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Tips for Financial Preparedness: Tax Prep

Tips for Financial Preparedness: Tax Prep

Are you dreading tax season? Fear not. We’re here to help. According to GOBankingRates, 43% of Americans file their own taxes. Many do so with the help of a tax preparation program. Others might feel it’s worth paying a professional to file their return. Whatever you choose, make sure you do it right.

For more than a decade, Tana Gildea has served as a CERTIFIED FINANCIAL PLANNER™ and a Certified College Funding Specialist. She is also the author of The Graduate’s Guide to Money and an instructor for our Certified Financial Planner™ Program. Here are some of her thoughts on the best ways to prepare your taxes:

It’s the season of tax reform, tax proposals in both the House and the Senate, and a big push for Santa to put a shiny new tax package under the tree – talk about the magic of Christmas! Keep an eye out for actions between now and year-end. I can assure you that everyone will be writing about what, when, why, and how, so stick to the reputable websites, understand the key provisions, and consider how it will impact your tax return.

Timing is Everything

There are many things to think about with taxes and a lot is about the timing – do you want income or deductions in 2017 or 2018? It just depends on your tax situation at the moment. This is where your tax preparer can earn his/her keep!

  • If you had a big income year in 2017, you will likely want to find/create deductions in 2017. That probably means retirement plan contributions or charitable gifts. Those two items seem to be safe bets for staying in place regardless of tax reform.
  • If you had a low-income year but see brighter skies for 2018, you may want to shift those deductions into 2018. The beauty of retirement plan contributions (for the self-employed or for those who don’t have a work plan and instead make IRA contributions) is that you have until April 15 of the following year to deposit those contributions. For the self-employed, you may have until the due date of your extended tax return to make those. That gives you a lot more time for analysis and for saving.

First, a quick tour of the tax system would be helpful for those who don’t know much about the tax game that we are all playing. You may want to go to irs.gov and pull up Form 1040 to view as we walk through the sections of the return.

Income

The U.S. taxes your worldwide income on a cash basis. That means that if you earned income and received the cash in 2017, it is taxable in 2017. Business owners who use the cash basis (you are a sole proprietor or LLC and file a Schedule C), you may have some control over the timing of cash receipts based on when you do your billing. Perhaps it makes sense to push income into 2018. Talk to your tax accountant or run a tax projection to see if that would be beneficial. (Note – simply putting the check into a drawer and holding it until January 1 is technically tax evasion so if you got it, deposit it, and include it in your income.)

  • One thing that is possible with respect to income reduction relates to capital gains. If you have “capital” property, the most common of which is investments like stocks and bonds, you might have the opportunity to “tax loss harvest” if any of your investments have lost money.
    • You can take up to $3,000 in losses from Schedule D on your 1040. Losses above $3,000 are carried forward to next year. The markets have performed pretty well this year, but if you do have positions showing a loss (the market value is less than what you originally paid), you could sell those positions to take the loss.
    • As long as you don’t repurchase the same or “substantially the same” security within 30 days, you can take the loss. (These are the “wash sale” rules so make sure you understand the timing.) Note that transactions in tax favored accounts like IRAs and other retirement accounts don’t have a tax impact so you would have to look only to taxable accounts.
    • The losses would first offset any realized gains or capital gain distributions from mutual funds. A reduction of income is a reduction in income so talk to your financial advisor or tax professional to see if this might apply to you.
    • It doesn’t look like tax reform is going to impact investors much, but we obviously won’t know for sure until something becomes law.

Adjustments

These are subtractions from income. The more common items are:

  • Educator expenses: Teachers of grades K through 12 can use up to $250 of paid expenses to reduce income. Planning to get some supplies for the classroom? Perhaps you want to do it in 2017, save your receipt and take up to $250 off your income. Every little bit helps.
  • Health savings account: If you have a high deductible health insurance plan that qualifies for an HSA, you have until April 15th of 2018 to fully fund that account for 2017. Check all the rules but you want to do everything possible to fully fund the account. See IRS Publication 969 for all of the details.
  • IRA contribution: This is another one where you have until April 15, 2018 to contribute for 2017. There are income limits for the deductibility of your contribution, especially if you have a retirement plan through work, so do your research. Irs.gov is an easy site to use and it is the ultimate source – search IRA and you will get all the information that you need.
  • Student loan interest: If you are paying on student loans, consider making your January payment in December so that you slide a bit more interest into 2017. This adjustment “phases out” at higher levels of income so check IRS Publication 970 for details. (This also applies to your home mortgage payment. That interest is a deduction on Schedule A but the same strategy applies: get more deductions into 2017.) Student loan interest is on the chopping block for tax reform so stay tuned. Mortgage interest is NOT. It is explicitly protected, at least today.
  • Others: For other adjustments, look at the Form 1040 under “Adjustments” and see if those apply to you. The big ones apply to the self-employed so if that’s you, make sure you maximize those items.

