By Matthew Theal, CFP®
As the year winds to a close, we thought it would be beneficial to take a look at some strategies you can implement right now that could give you tremendous tax savings in April.
Make Retirement Contributions
A simple strategy to reduce your tax benefits while saving for your future is to increase your retirement account contributions. If you have extra money or you know you have a massive tax bill coming in April, you might consider maxing out your 401(k) (or other employer-sponsored retirement accounts). If you have no retirement account through your workplace, you can open a traditional IRA and receive a tax benefit.
For tax year 2018, you can contribute a maximum of $18,000 to your 401(k), plus an extra $6,000 if you are over the age of 50 for a grand total of $24,000. You can also contribute $5,500 to an IRA, with a $1,000 catch-up contribution equaling a total of $6,500. Let’s look at an example to see the tax savings.
Let’s pretend you make W-2 wages of $100,000 a year with no other income sources. If you contribute the maximum plus the catch-up to a 401(k), the amount of income you will owe taxes on is now $76,000 ($100,000 – $24,000). If you made no 401(k) contributions, you would be taxed at $100,000 of income.
Tax Loss Selling
As the year winds down, it is always smart to look at your taxable brokerage account and see if there are any losing investments in your portfolio that you can sell. The IRS allows you to write off $3,000 a year in investment losses. Let’s look at an example of what we mean by this.
Say you purchased XYZ stock for $10,000 (that is your basis), and the investment today is worth $6,500. If you sell the position, you will incur a loss of $3,500 ( $10,000 – $6,500). You are allowed to write off $3,000 of that loss on your tax return.
That means that if you had wages of $100,000, you could subtract $3,000 from that $100,000. So your new taxable income base is $97,000 ($100,000 – $3,000).
Taking it a step further, you could also net winning stocks positions against losing stock positions.
Example 2: Lets pretend that in addition to purchasing XYZ, you bought ABC stock. You paid $10,000 for ABC, and it is now worth $14,000. If you sold ABC, you would have a gain of $4,000 ($14,000 – $10,000). That $4,000 gain is taxable at your capital gains tax rate.
If you also sold your XZY stock for the $3,500 loss, you could net your gain in ABC against your loss in XYZ. The end result would show a gain of only $500 on your tax return ($4,000 – $3,500).
Trimming your winners and losers in your taxable portfolio could have a significant impact on your taxes come April.
Charitable gifting is a much more complex topic than tax loss harvesting and retirement account contributions.
When gifting to charity, the first question you have to take into consideration is, do you itemize your deductions? Most of our clients previously did this, but with the new tax law changes for 2018 and the increase in the standard deduction, a lot fewer people will be itemizing their deductions. (For tax year 2018, the standard deduction for a single taxpayer is $12,000, while the standard deduction for a married couple is $24,000.)
Example: A couple gives 10% of their income every year to a charity, and this couple makes $150,000. That means they are donating $15,000 to charity annually. Under the new tax law, this couple would get no tax benefit for the gift to charity. The $24,000 standard deduction is greater than the $15,000 donation to charity.
A better strategy would be for the couple to lump their charitable gifting into one year. So instead of giving $15,000 every year, give $30,000 one year and $0 the next. This strategy would total out to $54,000 in tax deductions compared with $48,000 in deductions ($30,000 + $24,000 = $54,000).
There are other charitable donations you can make, such as donating securities (stocks, bonds, mutual funds) or real estate, contributing to a donor-advised fund, or even completing a qualified charitable distribution (QCD). That said, those strategies are beyond the scope of today’s article. Contact your fee-only financial planner if you want to learn more about them.
Business Owner Strategy: Section 179 Expense
Finally, the last strategy is for business owners only, and it’s super complex, so we will not dive too deeply into it.
The basic idea behind the strategy is that you can purchase a piece of qualifying equipment that must be used in your business. Instead of using the normal depreciation schedule for that property, you can speed up the depreciation by taking it all during that current tax year.
Example: You own a business that screen-prints on blank T-shirts. If you buy a new screen printing machine for $250,000, you may deduct that full amount against your income, creating a huge one-year tax benefit.
The Section 179 strategy (and all of the above strategies) is much more complex and nuanced than I am making it seem. If you think this strategy could work for you, consult with your CPA and financial planner before doing anything.