Before the end of the calendar year, I review tax planning with clients. The goal is to take advantage of strategies limited to the year that ends Dec. 31. If they wait until after the new year to act, it may be too late to have an impact on their 2014 returns.
When Mark and Susan came in for their end-of-year meeting, this was on my list of items for us to review together. While I reminded them that I do not offer tax advice nor prepare tax returns, tax planning is part of comprehensive financial planning.
Tax rules have changed mostly for higher-income individuals and couples. There are a couple of new taxes, including the Medicare surtax of .09 percent and a 3.8 percent tax on net investment. This affects individuals with adjusted gross income of $200,000 or more and couples with $250,000 or more AGI.
I manage a stock portfolio for Mark and Susan, so the first step on our tax-efficiency search was an analysis of their portfolio. We looked at rebalancing and selling securities to generate a loss that could offset any capital gains generated in their taxable account for this year. Also, any losses generated that are not used this year can be used in future years to offset capital gains.
In addition, if they have no capital gains in a given year, then up to $3,000 of the unused losses can be used to offset ordinary income. This is often called tax-loss harvesting. Once you take the loss, it is possible to reinvest the funds in another security, but you have to be careful not to violate something called the “wash sale rule,” which prohibits taking a loss on your taxes if you purchase a similar security. Check with your adviser to make sure you do not violate that rule, or your losses will be disallowed.
December is the last time to max out your employer retirement plan. If you can afford to, go ahead and raise your contributions to the 2014 max for qualified employer-sponsored retirement accounts, which is $17,500. If you are 50 or older, you can also make a catch-up contribution of $5,500 for 2014. In 2015, the maximum will increase to $18,000, plus a $6,000 catch-up contribution for 50 and older. Plan ahead for 2015 and make sure you max out your contribution.
If you can defer income to next year and accelerate deductions for this year, plan accordingly. For example, you might prepay tuition if you are eligible for the lifetime learning credit or the Amer-ican Opportunity Tax Credit. Or if you have exceeded your 10 percent of AGI medical deduction and you have any upcoming procedures or medical care expenses, undertake them this year instead of waiting until 2015.
Some retirement plans must be set up by the end of the calendar year in order to make 2014 contributions to a solo 401(k) account, for example.
Roth conversions also need to be made before the end of the calendar year to offset this year’s income. April 15, when you file your taxes, is too late.
Charitable contributions also are based on the calendar year. Spend some time thinking about which causes interest you, and do a little research on which organization would benefit from your contribution. Also, donating appreciated assets, such as stock, is very tax-efficient because although your cost basis in the stock might be low, you receive a charitable deduction for the full value of the stock. You also avoid paying capital gains on the sale of the asset.
Since Mark and Susan own stocks with a low cost basis and were unsure which charity to donate to, I recommended setting up a donor-advised fund. That would allow them to donate appreciated assets such as stock now, receive the deduction and then take their time deciding where to give grants. Many large nonprofit foundations as well as mutual fund companies offer assistance with donor-advised funds.
In summary, look at your investment portfolio and stocks in particular to see whether it is appropriate to sell at a loss to offset gains, as well as offset up to $3,000 in ordinary income. Accelerate deductible expenses and defer income. Consider converting traditional qualified retirement funds to a Roth IRA. Set up any retirement funds by the end of the calendar year. Make those charitable contributions.
Ira Fateman is a certified financial planner at SAS in San Francisco who conducts free personal finance workshops for Hebrew Free Loan (www.hflasf.org/financialfitness). One on Social Security is Dec. 9. For a free pamphlet on Social Security, send an email to firstname.lastname@example.org.