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All Contents © 2019The Kiplinger Washington Editors
By Sandra Block, Senior Editor
| November 1, 2018From Kiplinger’s Personal Finance
Moves you make between now and the end of the year can have a significant effect on how much tax you have to pay next April, particularly when it comes to investments you might hold outside a retirement account.
But time is running short. Review our list and get cracking.
Employers adjusted workers’ withholding earlier this year to reflect the federal tax overhaul, which reduces tax rates and doubles the standard deduction. But the new law also limits or scraps some popular tax breaks. If you continue to itemize and some of your large deductions have been eliminated, you may not be having enough withheld from your paychecks, which could lead to an unexpected tax bill next April. You are more vulnerable if you live in a high-tax state because the law now caps the deduction for state and local taxes at $10,000.
To find out where you stand, go to the IRS withholding calculator. If you discover you’re not having enough withheld, file a new W-4 with your employer. Because there are only a few pay periods left in the year, reducing the number of allowances you claim may not make a big difference in your withholding, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Instead, go to line 6 on the W-4 and fill in the dollar amount you’d like to have withheld.
In general, you don’t have to worry about a penalty if you owe less than $1,000 after subtracting withholdings and credits, or if you paid at least 90% of the amount of tax due for the current year or 100% of taxes due the previous year, whichever is smaller.
In the past, many taxpayers paid their mortgage and state taxes due in January before December 31 so they didn’t have to wait another year to take the deduction. But prepaying deductible expenses only makes sense if you itemize, and there’s a good chance you won’t have to go through that rigmarole when you file your 2018 tax return. The new tax law nearly doubles the standard deduction to $12,000 for single taxpayers and $24,000 for married couples who file jointly. As a result, only about 13% of taxpayers are expected to itemize on their 2018 return, down from nearly one-third in 2017, according to the Joint Committee on Taxation.
Still, if you itemized in the past, it’s worth sitting down with a tax professional or firing up a tax software program. If you’re close to the threshold for itemizing deductions, prepaying your mortgage and increasing your charitable contributions could provide you with enough deductions to itemize and lower your tax bill, says Gil Charney, a director at H&R Block’s Tax Institute.
This is also a good time to review your medical bills for the year. For 2018, you can deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. If you’re close to the limit, consider scheduling a visit to the dentist or eye doctor before year-end. In 2019, your medical expenses will have to exceed 10% of your AGI before you can deduct them.
The tax code allows you to sell investments that have fallen below your purchase price and use the resulting loss to offset capital gains in taxable accounts. That’s a compelling reason to consider jettisoning your losing positions. Investments that you’ve held for a year or less are taxed as ordinary income, but investments you’ve held longer are taxed at the long-term capital gains rate, which ranges from 0% to 23.8%.
After matching short-term losses against short-term gains, and long-term losses against long-term gains, any excess losses can be used to offset the opposite kind of gain. If you still wind up with an overall net capital loss, you can use up to $3,000 of that loss to offset ordinary income and roll the rest over to the following year. Note that once you sell an asset at a loss, you must wait 30 days before reinvesting in it or buying a substantially identical investment.
Investors in the bottom two tax brackets (with income less than $38,600 for single filers and $77,200 for joint filers) pay no capital gains tax on investments held for more than a year. If that’s the case, it may make sense to sell winning investments tax-free and reinvest (no need to wait 30 days), effectively resetting the odometer on future gains.
Regardless of your situation, tax considerations shouldn’t drive your decision to sell an investment you’d otherwise hold on to, says Luscombe, of Wolters Kluwer. “Don’t let the tax tail wag the investing dog.”
Mutual funds are required to pay out to their shareholders any gains realized from the sale of stocks or bonds during the year. If you own the fund in a taxable account, you must pay taxes on these distributions when you file your tax return, even if you reinvest them. “Given the 10-year run of the bull market in stocks, there will probably be somewhat higher capital gains distributions this year,” says Joel Dickson, Vanguard’s global head of investment research and development.
If you get hit with a distribution, review your portfolio to see if you have any mutual funds, stocks or bonds that have declined in value since you purchased them. Selling them before year-end will provide losses to offset your gains. Mutual funds typically publish an estimate of their capital gains distributions in November or December, along with the date of the distribution. Estimates are on a per-share basis, so if you figure out how many shares you have, you can gauge the size of your distribution.
Interested in buying a fund before the end of the year? Check its website first. If the fund plans to make a capital gains distribution, postpone your purchase until after the distribution date. Otherwise, you’ll have to pay taxes on gains racked up before you got on board.