Deductions

These further reduce your taxable income. There are two ways these play:

  1. Standard deduction: You just claim it – no receipts, no fuss. The amount is based on your filing status (single, married filing jointly, etc.) The tax proposals look to dramatically increase the standard deduction. This goes into the “simplify” category.
  2. Itemized: You fill out Schedule A and keep receipts. The only “safe” items under the tax proposals are mortgage interest and charitable deductions. Actions you can take to increase deductions:
    • Make your January mortgage payment in December.
    • Make your charitable contributions by year-end. This includes both cash donations and your clothing and household goods donations. As you look at the latter, make a list of every item you donate (12 men’s dress shirts, 4 men’s t-shirts, etc.), use a value guide (Goodwill’s website has one) to value each item, keep your actual receipt from the charity with the list and the calculated value, and make sure to include it on your Schedule A if you itemize.
      • If you give more than $500 of items to a single organization, you will have to fill out a separate tax form. If you have a high volume of items, consider splitting up your donations among several organizations to make this easier. Keep records of exactly what you are giving to which charity.
    • Pay your state income tax estimated payment in December. For the self-employed who make estimated tax payments, your 4th quarter estimate is due January 15 but if you pay it in December, it will go on the 2017 Schedule A. If you are in this situation, you should consider which year is best. However, under the tax proposals, the deduction for state income taxes is on the chopping block. Keep a close eye on the final package to see if this will be relevant or not.

Exemptions

These are fixed amounts that reduce your taxable income and are based on the number of dependents you have. There is nothing to be done here, but I want to mention that these are on the chopping block under the tax proposals. (The tax rates are proposed to decrease and that in combination with other changes is not supposed to create higher taxes for most. We’ll see.)

Alternative minimum tax

This is a (hated) second way to calculate your tax to make sure that “high income” taxpayers pay their fair share. It may or may not apply to you (look at last year’s tax return), but it is definitely on the chopping block under tax reform, and everyone hopes it is finally, after decades of discussion, chopped!

Tax credits

These are dollar-for-dollar reductions in your tax. They are valuable, so check the list of items (page 2 of Form 1040) and make sure you claim any credits that you can. The most common are the child tax credit and the credit for child and dependent care. You either have kids or you don’t so nothing much to be done on these except to be aware of them and make sure you claim them if they are available to you. Two that could be relevant are:

  • Education credits (see publication 970 for details): This is one where you may be able to pay tuition due for your child’s winter/spring semester in December if you have not already maxed out the amount of eligible tuition paid for you or your dependent. There are a lot of rules, income phase-outs, etc. with respect to these so take a look at the publication. The IRS also has an Interactive Tax Assistant to help you determine if you are eligible. Tax reform could chop two of the three credits but the proposal keeps the more valuable one – The American Opportunity Credit – so stay tuned to see how it fares through the debate and compromise.
  • Residential energy credit: If you made (or make in December) certain home improvements that improve energy efficiency (wind, solar, geothermal heat pump) and qualify for the tax credit, you may get some help from Uncle Sam. Watch this closely as the House proposal and Senate proposal differ on these. Who knows what will happen in the final approved version.

So, that is a not-so-quick overview of the tax items most likely to impact you. If you learned something new and are thinking, “I could have done that on my 2016 return,” fear not! The IRS allows you to amend a prior year’s tax return for up to three years in order to correct errors or missed deductions. Talk to your tax return preparer (or get yourself one!) to see if this makes sense for your situation.

Final Thoughts

One last thought on taxes:  Taxes are confusing, contain many rules, a lot of exceptions to the rules, and are just not fun. I get it. Unfortunately, we all have to play the tax game. It is really worth your time and energy to understand, at least at a high level, the rules of this game. It adds up to a lot of your money so it is worth it. Do a bit of research. Ask questions. Read the updates so you know what is happening. Look at last year’s tax return so you can see what may be changing for this year. If you are confused and unsure, the services of a qualified tax preparer could more than pay for the cost of the return, so consider getting some help. May the magic of the season be with you whether or not Santa delivers a magical tax package.

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