April 15th is barely past so you may be thinking it’s time for a break from thinking about taxes.
Yet if your 2012 tax bill was large, now is the perfect time to consider moves to lower next year’s tax liability. New tax provisions that became effective on January 1, 2013 provide even more reasons.
So what potential moves may lower your future taxes? Consider these ideas:
Reduce your taxable income. The key word here is ‘taxable’. Potential moves that might help reduce taxable income include deferring large amounts of income, making larger contributions to retirement accounts such as a 401(k) and traditional IRA (if eligible) or making larger contributions to a flexible spending account or health savings account.
Harvest unrealized investment losses. Then use those losses as an offset against realized capital gains or income. Up to $3000 in realized capital losses can be used as a direct offset against other income in any given year, with any remaining realized losses available for carryforward to future years. So the tax provisions provide you with a valuable assist for selling any investment whose value has fallen below your cost basis when held in a taxable account.
Bunch itemized deductions. If you sometimes, but not always, itemize deductions, consider adopting a strategy that may enable you to itemize every other year. As an example, plan to pay any real estate taxes which are due in 2 different calendar years in the same tax year. Or plan on incurring more elective medical expenses in a year when your other potential itemized deductions are larger.
Structure your investments for tax efficiency. Investments whose income payouts are treated as ordinary income are best held inside a tax deferred account such as a 401(k) or IRA. Examples of investments which fall into this category include bond mutual funds (especially high-yield bond funds) and REITs. Funds with a high turnover among underlying investment holdings are also good candidates for tax deferred accounts.
On the other hand, investments which tend to pay out qualified dividends are excellent candidates for taxable accounts in view of qualified dividends receiving more favorable tax treatment.
Be charitable. If you are charitably inclined or have plans for making a larger charitable contribution at some point, perhaps it may be beneficial for doing so in a year when your other income is larger. Recall that donations made to qualified charitable organizations can be claimed as an itemized deduction by those taxpayers who itemize.
Time your income. Perhaps you plan on selling an investment holding whose value has greatly appreciated over your original purchase and any subsequent adjusted cost basis. Let’s say that your total profit from the sale will push you into the next higher tax bracket if you sell all at one time. Rather than incurring the larger marginal tax, you instead might opt to sell a portion of the investment during one tax year and the remaining balance in the next tax year as part of a designed move to keep your income from being taxed at a higher rate.
These are a few ideas that may help lower your future tax liability. Consult your tax adviser or financial planner to further assess your own situation; these comments are not intended to be specific tax advice for everyone.