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Year-End Tax Planning: Preparing for Our New Administration

With the end of the year fast approaching, now is the time to review your 2016 income tax situation and evaluate whether it makes sense to do some year-end tax planning.

Many reputable commentators believe that Congress will pass a new tax bill next year lowering most taxpayer’s Federal tax rate. If that happens, then it might be in your best interest to accelerate tax deductions into this year (2016) and defer income into next year (2017).

Here are some specific ideas for consideration.

Accelerating Deductions

For most taxpayers, there are only a few types of deductions that can be controlled, essentially by paying them this year rather than next year. Here are the more common deductions you may accelerate:

Mortgage Interest

Paying your January mortgage payment or Home Equity Line of Credit payment by December 31, 2016 will increase your deductible mortgage interest expense this year. Then next year you would only have to make eleven mortgage payments, unless you choose to continue paying January’s mortgage payment in December each year.

State Income and Property Taxes

Do you pay your property taxes directly (rather than as part of your escrow payment)? Do you usually owe state income taxes on April 15 of every year? If so, prepay your property tax bill and make an estimated state income tax payment before December 31, 2016. Doing so will increase your itemized deductions and reduce your taxable income for 2016.

One word of caution regarding this strategy. If you are subject to the Alternative Minimum Tax (AMT) or are close to being subject to AMT, you should not prepay your property or state income taxes because you will not receive the tax deduction. AMT eliminates certain itemized deductions, including property and state income taxes. Unfortunately, AMT is a difficult tax to calculate so if you think it may apply to you, I strongly suggest speaking with your tax preparer to determine whether or not you will be subject to the tax.

Donations to Charity

Making donations of property or cash to qualified charities is a great way to increase your itemized deductions this year. Donations of property are particularly attractive to some because it doesn’t require additional cash outlays, which can be difficult this time of year.

If you already give to charity each year, a strategy to consider is to accelerate what you typically give over many years and make the donation in this calendar year. For example, if you typically donate $5,000 each and every year and you expect to be in a higher tax bracket this year, consider donating $15,000 before year-end (the equivalent of three years of donations) and taking the tax deduction now (assuming you have the cash to do so).

Some individuals may want to leverage this gifting strategy but prefer to not give the charity all of the money at once. In this case, you can donate to a Donor Advised Fund. This fund allows you to make the full amount of the donation and take the tax deduction now, but not give the money to the charity until later.

Deferring Income

Realize Capital Losses

Now is a good time to look at your investments to see if any of them would result in a loss if you sold them prior to the end of the year. If there are some, you may want to consider selling them now, particularly if you sold other investments for a gain this year. You can offset those gains with the losses.

If you implement this strategy, there are a couple of things to be aware of. First, only losses incurred by selling investments held outside of retirement accounts can be used to offset current gains. So be careful; positions held in your 401(k) or IRA accounts won’t help you offset any gains.

The second thing to be aware of is that losses that exceed gains can be deducted against ordinary income up to $3,000 per year. Any net loss in excess of $3,000 can be carried forward to next year’s income taxes.

Many taxpayers hesitate to sell investments at a loss and believe they can generate the loss and then immediately buy back the investment with the proceeds from the sale. Unfortunately, the IRS will not allow you to use the tax loss until you ultimately sell the investment you just bought back. This is called the “wash loss” rule; it states that you must wait 31 days to buy the investment or a substantially identical investment back. You can immediately buy an investment similar to the one you just sold, but care should be taken to make sure you are not buying a substantially identical investment. Buying the same or a substantially identical investment in your IRA or 401(k) account will also invalidate your ability to take a loss, even though it was done in a different account.

Maximize your 401(k) or 403(b) contributions

Employees can contribute up to $18,000 per year to a retirement plan such as a 401(k) or 403(b). For those employees age 50 or older, the amount increases to $24,000 in 2016. Increasing your contributions to reach the maximum allowable amount before December 31 will reduce your taxable income for this year. If you expect tax rates to go down in the future, then maxing out your contribution this year will save you more income tax than doing so next year. If cash flow is an issue, make the contribution now, and then suspend or reduce your contributions at the beginning of next year to help replenish your available cash.

While the best tax planning is done when there is plenty of time left in the year, there is still time to employ a number of strategies that can make a difference. The ideas above may help you save taxes and, in the case of increasing your charitable donations, help some great causes. Of course, you should always consult with your financial and tax advisors to verify which of these – and potentially other – strategies are right for your situation.