There are important tax-saving actions that must be taken before the calendar year ends or they’ll be lost forever. These last-minute moves can slim down your taxes and claw back some of your cash.
1. Don’t buy that mutual fund–yet!
At the end of each year, mutual funds distribute their capital gains–a gain that they’ve realized from selling a security–to the fund’s owners. Typically funds will distribute them in December, creating an immediate taxable gain, if you own the fund in a taxable account.
“Basically, the investor is receiving a taxable return of their own principal,” says Jeff Warnkin, certified financial planner and certified public accountant with the JL Smith Group. “They must report the distribution as taxable income on their tax return, but do not receive any economic benefit from it.”
“In other words, they did not actually own the shares and participate in the appreciation that led to the distribution itself, so they are paying tax on other shareholders’ gains,” says Warnkin.
To avoid this situation, you could buy the fund in a tax-advantaged account such as an IRA. The account shields you from capital gains tax, so you can buy at any time.
Warnkin also suggests that you could contact the fund company and see when their distribution will occur, so that you can time your purchase to avoid it. But you may find that the distribution is small or non-existent, in which case you can purchase the fund with no or minimal tax effect.
2. Max out those retirement contributions
While the deadline to contribute to an IRA is not until Tax Day, if you’re using a 401(k) or 403(b) or other employer retirement plan, you’ll want to get your contributions squared away before the year ends. Taking advantage of a workplace retirement plan, such as a traditional 401(k), allows you to contribute pre-tax money.
“Though it may seem obvious, many people neglect to utilize this as a year-end tax planning strategy,” says Elizabeth Lindsay-Ochoa, director at CBIZ MHM, a financial advisory.
Workers can save up to $19,000 (for 2019) in their 401(k) plans if they’re under 50, and up to $25,000 if they’re older than 50, says Lindsay-Ochoa. And the self-employed can take advantage, too.
“If you’re self-employed, you should consider setting up a self-employed retirement plan and contributing the maximum amount to minimize your 2019 tax bill,” she says.
3. Dodge the net investment income tax (NIIT)
If you have income from investments such as stocks and bonds, the IRS may levy an extra tax on your income called the net investment income tax (NIIT), if your income exceeds certain thresholds: $250,000 modified adjusted gross income if married filing jointly, $125,000 if married filing separately, or $200,000 in all other cases.
If you’re an individual, you’ll pay the lesser of 3.8 percent on (1) your net investment income or (2) the amount in excess above your threshold. If you’re under the dollar thresholds, you won’t pay any NIIT, but if you go over and you have investment income, then you’re going to get hit.
One solution is to make sure you’re selling unrealized losses on your investments to offset any gains, says Lindsay-Ochoa. This process is called tax-loss harvesting, and it can help keep your income below the threshold to pay NIIT or at least minimize it.
4. Avoid capital gains taxes and step up your basis
If you’re in a lower tax bracket, you may be able to ditch capital gains taxes entirely and set up your portfolio so that you pay lower taxes in the future, too.
“If your total income leaves you in the 12 percent tax bracket or lower, you are able to recognize capital gains in your non-retirement accounts at a zero percent federal capital gains tax rate,” according to Matthew Schwartz, a certified financial planner at Great Waters Financial.
“By selling, and realizing the gains, then repurchasing the investment, you would be able to step up your cost basis without paying additional federal tax,” says Schwartz.
This step-up in basis means you’d pay fewer taxes later on, if you sold for a gain.
5. Bunch your deductions in order to itemize
The Tax Cuts and Jobs Act of 2017 increased the standard deduction on tax returns, making it harder for filers to itemize and achieve a tax break greater than the standard deduction. For example, many taxpayers used to be able to itemize a deduction for all of their state and local taxes (SALT). But with this amount now being capped at $10,000, it often makes more financial sense to accept the standard deduction. (See CVAR Newswire for info on temporary hold on the cap.)
One way around this difficulty is to strategically bunch your deductions, so you can clear the threshold for the standard deduction and receive credit for your expenses. Other expenses that can be itemized include charitable donations and healthcare costs above a certain level.
If you frequently give charitable donations, Schwartz suggests another alternative – a donor-advised fund – for achieving the effect of bunching while allowing you to give what you want.
“Utilizing a donor-advised fund would allow you to receive a deduction for several years of giving (in this year), while maintaining control over where the money is directed in the future,” Schwartz says.
And donating a winning investment to charity could be another way to help bunch deductions.
“Especially after a year of strong market returns, investors should consider donating appreciated stock to a charity to avoid paying capital gains and potentially get a charitable deduction,” says Lindsay-Ochoa.
6. Get a two-for-one with a losing investment
Turn your capital loss into a charitable deduction and get two deductions.
“If you do have losses, what many don’t realize is that you can sell the stock for cash, donate the cash proceeds to charity (and possibly receive a charitable deduction) and also take advantage of a capital loss on the sale of the stock,” says Lindsay-Ochoa.