END OF YEAR TAX PLANNING

Nine Simple Steps that Can Cut Taxes and Pain

 With the end of the year fast approaching, you’re probably wondering what you can do to cut your taxes. Remember: if you wait until April to start thinking about this, it’s just too late. Here are some ideas to get you moving in the right direction now.

1. Consider paying state income taxes before December 31. Many people wait until April 15 to pay their state income taxes, since that’s when they file their state tax returns. However, if you pay your state income taxes in 2024, you can’t claim the deduction for those taxes until you file your 2024 tax return. That doesn’t happen until April 2025. Thus, you have to wait an entire year before getting the tax benefit of the expense.

By paying your state taxes now, you get a deduction for those taxes in 2024. That means you get the benefit of the expense more than one year sooner than you’d otherwise realize.

Keep in mind, however, that the standard deduction is such that you may get a larger tax benefit by not itemizing, depending on your situation. It is also true that there is a $10,000 cap on what you can deduct for state and local taxes in 2024. Thus, if you are already at the cap for 2024, it won’t help to pay more state taxes this year. You have to look at your situation carefully.

2. Review your wage withholding or estimated payments. About 85% of all taxpayers get a tax refund when they file their tax returns. The average refund is $3,200. If you get a tax refund, it doesn’t mean the government got religion and decided to give you free money. It means you paid more taxes than you owe. If you got a refund in 2024, you need to examine your withholding situation going into 2025 to make sure you don’t overpay.

Whether you’re an employee or you make quarterly estimated tax payments as a self-employed person, sit down now and do some preliminary calculations on your tax liability. Figure out if you overpaid. If so, you need to adjust Form W-4 (for wage earners) or your estimated tax payment pattern (for self-employed people).

Keep in mind that no law requires you to pay more taxes than you owe. For withholding purposes, you avoid under-withholding penalties if you pay either 100% of last year’s tax (2023) or 90% of this year’s tax (2024), whichever is less. Use that yardstick to guide you in adjusting your withholding.

3. Count your money now. Each year, millions of people are blindsided come April 15 with surprise tax liabilities they can’t pay. Don’t wait until March or April to start figuring your tax, especially if 2024 was a particularly good year for you. On the other hand, the Jobs Act cut taxes for about 80% of all taxpayers. And if you own a small business such as a sole proprietorship or S corporation, you get the benefit of the 20% deduction under §199A. That reduced taxes considerably for most small business owners.

It is important for you sit down now and examine your 2024 financial situation. If there were substantial changes to your economic condition, that might increase your tax burden. If you don’t have the money to cover the tax, you’ll wind up as one of the 3-plus million taxpayers facing enforced tax collection actions.

Make sure you have a good handle on what you’re going to owe. If you figure it out now, you have four and a half months to put together a plan to pay the tax. If you don’t, you could be hit over the head in April. In my experience, it’s that kind of shock that causes people to start making critical mistakes in how they handle their tax burdens. Often, it leads to years of hassle and harassment from the IRS.

4. Review your financial portfolio. One of the biggest problems with our tax system is the unfair treatment it affords to investment gains and losses. If you win with your investment, the IRS is standing next to you with its hand out to get “its share” of your success. If you lose, you are, for the most part, standing alone.

The reason is that capital gains are subject to tax in their entirety in the year they are realized. However, capital losses are subject to a $3,000 deduction cap in a given year. That means if you lose $15,000 in an investment, you can only deduct $3,000 at time. This means it will take you five years to fully write off your loss.

This is true unless you have both capital gains and capital losses in the same year. If that’s that case, you offset your gains against your losses, plus you can take an extra $3,000 of loss. Suppose you have $10,000 of capital gains and $12,000 of losses. In that case, the first $10,000 of losses offset against the gains. Then, you get the additional $2,000 of losses as a deduction that can offset other income.

In order to best utilize this rule, you should consider selling investments that are down in 2024 so you can offset that loss against any investments that made money during 2024. This allows you to effectively increase the allowable capital loss deduction, thereby recovering your losses much faster than you otherwise would. You should talk with your investment advisor regarding this strategy.

