As 2008 draws to a close, take some time to consider what you can do before year-end to reduce your income tax bill.
In late November, a financial planner’s fancy lightly turns to thoughts of…minimizing taxes. Actually, I’m thinking about Thanksgiving too, but while there’s still time to act, it’s wise to spend a little time thinking creatively about managing your tax liabilities.
This year, end-of-the-year strategies are trickier, as no one can say for sure whether income taxes will increase significantly in 2009 under a new presidential administration. In the midst of recession, it’s becoming less likely that taxes will go up soon, but anything is possible. Having noted that wildcard possibility, let’s look at some potential strategies.
Shifting Income and Expenses
For taxpayers who aren’t subject to the Alternative Minimum Tax (AMT), the traditional strategies apply: use your deductions at the highest possible marginal tax rate, and try to have income taxed at the lowest possible rate.
If you think your income this year is significantly higher than it will be next year, you’re better off working in as many deductible expenses as possible in 2008 to take advantage of being in a higher tax bracket this year. If you expect significantly higher income in 2009 versus 2008, the opposite strategy applies.
If you’re self-employed, you probably have opportunities to accelerate or decelerate some of your income and/or business expenses. But there are also some income- and expense-shifting strategies available for the non-self-employed.
It may be a good move to increase your 401(k)/403(b) contribution in order to reduce your taxable income this year; you can contribute up to $15,500 or if you were born in 1958 or earlier, you can contribute up to $20,500.
If you managed to realize a capital gain this year, you might consider also selling a security in which you have a capital loss in order to reduce your income. This won’t be a useful strategy if your income puts you in the 0% capital gains bracket. However, if all you have is a capital loss – and there are plenty of those to go around this year – you can apply up to $3,000 of capital losses to reduce your ordinary income. You shouldn’t be selling investment positions just for tax purposes, but if you’re thinking about selling anyway, you should give some thought to whether it makes more sense to sell in 2008 or 2009.
Converting a traditional IRA to a Roth IRA will boost your taxable income, so such a conversion is best done in a year when your tax bracket is lower.
If you’re entitled to a bonus, you may be able to arrange with your employer to defer receipt of your bonus into 2009.
Here are two easy ways to increase your deductions if you own your home: (1) make your January 2009 mortgage payment in 2008, (2) prepay your property tax bill.
If you become eligible to make Health Savings Account contributions as late as December of this year, you can make a full year’s worth of tax deductible-contributions in 2008.
Charitable gifts made before yearend, even by credit card, are deductible this year. If you make a deduction by any other method, be sure to obtain a receipt or keep a cancelled check. The IRS requires one or the other as evidence of a charitable gift, and your gift can be disallowed if you don’t have acceptable proof that you made the gift.
Living on the Edge – of the Standard Deduction
If you have just a bit more in itemized deductions than the standard deduction amount ($5,450 single, $10,900 married), it may be advantageous for you to accelerate some deductions into 2008 and take the standard deduction in 2009, when it will increase.
Avoiding Deduction Phaseouts
If your adjusted gross income exceeds $159,950, your deductions are reduced by 1% of the amount of income in excess of the limit up to 80% of the deduction total. If you’re in this situation and have a way to defer income into 2009, that may allow you to preserve some deductions that would otherwise be lost. Alternatively, if you’re well above the threshold in 2008 but expect to be below it in 2009, your deductions may be worth more to you in 2009, so try to push them out past yearend.
The (dreaded) Alternative Minimum Tax
Tax planning under the AMT is sort of like living in Bizarro World, the comic book alternative universe where things tend to work backwards. When you’re subject to AMT, typical tax minimization strategies often don’t work. Under the AMT, it could be that you’re better off accelerating income and pushing deductions out, but this isn’t an area where I feel safe generalizing. If you live in AMT-land, you either need some good tax software or a tax adviser who can sort through the arcane details to determine the best strategy. This is especially true if you expect to be under AMT in one year but not in another.
As always, you should obtain tax advice specific to your situation; these strategies may or may not be appropriate for you.