This is the time of year when many of us take stock of our lives, and it’s not a bad idea to apply that same introspection to your investment portfolio. The stock market has been surprisingly resilient, but that doesn’t mean everything in your portfolio escaped unscathed. Some last-minute trades could lower your 2016 tax bill, and you may be able to reap some tax-free profits, too.
If you have stocks or mutual funds in a taxable account that have fallen from the price you paid, you can sell them and use the losses to offset profits you’ve locked in from selling other investments during the year. Losses will also come in handy if you have unexpected distributions from your mutual funds. Every December, funds pay out dividends and capital-gains distributions that have built up during the year. In taxable accounts, such payouts are taxable, even if you reinvest them in additional shares.
If losses exceed your gains (or you don’t have any gains to offset), you can use up to $3,000 of losses to offset ordinary income. Unused losses can be rolled over to future years.
Even if you don’t have losses to harvest, you may be able to cash in some of your top performers tax-free. Taxpayers in the 10% or 15% tax bracket qualify for a 0% long-term capital-gains rate. In 2016, married couples filing jointly with taxable income of up to $75,300 are eligible for the 0% capital-gains rate, and singles with taxable income of up to $37,650 can cash in winners tax-free. Recent retirees who have been living off their cash reserves are good candidates for this tax break, says Kevin Meehan, a certified financial planner in Itasca, Ill.
But don’t get carried away. The sweet 0% rate applies only to the extent that your gains don’t push your taxable income into the 25% bracket; profit that falls in that bracket is taxed at 15%. Let’s say you estimate your taxable income for the year on a joint return (before a sale) at $70,000. If you sell a stock for a $6,000 profit, the first $5,300 would enjoy the 0% rate, but the other $700 would be taxed at 15%.
Try to sell for enough profit to fully exploit the 0% rate. If you don’t want to part with the stock, you can immediately buy it back, and any future tax would be based on today’s higher purchase price. Keep in mind, too, that if your state has an income tax, you may owe state taxes on your capital gains, even if Uncle Sam turns a blind eye.
If you won’t fall into the 10% or 15% tax bracket, perhaps someone in your family will—an adult child, for example, or an elderly parent. In that case, appreciated stocks make great gifts. Your family member (or anyone else you want to help) can sell the securities and use the 0% rate as long as the profit falls in the 10% or 15% bracket. (You can also give appreciated stock to charity; see below.) In 2016, you can give cash, securities or other property valued at up to $14,000 to as many people as you want without filing a gift-tax return or dipping into the credit that will protect your estate from the federal estate tax.
Most taxpayers don’t have to worry about the federal estate tax. The 2016 estate-tax exemption, which is adjusted annually for inflation, is $5.45 million, or $10.9 million for married couples. But 11 states and Washington, D.C., have lower estate-tax thresholds than the federal government. New Jersey, for example, taxes estates valued at as little as $675,000.
Manage your IRA. If your income declined this year—because you retired, for example, or took an unpaid sabbatical—consider whether this is the time to convert some or all of the funds in your traditional IRA to a Roth before year-end. You must pay tax on the amount you convert (except for any after-tax contributions), but if you’re in a lower bracket now than you’re likely to be in later, it can really pay off. Once you convert, future earnings are tax-free, as long as you’re at least 59½ and have owned the Roth for at least five years when you withdraw the money. To get the maximum amount of tax-free growth, use money from outside your IRA to pay the tax bill, Meehan says.
Show your generosity. For the first time in years, retirees won’t have to wait for Congress to renew a valuable tax break for charitably inclined IRA owners. Last December, Congress made permanent a law that allows seniors age 70½ and older to donate up to $100,000 from their IRAs directly to charity. The contribution counts toward your required minimum distribution and isn’t included in your adjusted gross income. That could qualify you for tax breaks tied to your AGI and reduce or eliminate taxes on your Social Security benefits.
You don’t need to be wealthy to take advantage of this tax break, says Jackie Perlman, senior analyst for H&R Block’s Tax Institute. Although you can transfer up to $100,000 from your IRA, even small donations will lower your AGI. It’s a useful tax break for seniors who no longer have enough deductions to itemize, she says.
