Fourth-quarter tax strategies

Before you get caught up in holiday planning, take time to consider financial moves that could pay off next April.

You undoubtedly already know that the fourth quarter is a good time to review your tax planning and that a key strategy involves accelerating deductions to the current year and pushing income into the following one. Here are some tips for how to do that, along with some other factors you should consider as 2016 winds down.

Check tax withholding rates.

If you receive bonuses or other large sums toward the end of the year, determine whether you need to increase your tax withholding or make estimated tax payments, says Jared Feldman, a partner at the accounting firm of Anchin, Block & Anchin. You don’t want to get caught next spring owing the IRS or your state a penalty for underpayment.

Take advantage of investment losses.

Each year, you can deduct $3,000 of capital losses from your ordinary income. You’ll have to offset any amount over that with capital gains of the same kind, or carry it forward to future years. So if you have large losses, now’s the time to sell stocks that have risen in value. You can reduce long- and short-term gains by losses of the same type, thereby reducing or eliminating tax on your profit.

Make charitable contributions.

Planning contributions for next year? Why not make them now and get the tax deduction sooner? The most efficient way to make a contribution is by donating appreciated stock, Feldman says. That allows you to avoid paying taxes on the capital gains you would have owed had you sold the shares while giving you a deduction for their value at the time you donate them.
If you’ve had a considerable increase in income this year, look into establishing a donor-advised fund, which allows you to pre-fund philanthropic contributions for future years. For instance, Feldman says, if you typically give $100,000 to charity each year, you can make a $500,000 contribution to a donor-advised fund that you set up. You can transfer that money to charities in future years, he says; meanwhile, you get the tax deduction up front for the full amount.

Use your gift-tax exemption.

Always make sure that you’re using up your annual gift-tax exemption, which is $14,000 per beneficiary. “If you don’t use it in a given year, it goes away,” says Jamie Hopkins, associate director of the retirement income program at the American College of Financial Services. He recommends checking your list of beneficiaries—children, grandchildren, nieces and nephews, or non-relatives—at the end of the year to be certain you’ve written all the checks you want to write.

Beware of Alternative Minimum Tax.

When considering your tax liability as the end of the year approaches, think about whether you’ll have to pay the Alternative Minimum Tax. That changes your tax rate—a flat 28 percent rate applies to ordinary income under the AMT—as well as the way you’re able to take deductions, says Feldman. Take this calculation into account as you decide when to make charitable contributions or pay state, local, and real estate taxes.

Consider a Roth IRA conversion.

If you expect your tax rate to rise, you might want to convert your traditional IRA to a Roth account and pay the taxes on it now, thereby rendering all future withdrawals tax-free. In fact, you’ll want to maximize contributions to all your tax-advantaged retirement accounts. Although it’s best to do this at the beginning of January, if you haven’t yet done so, you can make those contributions as late as April of the following year. The sooner, the better, so do this as quickly you as can. Note that even if you earn too much to contribute to a Roth, you can convert a traditional IRA to one.

Review other tax-advantaged accounts.

If you haven’t maximized your contributions to such accounts as 529s (for higher-education savings) or HSAs (for medical bills), you should do that in the fourth quarter, Hopkins says.
With a 529, each state has its own rules on the deductions you can take and the maximum size of the account. The money grows tax-free and you don’t pay taxes on gains if beneficiaries use the funds for qualified higher-education expenses; otherwise, they’ll owe taxes on any gains plus a 10 percent penalty. The timing issue arises because many states enable you to deduct your 529 contributions up to a certain amount—for example, $10,000 per year in New York.

An HSA is a smart move for individuals with high-deductible insurance policies, Hopkins says. That’s because you can make deductible contributions to these accounts regardless of your income. In 2016, you can put $6,750 into an HSA for a family or $3,350 for an individual. You can invest the money in mutual funds, and gains are tax-free if you use distributions for healthcare costs or long-term-care insurance. Moreover, an HSA can pass to a beneficiary at your death, although owners often use the accounts for the significant medical costs that typically occur in the last year of life, preserving other assets for heirs, Hopkins says.

Savvy Moves for Airplane Owners

Owners of private aircraft, as well as owners of businesses that have aircraft, should look at tax strategies involving their airplanes in the fourth quarter.
If you buy an aircraft and bring it into service in the final months of the year, take care to maximize your business usage and minimize personal trips, says Greg Rosica of Ernst & Young. “The worst thing is to take December delivery and take the family on vacation,” he notes.

Even if you bought the airplane in a prior year, you need to monitor business usage carefully toward the end of each year. The reason: if annual business use drops below 50 percent, you may lose some of the tax depreciation you took in the past.

Donating flight time to charity—as an auction or raffle item, or by transporting people for charitable purposes—can also be a smart end-of-year move, says Ruth Wimer, a CPA and a partner at the law firm McDermott Will & Emery. If you own the airplane through a business, you or another employee can fly to the charitable event or on the raffle-prize flight, but the cost of the employee’s trip will represent taxable income. The business can deduct the remainder of the cost, Wimer says.

If you’re looking to upgrade to another airplane, consider donating your current ride to a charity that will use rather than sell it, she adds. That way, you can deduct its fair market value.