Once a tax return is filed, most taxpayers want nothing more than to get their refund, stuff the paperwork into a file cabinet and forget the whole ordeal until next time. But that can be a mistake, as the fresh return may tell you how to cut your bill next year.
“One of the biggest mistakes people make is not planning ahead to know what their year-end outcome will be,” says Greg Rosica, tax partner at Ernst & and co-author of the accounting and consulting firm’s annual tax guide.
“Questions you need to ask yourself include: Will you be subject to AMT (alternative minimum tax)? Will your itemized deductions be efficiently utilized? What losses will be allowed?”
While everyone’s income tax situation is different, here are some of the items to look at to minimize taxes for next year.
Your W-4. That’s the form you fill out with your employer that determines how much federal income tax will be withheld from your check. If you had too little withheld, you may have been hit with a penalty on top of the payment due. If too much, you’ll get a refund but gave Uncle Sam an interest-free loan and lost out on the interest or investment earnings you could have earned on that money.
[See: 8 Times When You Should Sell a Stock.]
It’s better to have just the right amount of income tax withheld than to get a big refund. But getting it right can be hard to do because certain factors like dividends and capital gains from investments are unpredictable. If you haven’t updated this information in years, key items like the number of dependents or your marital or filing status may be out of date.
A form with the correct information filed with your employer obviously will not automatically adjust for money you earn on the side, so you could select the option to increase withholdings a given amount if you have outside earnings with no withholdings.
You can also use numbers from your recent return for the W-4 worksheet on itemized deductions, to minimize any over or under-withholding of income tax on your check.
“The key to paying the right amount of tax is to update your W-4 whenever you have a major life change such as changing jobs, getting married or divorced or having a baby,” says Lisa Greene-Lewis, a CPA for TurboTax, the tax-prep software company. “Contributing to charity or donating goods can also help reduce your tax liability when you file your taxes next year.”
Account for children. “Those who have children 13 and under often overlook the child tax credit,” says Steven J. Weil, president of RMS Accounting in Fort Lauderdale, Florida. “For those who have college students, choosing the wrong education credit can hurt.”
So keep track of your options as your children get older.
Maximizing retirement savings. Chances are you can reduce your income tax by putting the maximum allowed into a retirement plan like an IRA or 401(k). So look at the adjusted gross income on your tax return and think about reducing it with bigger contributions.
“It’s a documented problem that many people, especially with lower incomes, don’t put as much into their accounts as they are allowed to,” says Mark Luscombe, principal federal tax analyst at Wolters Kluwer Tax & Accounting in Riverwoods, Illinois.
[See: 8 Tips for Investing in Your 30s.]
Alternative minimum tax. If you were hit with the alternative minimum tax, which denies many deductions allowed on the standard return, look for reasons like having exercised large employee stock options, claiming lots of dependent deductions or using a home-equity loan for something other than home improvements. You may be able to avoid this tax next time by postponing sales of profitable investments or delaying income from bonuses or bills you send customers for a freelancing sideline, for instance.
The standard deduction. Taxpayers who have taken itemized deductions for years may have lost track of the standard deduction, which this year is $6,350 for singles, $12,700 for married couples filing a joint return. If your itemized deductions are smaller than that, the standard deduction is a better choice.
Older taxpayers, for example, may do better with the standard deduction if they no longer have a mortgage interest deduction, their children are no longer dependents or they’ve moved to a home with lower real estate taxes, or to a state with no state income tax.
Younger taxpayers may find that with a growing family, a mortgage and other expenses it now makes sense to itemize rather than continue with the standard deduction.
Mutual funds. Many actively managed funds have large year-end distributions that are taxable unless the fund is in an IRA, 401(k) or similar tax-favored account. If you were hit with big distributions, consider switching to funds that behave the same but don’t have big payouts, such as index funds or exchange-traded funds.
Bond investors can think about switching from government and corporate bonds to municipal bonds, which are tax-free, notes Lisa R. Featherngill, managing director for planning at the Charlotte, North Carolina office of Abbot Downing, a wealth management firm.
Another common problem is incorrectly booking profits after fund shares are sold by not accounting for reinvested dividends and capital gains distributions, Rosica says. Forgetting to account for this after a sale could leave you with a bigger taxable gain than you should have. Most fund companies and brokerages will calculate a cost basis per share, but it’s worth checking.
Booking losses. Most experts say investors who want to sell money-losing holdings should do so as soon as they decide to dump the holding, rather than waiting to the end of the year, as tax issues should not drive investment decisions. Putting losses on the books during the year will make it easier psychologically to book gains on winners you’re ready to sell later.
“If losses exceed gains, you can apply up to $3,000 of that against your taxable income to lower your overall liability,” says Greene-Lewis. Losses above $3,000 can be “carried forward” to offset gains or income in future years.
Losses booked in 2016 or 2017 can also, in effect, be “carried backward” and used to offset big gains of the past, says Vincenzo Villamena, managing partner of the CPA firm, Online Taxman. That’s done by filing an amended return for a prior year, he says.
[See: 9 Psychological Biases That Hurt Investors.]
Finally, experts urge taxpayers to keep abreast of tax-reform moves in Washington. Republicans’ vow to cut tax rates and horse-trading could eliminate some deductions, Weil says.
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Use Your Tax Return to Cut Next Year’s Tax Payment originally appeared on usnews.com
