As 2013 comes to a close, there is still time to plan your year-end strategies for minimizing your 2013 tax liability. Let’s consider some savvy tax-planning tactics that might apply to you.
Timing, Deductions And Credits
In order to plan, you will need a good sense of your expected 2013 income, adjusted gross income and corresponding tax bracket.
When it comes to taxes, timing can be important. By delaying income such as a year-end bonus or commissions, you can defer your taxes on that income until 2014. Or, if you expect to be in a higher tax bracket in 2014, taking that income in 2013 may be a better move. After you decide about the timing of your bonuses or commissions, you can then estimate your adjusted gross income by deducting common adjustments from your expected income, such as 401(k) and individual retirement account contributions, alimony and student loan interest payments, for example. These are adjustments you can take even if you do not itemize.
Next, you’ll want to take a close look at possible deductions and tax credits. A deduction reduces your taxable income — that is, the amount of income on which your tax is calculated. How much a deduction saves you depends on your tax bracket. For example, in a 25 percent bracket, a $1,000 deduction saves $250 of tax. In a 33 percent bracket, the same deduction saves $330. Many people find that claiming itemized deductions for expenses such as mortgage interest, state and local tax, and charitable contributions provides them with a better tax result than claiming the standard deduction.
Unlike a deduction, a tax credit directly reduces your tax liability. Whatever your tax bracket, generally speaking, a $1,000 tax credit saves you $1,000 of tax. There are several tax credits you may qualify for, such as tax credits for children, child and dependent care, post-secondary education for someone in your household and even a saver’s credit.
Investment income includes taxable interest, dividends, rents, royalties, annuities, capital gains and income from a business investment. If you have realized capital gains on investment sales this year, you can lower your tax liability by generating offsetting losses. Capital losses can be used to offset your gains, plus up to $3,000 of your ordinary income, too.
Conversely, if you have already sold some investments at a loss, you can take capital gains on appreciated stock that you may have been hesitant to sell because of tax consequences. As long as the gains aren’t more than your available losses, you’ll be able to take them without the tax liability.
New Medicare Tax
If you are a high-income earner, you may be subject to the new 3.8 percent tax on investment income, designed to help pay for the Medicare program. This surcharge will be imposed on taxpayers who have any amount of combined net investment income, if their adjusted gross income is greater than $200,000 for single filers, $250,000 for married filing jointly and $125,000 for married but filing separately. Working to reduce your adjusted gross income to below the appropriate threshold could help you avoid this tax.
Decisions That Work Best For You
On a final note, remember that pre-tax contributions to an employer’s retirement savings plan and/or deductible contributions to an IRA can reduce your current taxes as well as help you save for retirement. If possible, try to max out your retirement plan contributions for the year.
Consulting with a tax professional can provide you clarity on how best to minimize your tax liability.
Erin Eddins is a chartered financial consultant, a member of the Financial Planning Association and is a certified financial planner with StanCorp Investment Advisers Inc. She specializes in Social Security maximization, pre- and post-retirement planning strategies and asset management. She can be reached at email@example.com or 425-212-5986.