For taxpayers who do itemize, another tax-smart strategy is to give appreciated securities to charity. As long as you’ve owned the securities for more than a year, you can deduct their value on the day you make the donation. You won’t pay taxes on the gains, and the charity won’t, either.
If you’d like to make a large donation but aren’t sure which charities you want to help, consider opening a donor-advised fund. You can donate now, claim the deduction on your 2016 tax return and distribute the funds later. If you donate securities, the donor-advised fund will sell them and add the proceeds to your account. (Note: Donor-advised funds aren’t eligible for direct charitable contributions from IRAs.)
In recent years, some of the largest donor-advised funds have lowered their minimum investment requirements. You can open an account with Fidelity Charitable and Schwab Charitable with as little as $5,000; Vanguard Charitable requires $25,000.
Don’t miss these tax savers. In addition to the IRA charitable rollover provision, Congress made permanent several other tax breaks that could affect your year-end tax planning. One such provision is the American Opportunity tax credit, which is designed to offset the cost of tuition, fees and textbooks during each of a student’s first four years of undergraduate education. The credit is worth up to 100% of the first $2,000 spent on qualifying expenses and 25% on the next $2,000, for a total maximum of $2,500 for each qualifying student. Married couples filing jointly qualify for the full credit if their modified adjusted gross income is $160,000 or less; for single filers, the cutoff for a full credit is $80,000. Married couples with MAGI of up to $180,000 and singles with MAGI of up to $90,000 can claim a reduced amount.
A credit represents a dollar-for-dollar reduction in your tax bill, so this tax break could save you a bundle. If you haven’t spent enough this year to take full advantage of the tax credit, consider paying your child’s January tuition bill before December 31. You can claim the credit only for money you actually spent this year, not the amount that you were billed.
Congress also put a forever stamp on the deduction for state and local sales taxes. You can claim this deduction or write off your state and local income taxes, but you can’t do both. The sales tax deduction is a no-brainer for residents of the nine states with no income tax. Taxpayers who live in low-income-tax states, along with seniors who live in states with special breaks for retiree income, could also get a bigger tax break by deducting sales taxes.
If you live in a no- or low-tax state and plan to buy a car or boat in the near future, making the purchase by year-end will let you add the tax on the big-ticket purchase to your deduction.
Finally, Congress made permanent a provision that allows elementary and secondary school teachers to claim a $250 above-the-line deduction for out-of-pocket classroom expenses, such as books and supplies. While the tax break won’t expire, if you want to claim the full $250 deduction on your 2016 tax bill, you should stock up before year-end. From now on, the amount of the deduction will be indexed to inflation, and qualified expenses will include professional development classes.
Disappearing tax breaks. This year is your last chance to claim a tax credit for installing new energy-efficient windows or making similar energy-saving home improvements, unless Congress renews the provision. You can claim up to $500 in total tax credits for eligible improvements. The credit applies to 10% of the purchase cost (not installation) of certain insulation, windows, doors and skylights. The credit is subject to a lifetime cap, so if you’ve already claimed it for energy-efficient home improvements, you’re out of luck.
A tax break for homeowners who pay private mortgage insurance is also scheduled to expire. If you itemize, you can deduct premiums paid this year—as long as you obtained your mortgage in 2007 or later and the loan is for your primary residence or a second home that’s not a rental property. The deduction is restricted if your 2016 adjusted gross income exceeds $100,000 and disappears when AGI exceeds $109,000.
If you’re negotiating with your mortgage lender to sell your home for less than you owe on the mortgage, be sure to get the contract signed before December 31. Ordinarily, forgiven debt is taxable, but Congress extended through the end of this year a provision that excludes from taxes up to $2 million in forgiven mortgage debt on a principal residence. The exclusion will apply to mortgage debt forgiven in 2017 if the agreement to discharge the debt is signed in 2016.
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Theresa Todman, Managing Partner/CEO of B&M Financial Management Services, LLC . Theresa specializes in bookkeeping, accounting, QuickBooks solutions, small business tax issues and consulting.