Thursday, February 25, 2016

Right now is the best time to start planning for next year’s taxes

With the recently passed Protecting Americans from Tax Hikes (PATH) Act providing more certainty to tax laws (as certain as anything can be when talking about Congress), the time to do your year-end tax planning should start earlier in the year.
And what better time to think about this year's taxes than when completing last year's taxes?
A great place to start is to look at your current tax return. If you use a tax preparer, ask them to review the return with you and point out certain areas of the return where you could have reduced your taxes.
If you prepare your own taxes take a look at your return and then consider the following.
Non-cash Donations
Most people are aware that they can deduct cash donations made to qualified charities as long as they itemize their deductions. However, donations of property can be deducted as well.
Rather than waiting until the end of the year to make these types of donations, make them now and throughout the year. The charity will benefit as will you, since you won't be scrambling around at year end.
Increased 401(k ) contributions
The tax code is littered with tax deductions that apply only to taxpayers whose income is at or below a certain amount.
Deductions for student loan interest, college tuition, medical expenses, deductible IRA contributions and personal and dependency exemptions are just some of the tax deductions that are subject to income limitations.
Increasing your 401k contributions in of itself may not save you a lot of taxes. This is because when you increase your 401(k) contributions you reduce the amount of income that is used to calculate how much tax to withhold from your paycheck.
However, increasing your 401(k) contributions does reduce your taxable income, which could result in additional deductions for some of the items mentioned above. And while most of the deductions gradually phase out as your taxable income increases, there are several which do not phase out and instead are not deductible as soon as the taxpayer has one dollar more than the limitation.
The best part about increasing your 401(k) contribution earlier in the year is that you spread the increase over more pay periods, which reduces your take home pay less than if you wait until the end of the year to increase your 401(k) by the same amount.
Make a tax deductible IRA contribution
The rules for taking a tax deduction for an IRA contribution are a bit confusing. However, if you are able to take a deduction, the value of the deduction will have a greater impact on the amount you owe or refund you are due, than the same amount contributed to a 401(k) due to the payroll withholding decrease described above.
Contrary to what many people think, it may be possible to take a tax deduction for an IRA contribution and still contribute to a 401(k).
For single taxpayers who are covered by a retirement plan such as a 401(k) plan, they can still take a full tax deduction, up to the contribution limit ($5,500 for taxpayers under age 50; $6,000 for taxpayers over age 50) if their adjusted gross income (AGI) is $61,000 or less. The deduction begins to phase out between $61,000 and $71,000 with no deduction allowed once AGI reaches $71,000.
For married taxpayers, a spouse who is covered by a retirement plan at work can take a full tax deduction, up to the contribution limit, if their AGI is $98,000 or less. The deduction begins to phase out between $98,000 and $118,000 with no deduction allowed once AGI reaches $118,000.
For married taxpayers where one spouse is not covered by a retirement plan at work, the non-covered spouse can take a full tax deduction, up to the contribution limit of their AGI is $184,000 or less. The deduction begins to phase out between $184,000 and $194,000 with no deduction allowed once AGI reaches $194,000.
Sharp readers may note from the above that increasing your401(k) contributions in a given year may reduce your AGI low enough that you can take a tax deduction for an IRA contribution as well.
The above are some of the more common planning strategies that can be employed earlier in the year and help you save income taxes.
You should still review your tax situation as the year progresses to fine tune or make adjustments especially in light of any changes that may occur during the year. Making this a habit each year at tax time means you're less likely to forget and have to play catchup in December.