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Savvy End-Of-The-Year Tax Moves

If you are like the vast majority of people, the thought of paying more taxes than legally necessary is troubling.  Unfortunately with our busy lives pulling us in all directions, it is easy to get distracted and not have the time to focus on potential sources of tax savings throughout the year.

However, the end of the year is a good time to take a few hours and focus on potential tax savings opportunities that you might be able to lock-in before the new year arrives.

Doing that every year-end could help you to save thousands on your tax bill due the following April.

Let’s take a look at a few of the most common year-end tax-savings opportunities:

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Give To Charity

The period from Thanksgiving to the end of the calendar year is the time when Americans tend to give the most to charity. In many cases, this is done for two reasons: to give back to worthwhile causes and to save a bit on your taxes by generating a charitable deduction.

In order to have your donations qualify for a tax break, you must itemize them on Form 1040. You do not qualify for the tax break if you don't itemize and instead claim the standard deduction. In the Tax Cuts and Jobs Act of 2017, Congress made the threshold for itemizing higher than it had been in previous years, but many givers, particularly generous ones, still qualify.

Note that in order to make a charitable contribution, you must have charitable intent.  For most people, the tax savings represents only 35 or 40% of the value of the charitable deduction, so it makes sense to do it if you both want to help and donate as well as save on taxes.

Another area to remember is that donating appreciated assets such as stocks that have increased in value and or art for example can be even more attractive because you save on the potential capital gains that you would have owed had you sold that asset as well as getting a tax deduction equal to the current full market value of the donated asset.

Charitable gifts can also involve more advanced approaches for somewhat larger donations, such as setting up a donor advised fund account or donating an assets over time while it continues to generate income for the donor.  These are more advanced charitable donation strategies that would be beyond the scope of this article.

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Tax-Loss Harvesting

End of year is a good time to review your investment holdings. In particular, review your unrealized and realized capital gains and losses for the year.

Capital gains are taxable at the prevailing rate in the year they are realized. Capital losses, however, can be used to offset gains.

Here’s how it works: If you have more capital losses than you have gains for a given year, then you can claim up to $3,000 of those losses and deduct them against your ordinary income.

Fortunately, if you have more than $3000 in capital losses, then you're allowed to carry the excess forward for use in future years. You calculate and claim the capital loss deduction by using Schedule D of your Form 1040 tax return as part of your required reporting of sales of investments throughout the year.

Depending on your investment holdings, year-end can be a good time for you to look at your holdings and sell the ones that could allow you to generate a capital loss in the current year.  This can be especially valuable if, as per the above, you have gains that can be offset with these year end losses. 

This process of looking at your holdings for unrealized losses in your taxable investment accounts is called tax loss harvesting and your cpa or investment advisor can help you with this process.

Tax loss harvesting is subject to some specialized rules, such as the wash sale rule.  This rule states that you can only realize the loss upon the sale of a holding if you do not buy it back within 30 days (before or after) the sale. 

If the position is one that you expect to appreciate over time, you may not want to tax loss harvest it (as you will miss out on the gains for the next 30 days) or alternatively, you may want to identify some other correlated position to own during the time when you are subject to the 30 day wash sale rule.  Of course, on the 31st day you are free if you so desire to buy back you original position and still take the tax loss from selling the position.

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Defer Taking Capital Gains Until Next Year

In addition to tax-loss harvesting, you may wish to defer any unrealized capital gains until next year. Remember, you will pay capital gains tax on gains realized during the tax year. You could elect to simply keep your paper profits going forward without realizing the gain. This may also make sense as part of a long-term investment plan focused on high-quality securities that you really want to hold for the long term anyway.

Some mutual funds distribute capital gains distributions at year end.  On the other hand, by owning individual securities and exchange traded funds, you can defer you gains (and continue to compound them) for potentially a long period of time.

Even if you are sure you want to liquidate a position, once you start getting towards the end of the year, you may be better off waiting until the early part of the following year to actually sell the position for two reasons.

First, by deferring the gain on the sale into the new year, you defer the tax due by around a year.  Second, many securities tend to decline at year end and bounce back in January (potentially due to tax loss selling by many investors) so you might get better execution by waiting for the new year as well (at least on average).

