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All Contents © 2017The Kiplinger Washington Editors
By Sandra Block, Senior Editor
| December 2016
Reducing your taxable income is one of the most effective ways to lower your taxes, with some moves doing double duty as both deductions themselves and as a means to slide under income thresholds at which other taxes would kick in. What's more, the prospect of tax reform via Donald Trump and the Republican-controlled Congress, which would produce lower rates, makes this strategy even more important now for many taxpayers.
While it’s late in the year now, there's still time to take steps that will lower the amount of income you must report on your 2016 tax return. Take a look.
Money contributed to an employer-sponsored retirement plan, such as a traditional 401(k), isn’t included in your taxable income. In 2016, you can contribute up to $18,000 or $24,000 if you’re 50 or older, by the end of the year. If you haven’t maxed out, ask your employer if you can make an additional contribution before December 31.
If you have self-employment income from a side job, you can sock away even more. You can contribute up to 20% of your net self-employment income to a Simplified Employee Pension, up to a total contribution limit of $53,000 for 2016. (Unlike 401(k) contributions, there’s no December 31 deadline for SEP deposits. You can make 2016 deposits anytime before the due date of your tax return.)
Another option: Depending on your income, you can also deduct contributions to an IRA, up to a maximum of $5,500 in 2016 (and $6,500 for workers 50 or older). You can make 2016 IRA contributions anytime before April 17, 2017. Roth IRAs, however, do not offer this upfront tax break because withdrawals are tax-free in retirement.
If you itemize, making charitable contributions before December 31 will reduce your taxable income.
For cash contributions, hang on to your canceled check or credit-card statement as proof of your donation. If you contribute $250 or more, you’ll also need an acknowledgment from the charity. Donations made by credit card before December 31 are deductible on your 2016 tax return, even if you pay the credit-card bill in January.
Donating appreciated securities can also reduce your taxable income. When you donate appreciated securities you have owned more than one year to charity, you can deduct the full value of the securities on the date of the gift. You won’t have to pay taxes on capital gains, and the charity won’t have to pay them, either.
Not all charities can accept donations of appreciated securities. If your favorite cause falls into that category, consider opening a donor-advised fund. The fund administrator will sell the securities for you and add the proceeds to your account. You can deduct the value of the securities on your 2016 tax return and decide later where you want to donate the money.
If you have a property tax bill due in January and you itemize, paying it before December 31 will allow you to deduct the payment from your taxable income on your 2016 tax return.
Caution: Prepaying your property taxes could trigger the alternative minimum tax, designed to prevent wealthy people from using so many legal deductions to avoid taxes. Several popular write-offs, including property taxes, must be added back when calculating AMT liability. Talk to your tax preparer or use tax software to determine whether you’re vulnerable to the AMT.
Further complication: Tax reform plans under consideration aim to lower rates and simultaneously reduce deductions and credits. Under the House GOP tax plan, deductions for a variety of local taxes, including real estate taxes, would be scrapped. Prepaying your tax bill and writing it off this year would sure beat not being able to write it off at all.
If you have losses in your taxable accounts, cut them loose before year-end and use the losses to offset capital-gains income.
If your losses exceed your gains, you can deduct up to $3,000 from your other taxable income. Losses that exceed that amount can be carried forward to future years.
If you’re about to rebalance your portfolio by selling some winners so you can redeploy the cash elsewhere, remember that waiting until after January 1 means you won’t have to report the gains as part of your 2016 income. Never make an investment move based solely on the tax impact, but don’t ignore it, either.
If you think a year-end bonus is in the works, ask that it be paid next year. That way, it won’t increase your 2016 taxable income. (If the firm has already announced that it will pay bonuses in December, though, it’s 2016 income even if you don’t cash the check until January.)
If you’re self-employed, send bills to clients in late December so you won’t receive payments until after the first of the year. And if you get income from a closely held firm, consider delaying that dividend.
In 2016, most taxpayers can only deduct unreimbursed medical expenses that exceed 10% of their adjusted gross income. (If you or your spouse are 65 or older, you can deduct medical expenses that exceed 7.5% of AGI.) That high hurdle prevents most taxpayers from writing off medical costs. If you’re close, though, consider scheduling medical or dental work before the end of the year to clear the 10% bar and take advantage of this tax break on your 2016 tax return. Deductible expenses include everything from laser eye surgery to a portion of your long-term-care insurance premiums.
Another deduction that could go away if the House tax reform plan was adopted is medical expenses, so next year, that move might not work at all. Something to consider—but don't rush your surgeon unnecessarily.
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