Year-End Tax Considerations
The year is quickly coming to an end, so you should act now to make changes to alter your tax liability for the year. With the exception of contributions to IRAs, the deadline for action is Dec. 31st. The clock is ticking.
The first thing to do is to estimate your taxes and determine if you will have a possible tax refund or owe additional taxes. Once you know your tax picture for 2015, you should do your best to estimate your 2016 outlook. Essentially, you want to estimate if your tax bracket will be substantially higher or lower next year, so you can make decisions to accelerate income or deductions before the end of the year.
As long as you itemize and donate to a qualified 501(c)3 nonprofit organization, you can deduct charitable contributions when you file your tax return. Besides being philanthropic, you can reduce your tax liability. (Note: Depending on your adjusted gross income, there may be some restrictions on total deductions.) Those donations must be made by Dec. 31, 2015.
You may also transfer wealth by gifting to individuals. You can give up to $14,000 per individual to as many people as you’d like prior to the end of the year… without the need to file a gift-tax return. For married couples, that amount increases to $28,000 per couple. (Note: The annual gift tax exclusion amount for 2016 is scheduled to stay the same: $14,000 for individuals, $28,000 for married couples.) The recipient of your generosity does not have to claim this money as income; therefore, it does not become taxable.
If you are helping children or grandchildren (or anyone else for that matter) with a 529 plan, you can put up to $14,000 this year into the plan tax free. Contributions are not deductible; however, plan earnings grow federally tax-free. Depending on your state, there may be full or partial tax deductions at the state level. Additionally, you can front-load a 529 plan (i.e. giving five years’ worth of annual maximum gifts of $14,000 at once) with $70,000. In this way, you eliminate the gift tax and also don’t chip away at the lifetime gift tax exclusion.
You may want to move up your deductions, so you can claim them for this tax year. This is especially important if you’ve had more income than anticipated, perhaps by selling property or cashing out investments with gains.
Here are some to consider:
- Make your January mortgage payment in December to increase the amount of interest you can deduct (e.g. 13 payments in the year rather than 12).
- Prepay 2016 property taxes.
- Make early estimated payments on state and local taxes that you would otherwise pay in January.
As mentioned, you’ll want to estimate your tax bracket for next year. If you are going to be in a higher bracket next year, you’ll want to hold these deductions and take them in the year in which your tax liability is higher.
Income vs. Deductible Expenditures
If you own a business that operates as a sole proprietorship, LLC, partnership, or S corporation, your share of business income is reported on your personal tax return and taxed at your personal rate. Looking ahead, tax rates for 2016 for individuals will not differ greatly from this year. If you expect to be in a similar tax bracket next year, you can consider deferring income until 2016 while you increase your deductible business expenses.
If you operate on a cash basis, here are a few ways to defer income and accelerate deductible expenses:
- For expenses that you anticipate early in 2016, charge them on a credit card before the end of the year. You can claim the expense for 2015 (when it was charged), but you won’t pay the bill until 2016.
- Likewise, you can pay by check and mail it just before year end. According to tax rules, you can deduct the expense for the current year even though the check will not be deposited and clear until into the new year. If it’s a big-ticket item, use registered or certified mail, so you can prove that payments were mailed in 2015.
- Prepay some expenses before year end, but there is a caveat: The economic benefit of the prepayment does not extend beyond the earlier of either 12 months after the first date on which your business realizes the benefit OR the end of the next tax year.
For cash-basis businesses, the inverse is true for income. You don’t have to report income until the year in which you actually receive the cash or check through the mail. You can defer income by invoicing customers near year end because you won’t receive payment until next year.