As the year comes to a close, you may be able to squeeze a little more money from each paycheck for your retirement savings. You can contribute up to $18,500 to a 401(k), 403(b) or federal Thrift Savings Plan in 2018, plus $6,000 in catch-up contributions if you’re 50 or older.
Pretax contributions will lower your take-home pay and reduce your tax bill. If your employer offers a Roth 401(k), you can make contributions that won’t lower your taxable income now but that can be withdrawn tax-free in retirement. If your employer offers both types of plans, you can direct new contributions to the Roth 401(k) rather than the pretax 401(k) at any time, says Marina Edwards, senior director of retirement for benefits consultant Willis Towers Watson.
Contact your 401(k) administrator or your employer’s human resources department ASAP to find out how much you’re on track to contribute to your 401(k) by the end of the year and to ask about the steps you need to take to boost your contributions. The earlier you make the change, the better: 401(k) contributions are made through payroll deduction. If you’re contributing to a traditional or Roth IRA for 2018, you have until April 15, 2019.
If you aren’t on track to max out your retirement account for the year, adding money from a year-end bonus can be a great way to boost your contributions without affecting your regular take-home pay. Rules vary, and some plans don’t allow participants to contribute their bonus, says Edwards. Make sure that you don’t cross the annual contribution limit. You have until the tax-filing deadline to withdraw any extra contribution and the earnings on it, which will both be taxable. If you don’t take it out, the excess contribution will be taxable now and you’ll have to pay taxes on it again when you finally withdraw the money.
If you have self-employment or freelance income, open a solo 401(k). You must open it by December 31, although you have until April 15, 2019, to contribute and take a tax deduction for 2018. You can contribute up to $18,500 ($24,500 if you’re 50 or older) to a solo 401(k), minus any contributions you’ve made to a 9-to-5 employer’s 401(k) for the year. You can also contribute up to 20% of your net self-employment income to the plan. Contributions to the solo 401(k) can total $55,000 in 2018 (or $61,000 if 50 or older) but can’t exceed your self-employed income for the year.Another option is to open a SEP account, but if you have just a little freelance income, you can contribute more money to a solo 401(k). SEP contributions are limited to 20% of net self-employment income, up to $55,000.
Putting your money or other assets, such as stocks or personal property, in a donor-advised fund allows you to deduct the entire contribution in the year you make it and decide later how you want to dole out grants to charities of your choice. You can open a donor-advised fund at financial-services firms such as Fidelity Charitable (minimum investment: $5,000) or Schwab Charitable ($5,000 minimum) or at community foundations. Contributing one lump sum this year may help lift your deductions above the amount of the new standard deduction and allow you to itemize.
Donating clothes, kitchenware or furniture you no longer need can also boost your deductions while helping a worthy cause. You’ll base your deduction on the “fair market value” (or what it might sell for at a thrift or consignment shop); you can use online tools such as TurboTax’s ItsDeductible tool to estimate this value. You will need a written acknowledgment from the organization if you are claiming a contribution of $250 or more (consider snapping a photo of the donation for your records). For art or antiques valued at more than $5,000, you’ll need a written appraisal.
Taxpayers who are 70½ or older can transfer up to $100,000 from a traditional IRA tax-free to charity each year, as long as they transfer the money to the charity directly.
The “qualified charitable distribution” will count as your required minimum distribution without being added to your adjusted gross income, which can be a boon if you were going to take the new, higher standard deduction instead of itemizing (you can’t deduct charitable transfers). The transfer could also help keep your income below the threshold at which you’re subject to the Medicare high-income surcharge as well as hold down the percentage of your Social Security benefits subject to tax. Make a QCD well in advance of New Year’s Eve because the money has to be out of the account and the check needs to be cashed by the charity by December 31.
Consider converting some money from a traditional IRA to a Roth IRA this year, up to the top end of your income tax bracket. You’ll pay taxes on the conversion (minus any portion that represents nondeductible IRA contributions), but the money will grow tax-free in the Roth after that. Converting your entire traditional IRA balance can bump you up to a higher tax bracket, but you can spread conversions over several years. Be careful about making a large conversion if you’re within two years of signing up for Medicare—you’ll have to pay extra for Medicare Part B if your adjusted gross income (plus tax-exempt interest income) is more than $85,000 if you’re single or $170,000 if you’re married filing jointly. Your last tax return on file determines your Medicare premiums, so a 2018 conversion could affect 2020 premiums.