As the year winds down, it’s essential to focus on tax planning to ensure you are well-prepared for the upcoming tax season. Effective tax planning can help you maximize your refund or minimize what you owe. Below is a detailed guide with specific, actionable steps to help you organize your financial and tax-related affairs before the year ends.
1. Assess and Adjust Withholdings
Examine your current withholdings on your paycheck to ensure they reflect your anticipated tax liability. Adjustments here can prevent a large tax bill or excess refund, smoothing out your cash flow throughout the year. Use the IRS Tax Withholding Estimator to see if your withholdings align with your projected tax liabilities. If discrepancies are found, update your Form W-4 with your employer by December 31 to make any necessary changes.
2. Maximize Retirement Contributions
Increasing contributions to retirement accounts like 401(k)s, IRAs, and Health Savings Accounts (HSAs) can lower your taxable income. Check contribution limits for the year and try to contribute the maximum allowable amount. If you’re 73 or older, be sure to take required minimum distributions (RMDs) from your retirement accounts by December 31 to avoid severe penalties.
3. Leverage Tax-Loss Harvesting
Review your investment portfolio for any underperforming stocks or funds. By selling these investments, you can realize losses that offset any capital gains you’ve made, which can help reduce your overall tax bill. This strategy, known as tax-loss harvesting, should be implemented after consulting with a financial advisor to ensure it fits your long-term investment strategy.
4. Bunch Deductible Expenses
For taxpayers who itemize deductions, consolidating significant deductible expenses into one tax year can be beneficial. This strategy, known as “bunching,” can help you surpass the standard deduction limit and maximize your tax savings. Consider scheduling payments for medical expenses or making charitable contributions by year-end to apply these deductions to the current tax year.
5. Utilize Your FSA
Ensure you fully utilize the funds in your Flexible Spending Account (FSA). Since FSAs operate on a “use-it-or-lose-it” basis, review your balance and spend the remaining amount on eligible medical expenses before the year ends to avoid losing these funds. Additionally, consider scheduling any upcoming medical appointments or purchasing necessary healthcare products now, as some plans may allow you to use remaining FSA funds for qualified expenses into the early months of the new year.
6. Charitable Contributions
Donate to charitable organizations by December 31 to ensure these contributions are deductible for the current tax year. This not only reduces your taxable income if you itemize deductions but also supports worthwhile causes during a critical fundraising period for many nonprofits.
7. Consider a Roth IRA Conversion
If you have a traditional IRA, consider converting it to a Roth IRA. This move could result in tax-free growth and withdrawals in retirement. Be aware that this conversion will increase your taxable income for the year, so it should be planned with the help of a financial advisor to understand the implications fully.
8. Review Your Filing Status and Deductions
Significant life changes – such as marriage, divorce, or a child’s birth – can affect your filing status and tax liabilities. Determine whether you’ll benefit more from taking the standard deduction or itemizing deductions, especially if you’ve incurred substantial expenses such as mortgage interest or medical bills.
9. Prepare Documentation Early
Organize your financial records, receipts, and documents as early as possible. This includes gathering forms like 1099s, W-2s, or year-end pay stubs. Preparing these documents in advance can streamline your tax filing process, making it less stressful as deadlines approach. Additionally, early preparation allows you to identify potential deductions and credits you might miss in a last-minute rush. This thoroughness can also highlight any inconsistencies or errors in reported income or deductions, giving you ample time to address them before filing.
10. Plan for Special Situations
If you were affected by natural disasters like Hurricane Beryl in Texas or Hurricane Debby in the Southeast, be aware that the IRS often grants extended filing deadlines. These extensions can provide additional time to gather documents and plan your tax strategy without the rush. It’s important to check the IRS website or consult with a tax professional to confirm the specifics of any extensions or additional relief options available, such as special deductions for property losses not covered by insurance. These provisions are designed to assist in recovering financially from the disaster while managing tax obligations.
11. Estimate Your Tax Liability
Use free online tools to estimate your tax liability based on your current income, deductions, and credits. This estimation will help you plan for any potential payment or refund, allowing you to better manage your finances. Understanding your tax liability early also aids in making strategic decisions, such as whether to defer income or accelerate deductions, based on anticipated changes in income or tax laws. Additionally, this proactive approach can prevent the surprise of a large tax bill or optimize the size of a refund, aiding in better financial planning and budgeting throughout the year.
12. Consult a Professional
Navigating the complexities of tax laws and personal finances can be challenging. We invite you to consult with us for personalized guidance tailored to your specific situation. We can also communicate with your CPA about strategies for you and your family.
By taking these steps, you can not only potentially reduce your tax bill but also enhance your financial well-being as you head into the new year. Remember, effective tax planning is about understanding how to leverage current laws to work in your favor, helping you to pay only what you owe while maximizing potential benefits.
If you have any questions, give us a call. For additional insight, read Chapter 6 of “Wealth on Purpose” by Bryan Ballentine.
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