Tax experts often talk about shifting your tax burden from one year to the next. While in theory it may make sense, how can you make it work for you in practice?
Since the tax code is complex in its construction, there are often opportunities to reduce your tax burden by controlling the amount of your taxable income from year to year. This is because:
- Income tax rates vary from 0% to 37% depending on your income and filing status.
- Many tax breaks have income limits.
- Tax breaks have income phase-out ranges.
- Incremental taxes like the alternative minimum tax are triggered by income level.
If you can shift your income and expenses from one year to the next, you could create a net tax obligation for both years that might be lower than if you did nothing. Here are six ideas to consider:
Idea 1 – Know the rules. Identify whether you are a good candidate for using shifting as a tax planning strategy. Did you know that for single filers, the income tax rate increases 80% or more on earnings over $40,125 (from 12% to 22%). For married filers, that increase occurs with adjusted gross income over $80,250. In addition, certain tax benefits are lost at various income levels. Common tax breaks subject to income limits are child tax credits, earned income credits, educational credits, premium health care credits and many educational tax benefits.
Idea 2 – Load up your contributions. If you itemize your deductions, consider loading up your cash and non-cash contributions into the year that will face higher income taxes. For example, you could shift next year’s donations to your church into this year if you anticipate earning more this year than next. This bunching of itemized deductions into one year makes even more sense with the higher standard deductions introduced in 2018.
Idea 3 – Leverage the cash basis concept. You are allowed to claim a deduction when you “pay” for it. Knowing this, you could pay a property tax statement or a house payment either a little early or a little late to change whether that deduction occurs in this year or next.
Idea 4 – Stop working or work a little less. There are many cases when this technique is an important tax shifting tool. The most common example applies to those who are under full retirement age and receiving Social Security benefits while continuing to earn income from employment. If this applies to you, consider actively managing your part-time work or you could end up paying taxes on some of your Social Security benefits or even losing some of them. Work can also hurt your tax situation when a dependent’s wages put you over the earnings threshold to receive the Health Insurance Premium Tax Credit. It may make sense to stop working or arrange to get your last paycheck delayed into the following year.
Idea 5 – Manage retirement plan distributions. Those over age 59½ can use distributions from pre-tax retirement plans to tightly control their taxable income. Your withdrawal calculation should include evaluating how to maximize the tax efficiency of your income. An analysis may indicate it is better to take out a little more this year to get these retirement earnings taxed at a lower rate than if you waited until next year. You may also wish to consider the type of account from which you are taking distributions. Distributions from Roth IRAs and Traditional IRAs have very different outcomes on your tax return.
Idea 6 – Manage your stock and investment sales. You can claim up to $3,000 in investment losses to offset your higher-taxed ordinary income. Use this to your advantage when deciding whether to take a stock loss this year or next. If done correctly, you can match your stock loss against ordinary income to save on taxes.
Recall the old saying, “It’s not what you make, it’s what you keep.” At Wisdom Wealth Strategies, we actively work with clients to achieve optimal tax results. If you would appreciate a review of your current tax strategy, please be in touch.
Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.