5. Consider making equipment purchases. If you own a small business, now is the time to consider purchasing any equipment you might need for your business. A special tax code section creates an advantage for acting now.

Code §179 allows you to claim a full deduction for the cost of business tools and equipment that is placed in service in the year in question. Ordinarily, the cost of such equipment must be depreciated over the useful life of the equipment. For example, if you purchase a copier for $5,000, you would normally have to depreciate that copier over three years. In that case, you get a deduction of $1,667 for each of three years.

But under §179, you can fully expense up to $1,220,000 of equipment placed in service in 2024. This allows you to get the full benefit of the deduction in the year of the purchase, rather than having to spread the recovery over several years.

This is a huge benefit, thanks to the Jobs Act. And the deduction is indexed for inflation. So, for example, it will go up next year. In years past, the deduction has bounced up and down, and even was on the verge of expiring on numerous occasions. However, the Jobs Act’s benefits to businesses include a huge bump for the purchase business tools and equipment.

Take advantage of this deduction if your income was unusually high this year. The best way to offset that income for tax purposes but still get the benefit of the money is to buy equipment you need to more effectively operate your business.

6. Fund a Medical Savings or Health Savings Account. One of the best-kept secrets in tax planning remains the Medical Savings or Health Savings Account. These accounts allow you to set aside money that is earmarked to pay medical expenses not covered by insurance (other than the insurance policy itself). By placing the money in a specially designated savings account, contributions to the account are tax deductible, up to certain limits.

It works much like an IRA or 401(k), except that you don’t have to pay taxes on the money when it’s distributed, provided you use it for medical expenses that are not covered by insurance. You can fund this account right up to December 31, 2024, and get a deduction for the money you put in, even if it’s not used for medical expenses in 2024. What’s more, any money left in the account at the end of the year carries over and remains in your account, under your control. You don’t lose the money. It’s always available to you.

Be careful with this, however, because there are a number of complicated rules that apply. First, you must not be covered by any other health plan, including Medicare, in order to qualify. Next, your own insurance must be considered a high deductible health plan. The limits to what you can deduct are based on family size the health insurance plan itself. You most definitely need to consult with a health insurance specialist to see if this plan will work for you.

7. Fund a retirement account. An IRA, 401(k) or other retirement account can be funded anytime during 2024, and you’ll get a deduction for the contribution (within limits) in 2024. In fact, for most retirement accounts, you have up to April 15 of the following year to contribute. You can get a deduction for the prior year simply by designating the contribution to apply to the prior year. That means a contribution made in 2025 can still apply to and be deductible in 2024.

8. Consider restructuring your business. There are millions of people operating small businesses in the form of sole proprietorships. And while this is probably the best way to start a new business, it may not be the best way to continue an existing business into the future. There are eight different forms of business entities available, including a small business corporation or partnership. Depending upon the nature of your business and other non-tax considerations, one or more of the available entities might be a better idea than continuing as a sole proprietorship. January 1 is generally the most convenient time to change the structure of an existing business.

But first you need to understand which entity is best for you. I have an entire chapter in my new book, Dan Pilla’s Small Business Tax Guide, to address this question. For the first time, business owners have a comprehensive guide to how each business entity works, and the pros and cons of each. If you are a small business owner, don’t go another day without reading this material.

9. Catch up on your charitable contributions. If you make it a practice to give generously, make another contribution before December 31. This gives you further opportunity to cut taxable income and help those in need around you at the same time. 

When making significant charitable contributions, note that you must have a contemporaneous acknowledgement from the donee organization if your contribution is for $250 or more. This applies to one-time contributions, not a total of contributions to a given organization over the span of one year. If you don’t have the proper acknowledgement in hand by the time you file your tax return, the deduction is not allowed, even if you have your canceled check and even you get the statement later. That’s why they call it a “contemporaneous acknowledgement.” 

How to Get More Help 

If you need more help with end-of-the-year tax planning, you must consult one of the professional members of my Taxpayer Defense Institute (formerly Tax Freedom Institute). Call our office for the latest list of the current consulting members.

Don’t wait to take this action. If you do, you’ll lose most of your opportunity to cut your taxes for this year.