It may be late in the year, but it’s not too late to start looking for ways to reduce your federal tax bill for 2019 and beyond. There are a number of steps you can take right now to ensure you don’t pay the IRS a dime more than you have to.
The end of the year is a good time to gather preliminary paperwork and financial data. Ask your tax preparer for a checklist of what you need to file your return.
The IRS starts accepting 2019 returns on Jan. 28, 2020, and April 15, 2020, is the filing deadline.
Here are 10 steps you can take right now to reduce your tax bill.
Maximize contributions to your retirement plan
If you’re not putting as much money as you can into your employer-sponsored 401(k), 403(b) or other tax-deferred retirement account, you’re losing out. Contributions to these accounts reduce your taxable income for the year.
For 2019, contribution limits are $19,000, plus $6,000 in catch-up contributions if you’re age 50 or older. Limits have been increased to $19,500 and $6,500 in catch-up contributions for 2020.
If you have an IRA set up through a broker or bank, your contribution limit for 2019 and 2020 is $6,000 and $1,000 in catch-up contributions.
Ask your human resources department about ramping up your retirement savings today.
Avoid early withdrawals from your 401(k)
If you take money out of your 401(k) for a holiday spending spree, you’ll feel the sting at tax time. Not only will you pay ordinary income tax on the distribution, the IRS typically penalizes you another 10 percent if you withdraw money before you turn age 59 ½.
You may be able to take out a loan against your 401(k), but most 401(k) loans charge fees. And if you leave your job before the loan is repaid, you still could end up owing income tax and penalty fees.
Do yourself a favor and don’t touch tax-advantaged retirement accounts. Let them grow until you reach retirement.
Take advantage of the gift-tax exemption
You can slash your taxable income for 2019 by giving away some of your money. The gift-tax exclusion is $15,000, but you can give up to that amount to as many recipients as you want without paying federal estate or gift taxes.
For example, a married couple with two grandchildren can give a total of $60,000 without gift-tax consequences because each grandchild can receive $15,000 from each grandparent.
For the very rich, the gift-tax exclusion is itself a gift. Individuals can exempt up to $11.4 million in gifts; the limit for couples is $22.8 million.
Boost 529 education savings contributions
Saving money in a 529 plan to pay tuition and other education expenses offers tax perks for both the contributor and the recipient. The donor can invest the money in a variety of investment options and the earnings are not subject to federal income tax. But the contributions are considered a gift to the beneficiary and are subject to the $15,000 gift-tax exclusion.
“For the beneficiary, withdrawals from a 529 plan are not subject to federal or state income taxes when the money is used for qualified higher education expenses,” says Linda O’Brien, legal tax analyst for Wolters Kluwer Legal & Regulatory U.S. “As of Jan. 1, 2018, tax-free withdrawals may also include up to $10,000 (per year, per beneficiary) in tuition expenses for private, public or religious elementary and secondary schools.”
In addition to the federal tax benefits, more than 30 states offer a full or partial tax deduction or credit for 529 plan contributions. Check with your state because the rules differ.
Take required minimum distributions, or RMDs
If you haven’t started taking distributions from your tax-deferred retirement plan by age 70 ½, the IRS will require you to start doing so every year.
“Failure to timely take an RMD results in a 50 percent penalty on the RMD amount,” says Shulem Rosenbaum, CPA and professor of accounting and business at Touro College in New York City. “This amount, which is based on the account balance and life expectancy, must be distributed before Dec. 31 (except for the first distribution), and is taxed as ordinary income, which can impact a taxpayer’s bracket and taxability of Social Security.”
A qualified charitable contribution of up to $100,000 made directly from the retirement account may be excluded from income and can be used as a deduction, says Rosenbaum.
The standard income tax deductions were nearly doubled by the federal tax overhaul passed in December 2017, so many taxpayers will not have enough expenses to exceed their standard deduction. But if you’re looking for enough deductions to push you above the standard deduction and lower your 2019 taxable income even more, try bundling contributions such as charity donations.
If you give to a church, for example, match your total annual gift with a year-end lump sum for what you would have given the following year.
If that’s enough to lift you above the standard deduction, start tacking on other small, deductible expenses. For example, it’s a good time of year to clean out your closet and donate your clothes to a nonprofit.
Sell losing investments
If your investments in taxable accounts have lost more money than they earned, you can deduct up to $3,000 a year to offset ordinary income. Any leftover losses can be carried forward to future tax years. This is a tax-deferral strategy known as “tax-loss harvesting.”
“Tax-loss harvesting is the selling of assets, such as stocks at a loss, in order to offset gains realized on other assets or stocks. This process eliminates current gains,” explains attorney Kevin J. Moore, whose Pasadena, California legal firm specializes in tax law and estate planning.
“It is most effective when losses offset taxes at higher rates. It is important to realize when to use tax-loss harvesting as its value is related to having high capital gains to offset,” Moore says. “For example, if you have $1 million in capital gains and a $500,000 tax loss, you can use the loss to offset the gain and reduce the tax liability.”
If you are making more money in 2019 than you did last year, you may be able to reduce your tax bill by deferring payment of a year-end bonus, for example, until early 2020.
“Employees do not recognize taxable income currently when it is earned, [but rather] when the compensation is received,” says O’Brien. “Deferring income into next year can be made from a regular salary or bonuses.”
If you’re a freelancer, you have more flexibility because you can simply delay billings until late December.
You can also defer income by taking any capital gains you may have realized in 2020 instead of 2019. Just make sure you don’t set yourself up to be in an even higher tax bracket next year.
Sign up for a flexible spending account (FSA)
You can plan for more tax savings next year by signing up for a flexible spending account. An FSA lets you make tax-free contributions from your gross salary to pay for medical expenses, up to $2,750 in 2020. The contribution cap for a dependent care FSA is $5,000.
Estimate your contribution amount carefully, though, because you must spend it all during the tax year or you could lose that money.
If you’re self-employed, you can open an HSA. Contribution limits for HSAs in 2020 are rising to $3,550 for an individual with a high-deductible health plan and $7,100 for an individual with a family plan.
Convert to a Roth IRA
There are two main tax advantages to Roth IRAs: Withdrawals are not counted as income for federal (and usually state) income tax purposes; and Roth IRAs do not have required minimum distributions every year starting at age 70 ½, like a traditional IRA. “The money can remain in the account and continue to grow tax-free,” says O’Brien of Wolters Kluwer.
However, conversions from a traditional IRA are considered a taxable distribution, which will raise your income tax bill for that year. The Tax Cuts and Jobs Act of 2017 did reduce federal income tax rates through 2025, which should ease the tax pain. You could also convert to a Roth during a year in which you know your income will be less.