With the end of the year approaching, many people have started to turn their attention to holiday preparations. But before this year’s holiday season, investors need to plan for potential tax changes next year—especially given what we know about the president-elect’s proposed economic approach. Sweeping tax reforms are possible, and though the specifics aren’t yet clear, the incoming administration has revealed a few of its priorities. Consequently, investors and business owners alike need to evaluate year-end strategies with their advisors and ensure they align with shifting policies. If you don’t know where to begin, below are three conversation kick-starters to act on right away.
Formula to Frontload – What Expenses Can I Pay in 2016?
Because of the likelihood of future tax cuts—a top priority according to the president-elect—planning should be geared toward accelerating expenses and losses, in an attempt to achieve a lower tax bracket. That means frontloading expenses and delaying income where possible to create lower taxable income in a higher tax year. Clients often don’t recognize how big of an impact these frontloading strategies can have. Wescott advisors recommend a few specific areas in which these strategies can help:
Prepay Expenses – Prepaying expenses that qualify as itemized deductions—for example, medical bills or state and real estate taxes—will result in a higher chance of larger deductions. There’s no guarantee that the itemized deductions provisions will remain, so it’s best to accelerate these expenses while it’s still possible to deduct them.
Prepare Your Business – Business owners specifically should take an aggressive approach to reducing their tax burden if they believe that their company’s profits will improve in the coming years. Buying new equipment and supplies before the end of the year, and paying business expenses like insurance and bonuses ahead of time can reduce a business owner’s self-employment tax and overall tax bill.
Charitable Choice—Where Should My Philanthropy Come From?
Similar to prepaying expenses, investors should consider frontloading charitable contributions as well. Because of tax law changes, your money may actually be worth more in 2016 than in future years. Beyond the timing, you can also donate in two distinct ways that also provide a tax benefit:
Donate Your Appreciated Stock – Investors who consistently contribute to charitable organizations and also have funds that have appreciated over the course of the year, can gift some of those gains. That lowers an investor’s taxable income, and may also avoid the capital gains tax altogether. Additionally, the donation becomes a charitable deduction on their taxes.
Donate Your Required Minimum Distribution – Most owners of an IRA or 401(k) are required to withdraw certain amounts once they reach a certain age. What many investors don’t realize is that they can donate a portion of their RMD to reduce their tax burden. This method wouldn’t result in a charitable deduction, but could move investors into a lower tax bracket.
Bold Rebalancing—How Can I Offset My Losses?
Investors can save thousands in taxes by effectively offsetting losses from investments. While portfolio rebalancing is a process that usually revolves around risk management and investment policy, loss harvesting can play a key role in reducing the tax burden on investors in some ways of which investors may not be fully aware:
Offset Capital Losses – Long-term capital gains are currently taxed as high as 20 percent and can be subject to an additional 3.8 percent tax on top of that. Selling holdings that are currently at a loss can offset some of those gains, thus lowering capital gains taxes incurred on any well-performing asset. After harvesting those losses, your advisor can help reallocate assets so that your portfolio remains balanced.
Review Passive Losses – Losses from passive investments like rental properties aren’t deductible in many cases, until income is generated from the investment—or until the investment is sold. Investors can offset passive losses by accelerating the income from those assets, or by selling the asset this year instead of in 2017.
With changes to tax policy on the horizon, the year-end is the best time to start thinking about where your taxes could use a tune-up. These strategies are some of the most effective ways to reduce present burden, with the expectation that tax cuts are on the way. With that in mind, not every strategy makes sense for every situation, so it’s important to consult with your advisor and accountant during the process. Knowing what we know about the future direction of tax policy, working to enact some of these strategies now will keep the most wonderful time of year from becoming the most stressful time of year.
To learn more about effective year-end tax planning strategies, contact Wescott Financial.