Individual Year-End Tax Planning
Herman & Company CPA’s, a tax preparation firm in Westchester, has all the answers to your personal finance questions!
The current federal income tax environment remains favorable through December 31st. Here are some tax planning ideas to consider as we approach year-end:
Leverage Standard Deduction by Bunching Deductible Expenditures. Are your 2012 itemized deductions likely to be just under or just over the standard deduction amount? If so, consider bunching expenditures for itemized deduction items every other year, while claiming the standard deduction in the intervening years. The 2012 standard deduction for married joint filers is $11,900; $5,950 for single and married filing separate filers; and $8,700 for heads of households.
For example, say you’re a joint filer whose only itemized deductions are $4,000 of annual property taxes and $8,000 of home mortgage interest. If you prepay your 2013 property taxes by December 31st, you could claim $16,000 of itemized deductions on your 2012 return ($4,000 of 2012 property taxes, plus an-other $4,000 for the 2013 property tax bill, plus the $8,000 of mortgage interest). Next year, you would only have the $8,000 of interest, but you could claim the standard deduction. Following this strategy will cut your taxable income by a meaningful amount over the two-year period (this year and next). You can repeat the drill again in future years. Finally, check for any negative AMT implications before implementing this strategy.
Examples of other deductible items that can be bunched together every other year to lower your taxes include charitable donations and state income tax payments.
Caution: If you think you’ll be in a higher tax bracket next year, you may want to claim the standard deduction this year and bunch your itemized deductions into 2013 when they can offset the higher taxed in-come. This will boost your overall tax savings for the two years combined.
Take Advantage of the 0% Rate on Investment Income. For 2012, the federal income tax rate on long-term capital gains and qualified dividends is 0% when they fall within the 10% or 15% federal income tax rate brackets. This will be the case to the extent your taxable income (including long-term capital gains and qualified dividends) does not exceed $70,700 if you are married and file jointly ($35,350 if you are single). While your income may be too high to benefit from the 0% rate, you may have children, grandchildren, or other loved ones who will be in one of the bottom two brackets. If so, consider giving them some appreciated stock or mutual fund shares that they can then sell and pay 0% tax on the resulting long-term gains. Gains will be long-term as long as your ownership period plus the gift recipient’s ownership period (before he or she sells) equals at least a year and a day.
Giving away stocks that pay dividends is another tax-smart idea. As long as the dividends fall within the gift recipient’s 10% or 15% rate bracket, they will be federal-income-tax-free.
Caution: The Kiddie Tax rules could cause capital gains and dividends to be taxed at the parent’s tax rate. Also, the gift tax exclusion is $13,000 in 2012.
Time Investment Gains and Losses. As you evaluate investments held in your taxable accounts, con-sider the impact of selling appreciated securities this year. The maximum federal income tax rate on long-term capital gains in 2012 is 15%. Therefore, it often makes sense to hold appreciated securities for at least a year and a day before selling. On the other hand, now may be a good time to cash in some long-term winners to benefit from today’s historically low capital gains tax rates.
Biting the bullet and selling some loser securities (currently worth less than you paid for them) before year-end can also be a good idea. The resulting capital losses will offset capital gains from other sales this year, including short-term gains from securities owned for one year or less that would otherwise be taxed at ordinary income tax rates. The bottom line is that you don’t have to worry about paying a higher tax rate on short-term gains if you have enough capital losses to shelter those short-term gains.
If capital losses for this year exceed capital gains, you will have a net capital loss for 2012. You can use that loss to shelter up to $3,000 of this year’s ordinary income from salaries, bonuses, self-employment, and so forth ($1,500 if you’re married and file separately). Any excess net capital loss is carried forward to next year.
For the Charitably Inclined. Say you want to make some gifts to favorite relatives (who may be hurting financially) and/or favorite charities. You can make gifts in conjunction with an overall revamping of your stock and equity mutual fund portfolio. Here’s how to get the best tax results from your generosity:
Gifts to Relatives (nondeductible). Do not give away loser shares. Instead sell the shares, and take ad-vantage of the resulting capital losses. Then give the cash sales proceeds to the relative. Do give away winner shares to relatives. Most likely, they will pay less tax than you would pay if you sold the same shares. In fact, relatives who are in the 10% or 15% federal income tax brackets will generally pay a 0% federal tax rate on long-term gains from shares that were held for over a year before being sold in 2012. (For purposes of meeting the more-than-one-year rule for gifted shares, you get to count your ownership period plus the recipient relative’s ownership period, however brief.) Even if the shares are held for one year or less before being sold, your relative will probably pay a lower tax rate than you would (typically only 10% or 15%). However, be aware that gains recognized by a relative who is under age 24 may be taxed at his or her parents’ higher rates under the so-called Kiddie Tax rules.
Gifts to Charities (deductible). The strategies for gifts to relatives work equally well for gifts to IRS-approved charities. Sell loser shares and claim the resulting tax-saving capital loss on your return. Then, give the sales proceeds to the charity and claim the resulting charitable write-off (assuming you itemize deductions). This strategy results in a double tax benefit (tax-saving capital loss plus tax-saving charitable contribution deduction). Give away winner shares to charity instead of giving cash. Here’s why. For publicly traded shares that you’ve owned over a year, your charitable deduction equals the full current market value at the time of the gift. Plus, when you give winner shares away, you walk away from the related capital gains tax. This idea is another double tax-saver (you avoid capital gains tax on the winner shares, and you get a tax-saving charitable contribution write-off). Because the charitable organization is tax-exempt, it can sell your donated shares without owing anything to the IRS.
This article should get you started thinking about tax planning moves for the rest of this year. Please don’t hesitate to contact us if you want more details or would like to schedule a tax planning strategy session.
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