In the quest to reduce your tax bill, year end planning can only go so far. Tax-saving strategies take time to implement, so review your options now. Here are several midyear strategies to consider.
Consider your bracket
The top income tax rate is 39.6% for individuals with taxable income over $400,000 ($450,000 for joint filers). If you expect this year’s income to be near the threshold, consider strategies for reducing your taxable income and staying out of the top bracket. For example, you could take steps to defer income and accelerate deductible expenses.
You could also shift income to family members in lower tax brackets by giving them income-producing assets. This strategy won’t work, however, if the “kiddie tax” applies. That tax applies the parents’ marginal rate to unearned income (including investment income) received by a dependent child under the age of 19 (24 for full-time students) in excess of a specified threshold ($2,000 in 2014).
Look at investment income
This year, the capital gains rate for taxpayers in the top bracket is 20%. If you’ve realized, or expect to realize, significant capital gains, consider selling some depreciated investments to generate losses you can use to offset those gains. It may be possible to repurchase those investments, so long as you wait at least 31 days to avoid the “wash sale” rule.
Another tax higher-income investors need to be concerned about is the 3.8% net investment income tax (NIIT). It applies to taxpayers with modified adjusted gross income (MAGI) over $200,000 ($250,000 for joint filers). The NIIT applies to your net investment income for the year or the excess of your MAGI over the threshold, whichever is less. So, you can lower your tax liability by reducing your MAGI, reducing net investment income or both.
Contribute to retirement plans
Deductible contributions to traditional IRAs and pretax deferrals to employer-sponsored retirement plans such as 401(k)s save taxes in a variety of ways. First, they reduce your taxable income, and thus your income taxes, for the current tax year.
Second, they reduce your adjusted gross income (AGI) and MAGI, which not only can reduce or eliminate your exposure to the NIIT, but also can help you reap maximum benefit from various tax breaks. The benefit of many deductions and credits is reduced if your AGI or MAGI falls within certain ranges or exceeds certain levels. For example, in 2014, if your AGI exceeds $254,200 (singles), $279,650 (heads of households) or $305,050 (married filing jointly), many of your itemized deductions will be reduced and your personal exemption reduced or even eliminated.
Third, traditional IRAs and employer-sponsored retirement plans grow tax-deferred. So you pay no tax as long as the funds are in the account, which reduces your taxes for years to come. Plus, tax-deferred compounding can help your investments grow more quickly. When you start taking distributions in retirement, they’ll be taxable — but if you aren’t working, you may be in a lower tax bracket.
Plan for medical expenses
Beginning last year, the threshold for deducting medical expenses went up from 7.5% of AGI to 10% of AGI (unless you’re age 65 or older). You can deduct only expenses that exceed that floor.
One way to save taxes even if your expenses don’t exceed the floor is to contribute to a tax-advantaged health care account, such as a Health Savings Account (HSA) or a Flexible Spending Account (FSA). Contributions are pretax or tax-deductible, and withdrawals used to pay qualified medical expenses are tax-free. Many rules and limits apply, however.
If an HSA or FSA isn’t an option or won’t cover all of your medical expenses, take a closer look at the medical expense deduction. Deductible expenses may include health insurance premiums (if not deducted from your wages pretax); long-term care insurance premiums (age-based limits apply); medical and dental services and prescription drugs (if not reimbursable by insurance or paid through a tax-advantaged account); and mileage driven for health care purposes (23.5 cents per mile driven). You may be able to control the timing of some of these expenses so you can bunch them into every other year and exceed the applicable floor.
Get a head start
These are just a few ideas for slashing your 2014 tax bill. To benefit from midyear tax planning, consult your tax advisors now. If you wait until the end of the year, it may be too late.
If you have any questions regarding this article, please contact Friedman LLP at firstname.lastname@example.org or 877-538-1670.