The window of time to cut your 2014 tax bill is closing. Before you pop open the champagne on New Year's Eve, make sure you've ticked off these valuable tax tasks.
1. Be Charitable Now
Individual Americans donate some $250 billion dollars to charity every year, according to the annual Giving USA report, and December is high season for giving.
Then you simply need to get a check in the mail by Dec. 31. Or put the gift on a credit card before year-end and pay the bill in January. Make sure you have a receipt, be it a cancelled check or your credit-card statement. But if you donate $250 or more, you must get a written record from the charity.
If you give away clothes or stuff from around the house, you’ll be able to deduct the fair market value, as long as the goods are in good condition or better.
“The end of the year is a great time to donate some items to charity," says financial planner Trent Porter. "Your good deed will be rewarded with a bigger tax refund and a clean closet”
2. Be Charitable Later
If you’re in search of a big deduction in 2014, but you’re not ready to support a single charity now, here’s a good option. With as little as $5,000, you can set up a donor advised fund with a brokerage or fund company such as Fidelity or Schwab. You get the upfront tax savings, the money is invested, and you can then donate a portion of the fund to the charities of your choice for years to come.
“These accounts make it easy to use appreciated securities and other assets to fund your philanthropy, thus avoiding paying capital gains tax on the appreciation,” says financial planner Eric Lewis.
3. Invest in Education
A year of tuition and fees at even a public college will cost you more than $23,000 today. You need all the tax breaks you can get.
If you’re saving for school in a 529 college savings plan, that money grows tax-free, and withdrawals are tax-free as long as the money goes toward higher ed.
You can’t deduct those contributions on your federal return. But in 34 states and the District of Columbia, you can qualify for at least a partial deduction or a credit on your state tax return, as long as you fund the account by Dec. 31. Look up your state's rules at savingforcollege.com.
4. Speed Up Deductions
A popular strategy for cutting your tax bill is to move up as many deductible expenses as you can. This is especially smart if your income will be high this year—say you cashed out winning investments or sold property.
One simple way is to donate more to charity. You can also make your January mortgage payment in December, which will give you extra interest to deduct. You could also prepay your property taxes, or send in estimated state and local taxes that you would otherwise pay in January. Or pay next year’s professional dues and subscriptions to trade publications.
Don’t employ this strategy, however, if you expect to be in a higher tax bracket in 2015. In that case, the deductions will be more valuable to you next year.
5. Top Off Retirement Plans
In 2014, you can save $17,500 in a 401(k) plan, or $23,000 if you’re 50 or older. If you haven’t saved that much, see if your employer will let you make an extra lump-sum contribution before Dec. 31. If you can't, make sure you hit the max next year by raising your contribution rate now. The limit will rise to $18,000 in 2015, or $24,000 if you’re 50 or older.
You have until next April 15 to fund a traditional or Roth IRA for 2014, but the sooner you save the more time you'll have to get the benefit of tax-deferred growth. What's more, planning ahead might make for better investment choices. A recent Vanguard study found that last-minute IRA investors are more likely to simply park the money in cash and leave it there.
You can contribute $5,500 dollars to an IRA in 2014, or $6,500 if you’re 50 or older.
If you run your own business and want to save in a solo 401(k), you must open that plan by Dec. 31, though you can still fund it through next April 15.
6. Look for Losers
Nearly six years into this bull market, long-term stock investors are sitting on big gains. Maybe you cashed in a profitable stock or mutual fund this year. Or you trimmed back your winners when you rebalanced your portfolio. Unless you sold within a retirement account, you’ll face a tax bill come April. And the best way to cut that is to offset your investment gains with investment losses.
By pairing gains with losses, you can avoid paying capital gains taxes. If you have more losses than gains, you can use up to $3,000 worth to offset your ordinary income, and then save the rest of the losses for future years.
However, don’t let tax avoidance get in the way of sound investing. You should sell a stock or fund before year-end because it doesn’t fit with your investing strategy, not just because you have a loss.
If you want to buy the investment back, you must wait 31 days. Do so sooner, and the IRS will disallow the write-off (what’s called the “wash sale” rule).
7. Part With Big Winners
If you donate winning stocks, bonds, or mutual funds directly to a charity, you can enjoy two tax breaks. You won’t owe any taxes on your capital gains. And you can deduct the full market value of the investment on your 2014 return.
8. Tap Your IRA
With a tax-deferred plan like an IRA, once you hit age 70 1/2 you must take out some money every year. You have to take your first distribution by April 1 the year after you turn 70 1/2. Then the annual deadline for your required minimum distribution, or RMD, is Dec. 31.
This rule doesn’t apply to Roth IRAs, and if you have a 401(k) plan and you’re still working, you can usually wait until you do retire to start withdrawing money.
The IRS minimum is based on your account balance at the end of last year and your current life expectancy. Your broker or adviser can help you with the calculation, but you’re responsible for making the withdrawal. If you fail to do so, you’ll owe a 50% penalty on the amount you should have withdrawn.
You can also donate your RMD directly to charity and avoid paying income taxes on the withdrawal. In mid-December, Congress extended that rule, which had expired, for at least one more year.
9. Spread the Wealth
Making outright gifts is a smart move tax-wise, says Ann Arbor financial planner Mo Vidwans. Your heirs are less likely to face estate taxes down the road—and you can help out your kids or grandchildren when they need it the most. In 2014, you can give as many people as you want up to $14,000 tax-free. If both you and your spouse make gifts, that’s $28,000.
If you’re funding 529 plan, you can frontload five years worth of gifts and put $70,000 into a child’s account now.
10. Pay Taxes Now and Never Again
With a traditional individual retirement account, your contributions are tax deductible, but you’ll owe income taxes on your withdrawals. A Roth IRA is the opposite: You invest after-tax money, but your withdrawals are 100% tax free.
Before year-end, you can convert a traditional IRA to a Roth. You’ll have to pay taxes on the conversion in 2014. But then you’ll never owe taxes on that money again.
Converting to a Roth is an especially smart move if your income was down this year and you’re in a low tax bracket. “If you have a low-income year, do a Roth conversion,” says New York City financial planner Annette Clearwaters. “Whenever I see a tax return with negative taxable income I cringe, because it’s such a wasted opportunity.”
And if you later change your mind, you have until the extended tax-filing deadline next October to switch back to a traditional IRA. Clearwaters recommends undoing any conversion that puts you above the 15% federal tax bracket.
Update: This post was updated to reflect Congress's extension of the rule allowing for direct charitable donations of RMDs.