Year-end Tax Strategies

Tips and strategies to minimize taxes for investors, entrepreneurs, employees, and philantropists.

As an investor…

• Harvest your losses – Selling an underperforming investment can provide up to a $3,000 deduction against ordinary income and accrue capital losses for future years. Many investment classes have gone up this year, so it might be challenging to identify good candidates to harvest. Look to international markets, particularly emerging markets, and bond investments for potential opportunities. This article explains the approach.


• Sell the winners – As contrarian investors, we believe in buying into markets that have significantly underperformed and selling those that have “abnormally” outperformed. It’s a judgment call on what represents abnormal outperformance, but U.S. Broad Market, Technology, and Healthcare stocks seem very hot on a trailing 1-year basis. Another opportunity is to sell the winners if you happen to be in a 10% or 15% ordinary income tax bracket. At these low rates, federal capital gains rates are 0%. Even if you love your appreciated Google stock and want to hold on to it, you could sell it, realize the gain, and re-buy immediately as a way to benefit from this strategy.


• Understand “unsolicited” distributions – One of the reasons we despise most actively managed mutual funds is that many of them will return a portion of your money through end-of-year distributions. Whether these distributions make sense to your own unique tax situation is largely irrelevant. We recommend checking the fund company's estimates of dividends, short-term gains, and long-term gains to get a sense of what’s coming and how this will impact your tax bill.


• Analyze Traditional to Roth IRA conversion – Income limits prevent many investors from funding a Roth IRA, which is a great vehicle to avoid paying taxes on future investment earnings. I strongly believe that tax rates in the U.S. will go up significantly in the future, and if so, the benefits of Roth IRA money will be even greater. Conversions from a Traditional to a Roth IRA are not limited based on income or other criteria. The catch, of course, is that in the year of the conversion, one must pay ordinary income taxes on the amount converted. There is a planning opportunity if you happen to be in a low tax bracket temporarily (e.g., pursuing an MBA, off on sabbatical, etc.) and can realize the tax arbitrage. Also, contributing to a non-deductible Traditional IRA and immediately converting it to Roth (“Back Door Roth IRA”) is the next best option. Note that if you have other traditional IRAs, the taxable portion of any conversion you make is prorated over all your IRAs. In other words, you cannot convert just the non-deductible amount, which mitigates the benefit of the Back Door Roth IRA.

As an employee…

• Ensure enough withholding – An insult added to injury for the high taxes we pay is having to pay additional penalties and interest for underpayment of taxes. For many people, the payroll withholding is enough to cover taxes owed. But for some, including couples who both work (default exemptions often cause under-withholding) and investors who have large capital gains for the year (no withholding is generally made on capital gain income), the withholding amount might not be enough. It’s a good time to estimate the difference between taxes paid and taxes owed. If there is an outstanding balance, you can send an additional payment to Uncle Sam before 12/31 and/or increase your withholding at work. Note that you generally can avoid any issues if you meet one of the following conditions:
  • Owe less than $1,000 in taxes
  • Paid at least 90 percent of the total you owed this year
  • Paid at least 100 percent of the total you owed last year (110 percent for high-income earners)


• Max out the 401(k) (…and then some) – If your marginal tax rate is 50% (e.g., many high-income earners living in California), then every dollar you contribute to a tax-deductible retirement account is only fifty cents out of your pocket. There is also the benefit of tax-deferred growth of earnings on the investments. The current maximum before-tax contribution is $17,500. (If you are age 50 or older, you can put in an extra $5,500). There are a couple of pay periods left in the year in which to up your contribution. In addition, you might want to contribute after-tax dollars, which would enable you to roll over that portion into a Roth IRA down the road. (See this article for a description of a recent IRS ruling on this strategy.)

As an entrepreneur…

• Defer income – The IRS uses the doctrine of constructive receipt to determine when a cash-basis taxpayer has received gross income and is therefore subject to tax in the current year. For example, if you receive a check from a client on 12/31/2014 and don’t cash it until 1/15/2015, you still must include this amount in your 2014 tax return. However, for some businesses and self-employed individuals, there is a tax planning opportunity to wait a few weeks and invoice next year. You’ll eventually have to include the payment in the return, but kicking the can down the road on the tax liability is a positive net present value strategy.


• Accelerate expenses – this is the other lever in reducing taxable income. One strategy is to pay for expenses with a credit card. You can claim 2014 deductions even though the credit card bills won’t be paid until 2015. Another strategy is to pay expenses with checks and mail them one or two days before 12/31. The IRS states that one can deduct the expenses in the year the checks were mailed, even though they are likely not to be deposited until 2015. Prepaying some expenses for next year is also allowed, within limits. The rule states that the economic benefit from the prepayment doesn’t extend beyond the earlier of the following: a) 12 months after the first date on which your business realizes the benefit, b) the tax year following the year in which the payment is made. Prepaying some rent or property insurance coverage are examples of implementing this strategy. A final strategy is to simply buy supplies and equipment now that you plan to buy in the coming year (e.g., the iPad Air 2 or laptop you’ll need in February).


