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The best time for investors to make tax moves is at the end of the year.
The primary reason for this year-end timing for tax planning and portfolio management is that investors have a clear picture of investment decisions made during the current year and a good idea of their personal finances in the coming year.
In addition, there are some investment-related tax benefits that can only be captured in the current calendar year.
Specifically, unless Santa Claus has a surprise for investors this month, 2015 will be the worst year for stocks since 2011. And those of us with taxable brokerage accounts may have one of the best opportunities in years to make the right moves for offsetting capital gains and losses.
So let’s jump into five year-end tax moves you should be thinking about in the next few weeks.
1. Tax-Loss Harvesting
For investors with taxable brokerage accounts, tax-loss harvesting minimizes taxes, which is an important aspect of higher net returns in the long run. By realizing, or “harvesting” a loss, investors are able to offset taxes on gains, and possibly income as well.
If net losses exceed $3,000, an investor can carry forward any unused losses into a future tax year. Since in 2015 investors in the 10% and 15% tax brackets are eligible for the 0% long-term capital-gains rate, taxpayers in higher tax brackets can benefit the most from tax-loss harvesting.
But watch out for the IRS wash sale rule, which essentially says that an investor cannot buy a “substantially equal security” within 30 days, before or after the sale, when the sold security is used to offset gains. However, if investors want to maintain their asset allocation, securities that are sold can be replaced by similar ones for the purpose of maintaining the investor’s target asset allocation and the expected returns.
2. Give to Charity
You can reduce taxable income by donating to your favorite charity by Dec. 31. Remember to hang on to your canceled check or credit card receipt as proof of your donation. If you contribute $250 or more, you’ll also need an acknowledgment from the charity.
If you itemize deductions, this is also a great time of year to get rid of the stuff piling up in your closets and garage and give it to a charitable organization. A few bags of clothes, small appliances and toys can add up to hundreds of dollars in tax deductions.
3. Contribute to Your 401(k) or IRA
Money you contribute to your 401(k) or a traditional IRA is excluded from your income, lowering your tax bill. If you’re not yet on track to max out your contributions by year’s end, you can increase contributions in December.
The maximum 401(k) contribution (not including employer match or profit sharing) for 2015 is $18,000. If you were 50 or older this year, you can contribute an extra $6,000 “catch-up” contribution. The IRA maximum for 2015 is $5,500 ($6,500 if 50 or older). But you still have until April 15, 2016, to make 2015 IRA contributions.
4. Increase Allowances
If you don’t want to give the IRS a tax-free loan by letting them hold your non-taxable money throughout the year, try your best not to get refunds. Ideally, the amount of tax withheld from your paycheck – or the amount small-business owners and self-employed people submit through estimated quarterly tax payments – should come as close as possible to the amount of tax you owe.
To make any necessary adjustments, file a revised Form W-4 with your employer. The more “allowances” you claim on the W-4, the less tax will be withheld.
5. Spend Down Flex Spending Accounts
Many employers with flexible spending plans for medical costs allow people to carry over up to $500 in their accounts from one year to the next. However, the IRS does not require companies to allow the carryover. So if your employer doesn’t allow the $500 carryover – or if you expect to end the year with more than $500 in your account – now is the time to use that money or lose it.
But you can’t just stock up on ibuprofen and cough syrup. For a list of what is allowed for flex spending accounts, see IRS Publication 502 for deducting medical and dental expenses.
Now go take a look at your personal finances and see how many of these year-end tax moves you can make before the calendar turns to 2016.
Kent Thune is the owner of an investment advisory firm in Hilton Head Island, S.C. Individuals should consult a tax professional to see which tax rules apply to them. Under no circumstances does this information represent a recommendation to buy or sell securities.