Ten Tax Planning Tips to Consider

by | Sep 8, 2017 | Taxes

Here are 10 tax planning tips to consider that might help reduce your federal income tax bill:

1. Contribute the maximum amount to your 401(k) plan. Up to applicable limits, your contributions are subtracted from your gross pay, so you don’t pay current income taxes on the contributions (although you still pay Social Security and Medicare taxes). In addition, earnings and gains on your investments grow tax deferred until withdrawal. When you make withdrawals, you’ll have to pay ordinary income taxes on the contributions and earnings (and possibly a 10% federal income tax penalty if withdrawals are made before age 59 and 1/2 ), but this tax-deferred growth typically means that you could have a larger nest egg than if you had been paying taxes currently during the years.

2. Decide which type of individual retirement account (IRA) to contribute to and then do so early in the year. Find out whether you’re eligible to contribute to a traditional deductible or Roth IRA and then decide which is the better alternative for you. Make your contribution early in the year to allow your funds to compound tax deferred or tax free for a longer time.

3. Consider investing in municipal bonds if bonds comprise a portion of your investment portfolio. Interest income from municipal bonds is generally exempt from federal income taxes, and sometimes state and local income taxes for investors who reside in local jurisdictions where the bonds were issued. (Income for some investors may be subject to the federal alternative minimum tax.) In general, the higher your marginal tax rate, the more advantageous you’ll find investing in municipal bonds. Before investing, compare the yield on the municipal bond to the after-tax yield on other types of fixed income assets.

4. Replace loans that generate personal interest with mortgage loans or home-equity loans. Personal interest cannot be deducted on your tax return, while mortgage interest and home-equity loan interest typically can, as long as the first mortgage does not exceed $1,000,000 and the home-equity loan does not exceed $100,000.

5. Investigate investments that generate capital gains, such as growth stocks. Capital gains on investments held for more than one year are subject to the 20% capital gains tax rate, compared to the top ordinary income tax rate of 39.6%. The 20% capital gains rate only affects singles with taxable income above $400,000, married joint-filing couples with income above $450,000, heads of households with income above $425,000, and married individuals who file separate returns with income above $225,000.

When selling investments that generate long-term capital gains, keep in mind that you do not pay the tax until the investment is sold, allowing you to plan when to recognize the gain. Capital gains on investments held less than a year are short-term capital gains and taxed at ordinary income tax rates of 10,15, 25, 28, 33, 35, or 39.6% for 2017 (and 2016).

6. You can make gifts of income-producing assets up to $14,000 per year or $28,000 if you split the gift with your spouse, to your children tax free, in 2017 and 2016. Doing so shifts the income from the assets to your children, who may be in a lower tax bracket.

However, if your child is under age 19, or age 24 if a full-time student, be aware that the Kiddie Tax rules may apply. If a child affected by the Kiddie Tax rules receives “unearned income” above an $2,100 threshold in 2017 (unchanged from  2016)  the excess is taxed at the top tax rate of the child’s parents. In other words, a portion of your child’s earnings could be taxed at a rate at a much higher rate. If the threshold is not exceeded, the Kiddie Tax doesn’t apply for that year. If it is exceeded, only unearned income in excess of the threshold gets taxed at your higher rates.

7. Take advantage of education tax breaks. If eligible, make sure to document and claim the tuition deduction, the American Opportunity Tax Credit or the Lifetime Learning Credit. Be aware that you may be able to deduct interest paid on student loans if you meet the eligibility requirements. Also, decide whether you want to save for college with a Coverdell Education Savings Account or a Section 529 plan.

8. Obtain a receipt for household goods donated to a charity. You may be able to deduct those contributions on your tax return. However, keep in mind that currently, no deduction is allowed for contributions of used clothing and household items that are not in “good condition or better.”

For purposes of this rule, “household items” include furniture, electronics, appliances and linens. A favorable exception allows write-offs for single items that are not in “good” condition or better if they are appraised at more than $500.

Also, keep track of any out-of-pocket expenses incurred while you are performing charitable work. Those may also be deducted.

9. Keep track of your expenses if you are looking for a new job. Items like resume preparation, mileage, air fare, and hotels may be deducted as a miscellaneous itemized deduction. If you get a new job and relocate, you may be able to deduct moving expenses, whether you itemize or not.

10. Start planning now. This gives you time to consider various tax planning strategies and ensure that you have adequate time to implement those strategies this year.