• Wait to incorporate – If you are considering starting a business now it might make sense to wait a couple months to incorporate or form an LLC to avoid some of the associated regulatory taxes (e.g., the $800 California Minimum Annual Franchise Tax). You can officially “be in business” by operating your entity as a sole proprietor, which requires little paperwork. My article on business entities can be found here.


• Get organized – Sometimes strategies are missed because of the unknown. In our experience, many new entrepreneurs and small business owners don’t have their books up to date, and therefore may miss planning opportunities before year end. We recommend inDinero, Quickbooks Online, Wave Accounting, and our team of external CPAs and tax accountants to help with executing the strategy.

As an philanthropist…

• Donate appreciated investments with long-term capital gains – Holidays are a time when many people give to their favorite charities. Donating appreciated stock, mutual funds, or other investments is an effective way to leverage charitable gifts. If done right, you’ll achieve a deduction against ordinary income and avoid the built-in tax liability on your appreciated investments. A good place to look is U.S. stocks, which at the time of this writing have had a good run in 2014. Click here for an article discussing some of the details of this strategy.

As a family member…

• Manage the Alternative Minimum Tax (AMT) – Drafted in 1969 because some high-income households paid no federal income tax, AMT has now become widespread even among middle-class taxpayers. Understanding the various levers that trigger AMT is an important skill. Households can manage AMT by implementing various year-end strategies, including the timing of deductible expenses such as payment of state and local taxes, home equity loan interest, and other miscellaneous itemized deductions. Another move is to defer a large capital gain from the sale of a business or security, since this may reduce or eliminate the AMT exemption amount.


• Pay for school early – For many colleges and universities the due date for spring semester tuition is around January. Paying this bill before 12/31 can enable you to claim one or more of the education credits available. For example, the American Opportunity Credit is worth up to $2,500, with up to 40 percent of the new credit being refundable.


• Shift income to children – A common tactic for us parents is to place investments under a child’s name, typically through a custodial account. The first $1,000 of unearned income (interest, dividends and capital gains, not income from wages or self-employment) is taxed at a 0% rate. The next $1,000 is taxed at the child’s rate, which is commonly around 10% for federal tax purposes.


• Use up Annual Gift Exclusion – In 2014, you can give up to $14,000 a year to as many people as you choose ($28,000 if you and your spouse both make gifts) to help reduce the amount of your estate and thereby reduce or avoid federal gift and estate taxes. This may include cash, stocks, bonds, and portions of real estate.


• Speed up deductions – If you have a mortgage, you can make the January 1 payment in December to get the tax deduction this year instead of next year. If you make estimated state or local tax payments, you could send the 1/15/15 payment in December. Assuming you are not subject to AMT, it might make sense to pre-pay the property tax bill typically due in April 2015 before the end of the year to receive the benefits of the deduction earlier. Other possibilities include accelerating payments for medical services or purchasing work-related items, such as uniforms, for which you are not reimbursed. This strategy only makes sense if you are itemizing deductions as opposed to using the standard deduction on your return.

Summary: 

There are a number of last-minute strategies that can be implemented to achieve tax efficiency – paying the lowest tax rate given your unique situation (without violating any laws, of course). A final recommendation is to either carve out some time during the holidays to analyze your tax exposures or consult a professional advisor or tax accountant to help you think through and – more importantly – execute your strategy before the clock strikes midnight on December 31^st.

Happy Holidays!

Disclosures: Non-deposit investment products are not FDIC insured, are not deposits or other obligations of MYeCFO, are not guaranteed by MYeCFO, and involve investment risks, including possible loss of principal. The information contained in this article is for informational purposes only and contains confidential and proprietary information that is subject to change without notice. Any opinions expressed are current only as of the time made and are subject to change without notice. This article may include estimates, projections, and other forward-looking statements; however, due to numerous factors, actual events may differ substantially from those presented. Any graphs and tables that make up this article have been based on unaudited, third party data and performance information provided to us by one or more commercial databases or publicly available websites and reports. While we believe this information to be reliable, MYeCFO bears no responsibility whatsoever for any errors or omissions. Additionally, please be aware that past performance is no guide to the future performance of any manager or strategy, and that the performance results displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. Therefore, caution must be used inferring that these results are indicative of the future performance of any strategy. Index results assume re-investment of all dividends and interest. Moreover, the information provided is not intended to be, and should not be construed as, investment, legal, or tax advice. Nothing contained herein should be construed as a recommendation or advice to purchase or sell any security, investment, or portfolio allocation. Any investment advice provided by MYeCFO is client-specific based on each client’s risk tolerance and investment objectives. Please consult your MYeCFO Advisor directly for investment advice related to your specific investment portfolio.