With the holidays fast approaching, it may seem like a downer to think about taxes. But given the impact of the new tax laws, it’s actually a good idea to review some things.
Here are just a few of the changes:
- Deductions like casualty and theft losses (except for federally declared disaster areas), moving expenses, unreimbursed employee expenses and miscellaneous deductions (subject to the 2% AGI cap) are gone.
- You can deduct interest for mortgage debt of up to $750,000 (the previous amount was $1 million) and interest on home equity debt is no longer deductible.
- The maximum deduction for state income, sales and property taxes is $10,000.
With that in mind, you might be wondering, what are the steps you can take to make a difference or avoid problems? Here are five tax moves to consider:
Year-End Tax Moves: Withholding
The IRS changed the withholding amounts to take into account the new tax brackets. This is why your take-home pay increased this year.
There’s a problem though: Some taxpayers may not be withholding enough. Actually, according to the Government Accountability Office, this applies to about 21% of the population.
Why is this so? The main reason is that certain deductions — such as for property taxes and mortgage interest — are less attractive. And this means some taxpayers will have to fork over more to Uncle Sam.
To see if this applies to you, the IRS has a free tax withholding calculator. You can then go to your HR department to adjust the withholding, which is done by filing out a new W-4 form.
Year-End Tax Moves: Tax Harvesting
This year has seen wrenching volatility in the markets. But this could mean a tax opportunity … that is, by “harvesting losses.” This means offsetting gains with your losses, which will lower or even eliminate your tax hit.
But it’s important to understand the two types of gains. First, there is a short-term gain, which is when you sell the stock within less than a year. In this case, you pay the same rates as you would for your wages.
Next, there is a long-term gain, which is for those investments you sell after holding them for one year. Keep in mind that there is favorable tax treatment (the maximum federal rate is 20%).
In light of all this, look first at the short-term losses you can take, which should provide the biggest tax benefit. But this should not be the only factor … also consider the prospects of the investment and your asset allocation.
Now if you do engage in tax harvesting, you should avoid buying the same investment (or even a “substantially identical” security) within 30 days. The reason is that you will trigger the “wash-sale rule,” which means you will lose the tax benefits.
Something else: If you do have a net loss, then up to $3,000 can be deducted on your tax return against your ordinary income. Any excess amount can be carried forward to future tax years.
Year-End Tax Moves: Mutual Fund Surprises
This time a year, some mutual funds will distribute capital gains to their shareholders.
So you might wonder, if you reinvest the money into more shares, can you avoid paying a tax? Well, unless the mutual fund is in a tax-free account (like an IRA), the answer is no. However, one approach is to use the harvesting strategy (which is discussed above). This can be a way to mute the impact.
What’s more, before making an investment in a mutual fund at the end of the year, make sure there are no likely capital gains distributions (the fund should provide an estimate). If there are, you might want to wait until the new year to make a purchase.
Year-End Tax Moves: Charitable Donations
With the doubling of the standard deduction, it may be tough to qualify for the itemization of deductions on your return. But there may be a way to work around this by increasing your charitable donations. So it is definitely worth running the numbers, with an accountant, H & R Block (NYSE:HRB) or Intuit’s (NASDAQ:INTU) TurboTax.
Another strategy is called bunching. This means that you may combine two years’ worth of deductions every two years. This could be enough to be able to itemize.
A great way to handle charitable donations is to use a donor-advised fund, which you can set up with a financial institution like Fidelity or Charles Schwab (NYSE:SCHW). This vehicle allows you to contribute cash and securities, which will provide you with immediate tax deductions. The assets’ earnings will also be tax free … until you make a grant to an IRS-qualified charity.
Year-End Tax Moves: Retirement
Participating in a 401k is one of your best tax moves. This allows you to use pre-tax dollars to invest in mutual funds and the earnings will grow tax-free. It’s not until you withdraw the money that you will pay any taxes.
For 2018, you can contribute up to $18,500 for a 401k and an additional $6,000 if you are 50 or older. So if you have the available cash, it’s definitely worth looking at maxing out the contributions (you will need to talk to the HR department about this as you will need to change your payroll information). You may also be eligible to get a certain percentage match from your employer.
If your employer does not provide a 401k, you can consider a traditional IRA, which provides the same tax benefits. The maximum contribution is $5,500 and $6,500 if you are 50 or older.
In fact, if you are self-employed, you can get an IRA that allows contributions of up to $55,000.