuals and $181,000 to $191,000 for married couples — that’s up from $112,000 to $127,000 and $178,000 to $188,000, respectively, in 2013.
If you qualify for a Roth contribution, do it. The Roth IRA is the best retirement vehicle ever created in this country. But if you don’t qualify for a Roth, a traditional IRA still is worth considering, even if you have a 401k at work and you’re disqualified from the current-year tax deduction. You still benefit from tax-free compounding of capital gains, dividends and interest, and you also enjoy the lawsuit protection and estate planning benefits of an IRA.
Tax Tip #3: Adjust the timing on your investment sales to push gains into next year and losses into this year.
You should never — and I repeat, never — make an investment decision based purely on tax minimization. Taxes should be a consideration, but fearing the tax man alone is not a legitimate reason to hold on to an appreciated investment you feel might be at risk, nor is it a legitimate reason to sell an investment that has fallen in value but that you still feel is a bargain.
That said, if you’re going to do a little portfolio pruning, this is a good time to do it. We all make that occasional bad investment, and it’s prudent to cut your losers.
And if you’ve been looking to take profits or rebalance, it makes sense to wait until after the first of the year, so long as you’re observing your usual trading rules (following stop losses, etc.)
If you sell an investment to harvest a tax loss, you’re subject to the wash sale rule. This means that you can’t buy it again within 30 days if you want to claim the loss for tax purposes. But there is absolutely nothing in the rulebook that says you can’t buy substantially similar securities. For example, you could take a loss in the SPDR S&P 500 ETF (SPY) and buy the iShares Core S&P 500 ETF (IVV) the very same day and not be subject to the wash sale rule.
Given that the market is near all-time highs, portfolio losses might be few and far between. But it’s good advice to keep in mind during the next correction.
Tax Tip #4: Make a large contribution to a Health Savings Account (HSA).
This is only applicable if you have a high-deductible health insurance policy that is compatible with HSAs, but millions of Americans — and particularly the self-employed — fall into this category.
The uncertainty surrounding Obamacare complicates matters in 2014. Assuming no changes to the Affordable Care Act, HSAs still will be available, even if the connected insurance policies are more expensive. But the entire healthcare industry is in a state of flux right now, and HSAs might no longer make sense once the dust settles.
I’m a big fan of the HSA structure because it encourages patients to be more careful with their medical dollars and gives them a degree of power they don’t have with traditional insurance, but you really have to run the numbers for yourself. If a bare-bones insurance policy is all you need, then you might as well take advantage of the tax breaks.
HSA contributions give you a similar tax breaks as traditional IRAs. In 2013, an individual policyholder can contribute a maximum of $3,250, and a family can contribute $6,450. Next year, the limits rise modestly to $3,300 and $6,550, respectively. If you’re age 55 or older, you can chip in an additional $1,000.
Unlike IRAs and Roth IRAs, HSAs are not subject to any income limitations.
Tax Tip #5: Get any elective medical or dental work done in 2013
Medical expenses not covered by your health insurance are deductible in 2013 if they exceed 10% of your adjusted gross income. And if you’re 65 or older, you benefit from a lower threshold of 7.5% of adjusted gross income.
If you have a high-deductible health insurance policy or somehow managed to find yourself uninsured in 2013, it can be remarkably easy to hit those levels. Ten percent of an AGI of $75,000 would mean that you need only $7,500 in medical expenses to take this deduction, and plenty of Americans spend more than that in a given year. Keep good records of all of your medical expenses — everything from doctor visit copays to prescription drug refills — and popular tax programs like Turbo Tax and TaxAct can calculate
It absolutely never makes sense to get unnecessary medical work done to get a tax break. But if you’ve been putting off an elective surgery or even needed dental work, you might as well do it now if doing so will get you over the deduction threshold.
Want an extreme example? I write this tongue-in-cheek, but I’ve seen people do more drastic things for a tax break:
If you are an expecting mother and have a scheduled caesarian delivery planned for the first two weeks of January, ask your doctor if moving the delivery into 2013 is a possibility. You have 18 years of living expenses to pay before you send junior to college. You might as well get the medical deduction this year, as well as an extra year of the child tax credit and the $3,900 dependent exemption for 2013.
Tax Tip #6: Pull charitable contributions forward
If you give regular sums of money to a church or charity, consider making any contributions you originally planned for the first quarter of next year to December. Or, if you don’t regularly give to charity, this might be a good time to start.
Cash contributions are the easiest and most likely to survive an audit. But the IRS is actually pretty generous when it comes to donating things like old cars or old clothes. For low-hanging fruit, spend a Saturday cleaning out your closet. Chances are good you can generate a couple hundred dollars in tax breaks by donating clothes that you’re no longer wearing. Just make sure you keep good records about the items donated, the condition they were in, and the date you donated them. If you want to be meticulous about it, take photos of the items with your camera phone and file them away with your tax materials for the year.
Reaching an estimated value can be tricky if you’re trying to do it on your own, but popular tax programs like TurboTax and TaxAct will walk you through the process and help you assign proper values.
Tax Tip #7: Get creative with your monthly bills
No one ever complains about getting paid too early, and your creditors are no exception. If you mortgage payment falls near the first of the month, make your January payment a week early this year.
You have to be careful that your mortgage lender understands that you are making the January payment and not simply making an unscheduled principal reduction. There is nothing wrong with reducing your principal early, of course, and I recommend that you do exactly that if your cash flow allows. But for the purposes of minimizing tax, you’re specifically looking to get another month’s worth of interest on the books.
The same goes for health insurance premiums if you pay your own. If your regular payment date falls in early January, pay it early.
If you own your own business or utilize a home office, you have a lot more leeway here. You can pay your electric, phone and Internet bills a couple weeks early. And you can buy basic office supplies or equipment a little earlier than planned.
Will any of these prepayments make a huge dent in your tax bill? No, probably not. But every dollar not spent paying taxes is a dollar available to be spent on something else in 2014.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Check out his new premium service, Macro Trend Investor, which includes a free copy of his e-book, The New Megatrend Investor: The Ultimate Buy-and-Hold Strategy That Will Make You Rich.