Last-Chance Moves for Retirees to Cut Their 2016 Tax Bill

Zero. Zip. Zilch. Zippo. Imagine locking in a 0% tax rate for your own investment profits. And that sweetest-of-all rates is available for the long-term capital gains—those from investments held more than a year—of taxpayers who fall in the 10% or 15% tax bracket.

Since the 15% bracket rises as high as $75,300 on joint returns, a married couple with typical deductions could have $100,000 or more of income and still qualify for the 0% rate.

Year-end is prime time for actions that can reduce your tax bill. And your portfolio probably holds the mother lode of opportunities.

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To get an idea of whether the 0% rate is within your reach, get a bead on your taxable income for 2016. Tote up what you’ve received so far from a job or self-employment, interest, dividends, realized net capital gains, Social Security benefits, pension payments, IRA withdrawals and so on. Add expected additional income for the rest of the year. Next, estimate the adjustments to income, exemptions and deductions that will eat away at the taxable total. (Last year’s return will be a good guide for this part of the exercise.)

Your goal is to get a good idea of your 2016 taxable income because that’s the ticket for this break. The 15% bracket tops out at $37,650 on single returns and twice that amount ($75,300) for married couples filing jointly. If there’s some leeway between your estimated taxable income and the top of the bracket, 0% gains are calling.

Check your stocks and mutual funds for paper profits. If your estimated 2016 taxable income is $60,000, for example, you can realize $15,300 of long-term gains without owing Uncle Sam an extra dime. Any profit that falls in the 25% bracket will be taxed at the 15% capital-gains rate. Cashing out to lock in the 0% rate can make sense even if you don’t want to part with the securities. You can immediately buy them back and owe tax only on profit that builds up in the future. The “wash sale” rule that refuses to recognize sales if you repurchase the same securities within 30 days only applies to sales that produce losses.

(Note this: Although gains that fall in the 10% and 15% brackets are taxed at 0%, the income does show up in your adjusted gross income, which might force more of your Social Security benefits to be taxed. And, if your state has an income tax, the gains probably won’t get the wink-and-a-nod of a 0% rate on that return.)

Search for paper losses, too, as you review your portfolio. Harvesting losses is a time-honored year-end strategy. Capital losses first offset capital gains; then, up to $3,000 of excess loss can be deducted against other kinds of income, such as salary or retirement plan payouts. Extinguishing a gain with a loss can be even more powerful than scoring the 0% rate, because the income won’t show up in your adjusted gross income or be taxed by your state.

One more silver lining for taking your lumps and selling losing securities: As such losses pull taxable income down, they may open more opportunity to take advantage of the 0% rate on capital gains.

Generosity Pays

Your portfolio can also play a major role in tax-savvy gift giving. If you’re considering a major tax-deductible gift, consider donating appreciated stocks or mutual fund shares rather than cash. If you have held the investment for more than a year, you can deduct the full market value and neither you nor the charity has to pay tax on the profit that built up while you owned it.

Appreciated assets can also be the gift of choice for family members. When you give away such assets, you also transfer your tax basis. If the recipient is in a lower tax bracket than you are, he or she can sell for a smaller tax bill. This can work great when it comes to gifts to adult children—to help with the down payment on a house, for example—but can be short-circuited by the “kiddie tax” when younger children are involved. If children younger than age 19, or younger than age 24 if they’re full-time students, sell gift assets for a gain, the profit can be taxed at their parents’ rate rather than their own. Keep this in mind as you plan your gifts. Also, remember that you can give up to $14,000 to any number of people this year without having to worry about the federal gift tax.

Time for a Roth Conversion?

Beyond the 0% gain strategy, another advantage to estimating your taxable income is that it can help you judge the value of converting part of your traditional IRA to a Roth. You have to pay tax in your top tax bracket on every dollar converted (unless you have made nondeductible contributions), but once the money is in the Roth, future earnings can be tax-free rather than simply tax-deferred.

You may want to convert just enough to push your taxable income to the top of a tax bracket but not tip you into the next, higher one. If your estimated taxable income for the year is $60,000 on a joint return, for example, you could convert $15,300 at the 15% rate, adding $2,295 to your tax bill. In the 25% bracket, the same conversion would cost $3,825.

There’s a special rule that can protect you if your taxable-income estimate proves faulty. If you discover next spring that part or all of the converted amount falls in the 25% bracket, you can undo part or all of the conversion in a process called recharacterization. Just tell the IRA sponsor to put the money back in your traditional IRA and you don’t have to report it as taxable income (see Deadline Nears to Reverse Conversion).

Make the Most of Medical Expenses

As we have reported in the past, this year marks the end of a four-year grace period for taxpayers age 65 and older when it comes to deducting medical expenses. Starting in 2013, Congress raised the bar for such deductions, allowing tax savings only to the extent the costs exceeded 10% of AGI. For those age 65 and older, though, the threshold was held at 7.5%. Next year, it rises to 10% for everyone. So, if you are considering elective medical procedures--LASIK surgery, perhaps, or dental work or a new hearing aid--taking action before year-end could mean Uncle Sam will pick up more of the tab.