Wednesday, November 26, 2014

Year-end tax tips for individuals

With December 31st right around the corner, it still isn't too late to make financial decisions to minimize your tax bill.  Individuals have many questions they can ask themselves about ways to save on their 2014 or future tax bills.  One of the best ways to save on tax is by accelerating or deferring income and deductions.

Taxpayers may want to accelerate income or defer deductions if they expect that their current tax bracket is going to be lower than their future tax brackets.  This could include having bonuses paid to you before year-end, accelerating IRA distributions, selling capital gain stocks or possibly converting a traditional IRA to a Roth IRA.  These are all ways to increase current year taxable income if you expect that this year’s tax rate will be lower than the future years’ tax rates.  Taxpayers who are not able to itemize their deductions in the current year may want to delay charitable contributions, mortgage payments, or state tax estimates until after January 1 in hopes that they will be able to itemize their deductions in the following year.

Most taxpayers, however, are concerned with lowering the tax bill in the current year, and there are several ways that this can be done with year-end planning.  Some of the best methods include:

  • Selling stocks that have lost value since date of purchase
  • Increasing 401(k) or traditional IRA contributions
  • Paying the 4th quarter state estimated tax payment in December
  • Paying the January mortgage payment in December
  • Making charitable contributions in December

These are just a few ways to effectively manage your individual tax liability.  Almost all of the ideas are decisions that will be made anyway, but if timed properly can provide the greatest tax benefit.

William A. “Bo” Taber, III

Monday, November 3, 2014

Current Tax Benefits for IRA Contributions

As an incentive to promote personal investing, the IRS allows individuals with earned income to deduct contributions made to a traditional Individual Retirement Account (IRA) in calculating adjusted gross income. There are certain limits to deductibility of contributions for those who are active in an employer sponsored retirement plan, such as a 401(k). However, those not considered active can contribute $5,500 per person or $6,500 for those 50 years old and over (see for deduction qualifications and contribution limits). Contributions must be made by the due date of your income tax return, excluding extensions, which means April 15.

Many couples are unaware that a spouse who does not have earned income can still receive a deduction provided the couple files a married filing joint return and meets certain requirements. This can be especially beneficial to couples in high tax rate brackets that are looking to reduce current tax liability by deferring it through traditional IRAs. It doesn't seem like much, but can start to add up if you consider the long term effects.

The 28% and 33% tax rate tables in 2014 for a joint return start at $148,850 and $226,850 for taxable income, respectively. If a couple under the age of 50 years old has $11,000 or more of taxable income over these thresholds, then the tax deferred savings will be maximized based on their marginal rate. Assume, for example, that a couple has taxable income of $159,850 ($148,850 + S11,000) and they do not have the option to defer income through employment. The deferred tax savings by each spouse contributing $5,500 would be $3,080 ($11,000*28%). The same would apply for those in the 33% bracket. If taxable income was $11,000 or more over the $226,850 threshold, then deferred tax savings would be $3,630 ($11,000*33%).

Now suppose the couple in the 28% bracket were 35 years old and made $11,000 ($5,500 each)of deductible contributions each year for 30 years and earned a compounded annual rate of 5% each year through investing the deferred tax savings amount. The potential future value just in the deferred tax savings of $3,080 each year could be up to $215,000 in 30 years from the initial payment. A more impressive figure is that your $11,000 annual investment for 30 years at 5% will have grown to approximately $767,000.

For those in higher tax brackets, the future value with equivalent assumptions would potentially yield an even higher amount. Keep in mind that withdrawals from one's traditional IRA will be taxable, so typically those who expect to have a lower taxable income rate at retirement or prefer more growth during investing years should consider this strategy.

Jon Holcomb