Q. What are the tax mistakes to avoid by year end?
A. There are a few common mistakes people tend to make that if you avoid them by the end of the yar, you can reduce your tax significantly.
1. Not Contributing to Your 401(k) or 403(b) and/or 457(b)
You ill not build your retirement nest egg, you will not receive any income tax break, and you will not receive any employer match which is free money.
Don't make this mistake! Also, if you are over age 50, additional contributions can be made with the “lifetime catch-up” with a 403(b) and a “double-limit catch-up” with a 457(b). Once you maximize your contribution you cannot make additional contributions to make up for under-contributing in previous years.
2. Not Timing Capital Gains and Losses
Capital gains and losses are classified as either short-term (less than one year) or long-term (more than one year). Long-term losses can only offset long-term gains, and vice versa. Selling investments, like stocks, bonds, or mutual funds you have held for more than one year generates a 0%, 15% or 20% capital gains tax rate (based on your income). Realizing a gain on investments held for less than one year could generate up to 39.6% tax rate (based on your income). On top of the capital gains tax is a 3.8% investment surtax (based on your income). Review your portfolio to maximize your gains and losses and remember losses can be carried forward to future years.
It's important not to violate "wash sale" rule as you time capital losses.
3. Leaving Money in Your Flexible Spending Account
Many employees take advantage of their employer provided Section 125 pre-tax flexible spending account. Unfortunately, many employees leave large balances in their accounts at year-end instead of spending them down. Balances in excess of $500 at the end of the year or balances not used within two and a half months of the next year (“grace period”) will be forfeited. Make sure you pay your child day care bill, your dentist’s root canal bill and your health insurance deductibles before Dec. 31.
4. Paying the Alternative Minimum Tax
Instead of prepaying your state income taxes and real estate taxes, pay them when they are due. Instead of exercising your incentive stock options early, exercise them when they are closer to their expiration date. Verify your municipal bonds and municipal bond funds holdings are exempt from AMT, as many are not exempt. Each of these measures could eliminate or mitigate your AMT exposure.
5. Forgetting to Take Your Required Minimum Distribution
Also know as RMD, required minimum distributions are necessary on traditional IRA accounts once you turn 70.5 years old (with certain exceptions) or if you inherit an IRA (with exceptions for spouses). If you have a 401k, 403b or 457b from a former employer and you are at least 70.5 years old, RMD applies as well. Forget to take your RMD and you can be subject to a 50% tax penalty.
6. Forgetting to Fund Your 529
For 2013, the maximum contribution per person, per beneficiary, to a 529 higher education savings plan is $14,000. There is a special five-year pull-forward rule, allowing you to contribute $70,000 in a single year, per owner, per beneficiary. Like a 401k, 403b or 457b, once you maximize your contribution you cannot make additional contributions to make up for undercontributing in previous years. Funding your 529 also provides state income tax deductions (depends on your state) and valuable estate planning benefits.
A. There are a few common mistakes people tend to make that if you avoid them by the end of the yar, you can reduce your tax significantly.
1. Not Contributing to Your 401(k) or 403(b) and/or 457(b)
You ill not build your retirement nest egg, you will not receive any income tax break, and you will not receive any employer match which is free money.
Don't make this mistake! Also, if you are over age 50, additional contributions can be made with the “lifetime catch-up” with a 403(b) and a “double-limit catch-up” with a 457(b). Once you maximize your contribution you cannot make additional contributions to make up for under-contributing in previous years.
2. Not Timing Capital Gains and Losses
Capital gains and losses are classified as either short-term (less than one year) or long-term (more than one year). Long-term losses can only offset long-term gains, and vice versa. Selling investments, like stocks, bonds, or mutual funds you have held for more than one year generates a 0%, 15% or 20% capital gains tax rate (based on your income). Realizing a gain on investments held for less than one year could generate up to 39.6% tax rate (based on your income). On top of the capital gains tax is a 3.8% investment surtax (based on your income). Review your portfolio to maximize your gains and losses and remember losses can be carried forward to future years.
It's important not to violate "wash sale" rule as you time capital losses.
3. Leaving Money in Your Flexible Spending Account
Many employees take advantage of their employer provided Section 125 pre-tax flexible spending account. Unfortunately, many employees leave large balances in their accounts at year-end instead of spending them down. Balances in excess of $500 at the end of the year or balances not used within two and a half months of the next year (“grace period”) will be forfeited. Make sure you pay your child day care bill, your dentist’s root canal bill and your health insurance deductibles before Dec. 31.
4. Paying the Alternative Minimum Tax
Instead of prepaying your state income taxes and real estate taxes, pay them when they are due. Instead of exercising your incentive stock options early, exercise them when they are closer to their expiration date. Verify your municipal bonds and municipal bond funds holdings are exempt from AMT, as many are not exempt. Each of these measures could eliminate or mitigate your AMT exposure.
5. Forgetting to Take Your Required Minimum Distribution
Also know as RMD, required minimum distributions are necessary on traditional IRA accounts once you turn 70.5 years old (with certain exceptions) or if you inherit an IRA (with exceptions for spouses). If you have a 401k, 403b or 457b from a former employer and you are at least 70.5 years old, RMD applies as well. Forget to take your RMD and you can be subject to a 50% tax penalty.
6. Forgetting to Fund Your 529
For 2013, the maximum contribution per person, per beneficiary, to a 529 higher education savings plan is $14,000. There is a special five-year pull-forward rule, allowing you to contribute $70,000 in a single year, per owner, per beneficiary. Like a 401k, 403b or 457b, once you maximize your contribution you cannot make additional contributions to make up for undercontributing in previous years. Funding your 529 also provides state income tax deductions (depends on your state) and valuable estate planning benefits.
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