Qualified Retirement Plans

If you are eligible for qualified retirement plans such as IRAs and 401-Ks, make sure that you maximize the tax-deductible contributions before year-end. In many cases, folks make regular bi-weekly contributions deducted from their payroll compensation. Also check to see if your situation qualifies for other types of deferred retirement plans?

For example, self-employed folks can set up a solo 401(k), or Simplified Employee Pension (SEP) IRA.  Depending upon your situation, the amounts that you can contribute may be substantially higher than in a Traditional or Roth IRA.

The deadline for establishing and contributing to a SEP IRA is the tax-filing deadline, including extensions.

A more advanced type of qualified retirement plan is called a Defined Benefit or Cash Balance Plan.  This type of retirement plan is more complicated and generally needs an actuary and a third party administrator.  It typically costs a bit more to set up and maintain as well.  However, for small but highly profitable businesses it can provide very large tax deductions as well as allow accumulation of substantial retirement plan assets.

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Review Your Medical Bills

Fortunately, the tax code provides for tax deductibility for qualified medical expenses. For 2019, you can deduct the total qualified and unreimbursed medical care expenses that exceed 10% of your adjusted gross income.

Qualifying expenses include things like:

  • Costs incurred for medical services from physicians, surgeons, dentists, and other medical professionals.
  • Purchases of medications prescribed by a medical professional.
  • Costs of medical devices, equipment, and supplies prescribed by a medical professional, including, among other commonly needed items, eyeglasses.
  • Premiums paid by you for health and dental insurance.
  • Long-term care costs and insurance.
  • Transportation and lodging costs for traveling to a health care facility including mileage

If you have a high deductible qualified health insurance plan, you may also be eligible to set up and fund a Health Savings Account or HSA prior to year end.

Since health care costs in retirement as a significant concern and expense for most individuals, the HSA is an excellent strategy with significant tax benefits to those who qualify and set it up properly.

Ridgewood Investments is experienced in setting up HSA’s and can assist you to do so.

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Look for Tax Incentives

Tax incentives are benefits, legally defined in federal and state tax codes, designed to attract business or encourage a specific economic or social activity. They are often used to help create affordable housing, catalyze job growth, set up enterprise zones, assist with historic preservation, and to encourage environmental responsibility.

Examples of these that you may qualify for include tax credits for installing energy-efficient residential appliances, tax breaks for using biodiesel fuel, and tax incentives for a wide variety of improvements for Americans with disabilities, to name a few. Consulting with your accountant may uncover a few that you can use prior to year end.

Make An Extra Mortgage Payment

Making an extra mortgage payment is something you might consider doing, especially if your monthly interest on the mortgage is relatively high. This simple trick may give you an extra amount of interest to deduct at the end of the year if you itemize. It may also reduce your principal more quickly as well.

This strategy can make sense if you want to payoff your mortgage more quickly or if you have a high interest mortgage (relatively rare these days). 

However, if your interest rate is lower than you average investment return, it may not make sense to accelerate your mortgage payments at year end despite the tax deduction.  This is especially true these days when the deductibility of mortgage interest was curtailed in the Tax Cuts and Jobs Act of 2017.

Avoid Future Estate Taxes

If you are a high-net-worth individual, looking at your estate tax situation may be highly beneficial. In 2019, the estate tax applied to folks with over $11.4 million in assets. You can reduce your potential estate, and its future tax burden, by making gifts. You can give up to $15,000 per person completely gift tax-free this tax year.

For example, each of you and your spouse can gift the above amount to each of your children (and even grandchildren).  Interestingly, the gift tax exemption is not limited to relatives.  Any amounts that you give as gifts reduced the future size of your estate and if the gifts are invested properly by or on behalf of the recipient the benefit in terms of future estate tax savings can be quite meaningful.

As an experienced investment and financial advisor based in New Jersey, Ridgewood Investments has comprehensive knowledge on a wide variety of savvy investing strategies and year-end tax-saving and planning ideas.

Take an opportunity to take advantage of a few of the above year-end tax saving moves to make your tax burden less taxing.

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.