While many of you are dreaming of sugar plums and holiday cheer, we hope thoughts of our first article about year-end planning still linger. (It was good stuff, right?)
Yes, that’s our wish because, at Redwood, taxes and year-end planning are such exciting topics we can’t send just one newsletter about them! As we wrap up 2016, let’s pick up where we left off and ensure you’ve made the most of it.
Here are some additional aspects of tax planning to consider:
Estimated Federal Tax Payments
Each year the IRS reviews your tax withholdings to ensure you retained a certain percentage of income on a quarterly basis. (If you don’t, they will charge you an underpayment penalty.)
The two most common ways to calculate your quarterly estimated payments are the 90% Rule and 100/110% Rule:
- 90% Rule:
- Pay 25% of 90% of your current year’s tax liability each quarter. (The challenge with this option is having a clear idea of how much you’ll owe in taxes for the current year.)
- 100/110% Rule:
- If your adjusted gross income (AGI) was <$150,000 for single or married filing jointly (MFJ) filers each quarter, pay 25% of 100% of last year’s tax.
- If your AGI was >$150,000 each quarter, pay 25% of 110% of last year’s tax.
If you need to make an estimated tax payment for the last quarter of this year, you have until Jan. 15, 2017, to submit your payment.
Tax-Deductible Retirement Plan Contributions
- Employer-sponsored retirement plan: If you’re eligible to participate in an employer-sponsored retirement plan, such as a 401(k) or 403(b), you can make pre-tax contributions (up to $18,000 if you’re under age 50 or $24,000 if you’re age 50 or older, unless your company has a lower contribution limit). If you haven’t maximized your plan contributions, this is an effective way to defer paying taxes on current income until your retirement. Some companies also allow for Roth (after-tax) contributions. Feel free to contact your advisor to discuss which option is best for your situation.
- Traditional IRA: Depending on your AGI for the year, you and your spouse may be able to take either a full or partial deduction for contributions to a traditional IRA. The contribution limit for 2017 is $5,500 for individuals under age 50 and $6,500 for individuals who are 50+. You have until April 15, 2017, to make them.
Here are the 2016 AGI phase-out limits:
|Filing Status:||Adjusted Gross Income:|
(if both spouses are eligible to participate in a workplace retirement plan)
|$98,000 - $117,999|
(if spouse making the contribution isn’t covered by a workplace retirement plan)
|$184,000 - $193,999|
(if eligible to participate in a workplace retirement plan)
|$61,000 - $70,999|
(if not covered by a workplace retirement plan)
|No AGI limit|
Back-Door Roth Contributions (Roth Conversions)
Roth conversions can make sense if you’re above the AGI limit for a direct Roth contribution and you don’t have an existing IRA balance. (This is what’s called a “back-door” Roth contribution.) Individuals who are less than 50 years old can contribute up to $5,500; those who are 50+ can contribute $6,500.
To take advantage of this, first make a non-deductible contribution to your IRA, then “convert” the IRA balance to your Roth IRA. (In this case, the contribution you’ve made to your IRA has already been taxed, so when you convert the contribution to your Roth, there are no tax consequences.) This strategy helps build your “tax-free bucket” of monies, which allows for greater tax flexibility in retirement.
Required Minimum Distributions
If prior to May 1, 2017, you are age 70½ or older and own a traditional IRA account, 401(k) account, or an inherited IRA, you must take a required minimum distribution (RMD) from your account(s) each year. It’s essential to do so before year end. If you don’t, there will be a 50% penalty on the funds you didn’t withdraw to meet the required distribution.
Qualified Charitable Distributions
If you’re age 70½ or older and need to take required minimum distribution (RMDs) from your IRA account, a qualified charitable distribution (QCD) allows you to make a charitable contribution by donating your RMD (up to $100,000 a year) directly to public charity.
The advantage is that the charitable contribution is withdrawn from the IRA to satisfy your RMD and you won’t have to pay taxes on the withdrawal. However, timing matters: a RMD is presumed to be satisfied by the first distribution from an IRA in that year and, once it occurs, the RMD is irrevocably distributed.
This could be an option if you haven’t taken a distribution from your IRA for 2016 or if we recommend having a conversation about QCDs with your advisor early in 2017 to provide time to utilize this tax strategy.
Gift of Appreciated Stock to Charity
If you plan to make any year-end charitable donations, one effective tax-savings idea is to donate appreciated stock instead of cash. The IRS allows you to donate securities to a charity if they’ve gained value since the original purchase date. After doing so, you can take a deduction for the full fair-market value of the stock at the time you gift it. In addition to receiving a charitable deduction for the donation, you also avoid capital gains taxes that the security has accrued and that you’d typically have to pay if you sold it rather than gifting it outright.
Estimated Tax Payments for State and Local Income Taxes
The deduction for state and local income taxes isn’t based on how much you owe on Tax Day; instead, it’s determined by how much you paid during the year in income tax withholdings, estimated payments, and tax liability, when you filed your taxes for the prior year. If you think you’ll owe money on your state tax return for the current year, making an estimated tax payment before year’s end will increase your state and local income tax deduction (thereby increasing the amount of your total itemized deductions).
Want to discuss any of these topics in more detail? We’re here to answer your questions. Simply contact your advisor, and we’ll discuss the steps you should take to ensure you’re taking advantage of these tax-saving strategies. Happy holidays!