Another tax return filed. Maybe you got a large refund or had to write a check. But either way, there’s a to-do: Use your 2015 tax return to help reduce your 2016 taxes. A careful review of your 2015 return could reveal tax-saving opportunities.
“A good time to do your tax planning is soon after you filed your return for the previous year, when everything is still fresh in your mind,” says Gil Charney, director of The Tax Institute at H&R Block. “Even if you go to a professional tax preparer, reviewing your finished return can help you know where to look for savings. It’s a lot like going to the doctor. You get better results when you’re well informed and ask the right questions.”
The tax you owe is directly related to your circumstances and financial activity during the past year, notes Charney. By looking closely at the income and behaviors that impacted your 2015 tax return, you might be able to manage your tax situation more effectively this year, and maybe reduce what you owe next April.
You might even discover that you missed something on your 2015 return that could have saved you some money. Missing something can be easy to do when you’re typing numbers into boxes in a tax software program. And if you find that you did make a mistake, you can file an amended return on Form 1040X.
Here’s where you might find some opportunities for smarter tax planning in 2016, based on amounts entered on your Form 1040 form. (Note: Since 1040A and 1040EZ are simpler forms, not all the information in this article will apply if you file either of those forms.)
|1.||Wages, salary, tips, etc.: line 7 (Form 1040 and 1040A); line 1 (1040EZ)|
Unless you’re self-employed or live off your investments, the largest component of your income is likely reported on line 7 (or line 1) of your tax return. You may be able to whittle down your taxable income through exemptions and deductions.
One way to lower wages, salary, or tips—short of asking for a pay cut—is to contribute to a traditional 401(k), 403(b), or 457 tax-advantaged retirement plan, if your employer offers one.
Look at Box 12 on Form W-2 provided by your employer. The amount or amounts listed there are your elective deferrals, with code letters like “D,” “E,” or “G.” These are the amounts by which you reduced your total wages through your pretax contributions to one or more of these plans.
If the total amount is less than the 2015 pretax contribution limit of $18,000 (or $24,000 if you’re age 50 or older), you didn’t take full advantage of the tax-deferral opportunity. The pretax contribution limit is the same for 2016, so increasing your contribution to a workplace retirement plan can be a great place to start when trying to lower your 2016 tax liability.
|2.||Taxable interest: lines 8a and 8b (1040 and 1040A); line 2 (1040EZ)|
Lines 8a and 8b show your interest income. If you see a relatively large amount of taxable interest on line 8a and you’re in a high tax bracket, you might want to consider shifting some of your money into investments that produce tax-free interest, primarily municipal bonds, which would be entered on line 8b and not added into your total taxable income. (Note, however, that municipal bond interest still may be taxed at the state level or under the alternative minimum tax (AMT), so be sure to consult with a tax professional so that you can choose the appropriate municipal income sources for you.)
Of course, your investment choices should not be based solely on taxes. Be sure not to allow the quest for tax savings to compromise your investment plan.
- Read Viewpoints: “How to invest tax-efficiently.”
|3.||Dividends: line 9 (1040 and 1040A)|
Pay close attention to how much of your dividend income was in the form of ordinary dividends (line 9a) versus qualified dividends (line 9b). Ordinary dividends, like those generated from a stock or mutual fund, are taxed at your ordinary income rate. Qualified dividends are taxed at your capital gains rate, which is likely to be lower.
If you see a large amount of ordinary dividends on line 9a, check your attached Schedule B to see where it came from. You might want to consider holding those investments in a tax-advantaged account, such as an IRA, if you can.
Also be aware of the rules governing qualified versus ordinary dividends, so you can try to avoid trading activity that might cause potential qualified dividends to be taxed as ordinary income. For higher-income individuals, the 3.8% Medicare surtax is levied on the lesser of net investment income, which includes dividends, or the excess of modified adjusted gross income (MAGI) above $200,000 for individuals, $250,000 for couples filing jointly, and $125,000 for spouses filing separately. There are some ways to help manage this tax.
- Read Viewpoints: "The Medicare taxes and you."
|4.||Capital gains (or losses): line 13 (1040); line 10 (1040A)|
If you reported significant capital gains in 2015, you might want to consider several tax strategies aimed at offsetting gains from selling appreciated assets or limiting your realized gains. One possible strategy is tax-loss harvesting, which involves selling losing investments and using the realized losses to offset taxable gains. The tax code allows you to apply up to $3,000 a year in capital losses to reduce ordinary income.
- Read Viewpoints: "Harvesting losses."
Another strategy to consider is investing in mutual funds that have relatively low turnover within the funds, which typically results in fewer capital gains being generated. You might consider index funds, including exchange-traded funds (ETFs), or use Fidelity’s Mutual Funds Research tool to look for other funds with low turnover rates. There are also mutual funds that invest for tax efficiency. But be sure that they are appropriate investments for you. Your investment choices should not primarily be based on taxes. For more information, read Tax-Advantaged Fidelity Solutions.
Also, be sure to take a look at Schedule D and Form 8949, which list your realized short-term and long-term capital gains. If Part 1 of Schedule D and Form 8949 show a significant amount of short-term gains—those generated by selling assets held less than one year—you might evaluate whether those investments are worth keeping in your taxable portfolio.
Short-term gains, like ordinary dividends, are taxed at your marginal rate for ordinary income, which is likely to be higher than the rate for long-term capital gains. Investments that generate short-term gains may be better held in a tax-deferred account like an IRA or 401(k).
|5.||HSA, SEP, and IRA deductions: lines 25, 28, and 32, respectively (1040); line 17, IRA deduction (1040A)|
Like contributing to a workplace retirement savings plan, contributing to a health savings account (HSA); or a self-employed plan such as a Simplified Employee Pension (SEP), Solo 401(k) plan, or SIMPLE IRA if you’re self-employed; or a traditional IRA are all effective ways to potentially reduce your taxable income. Not everyone qualifies to contribute to these plans or IRAs, but if you do and the amounts on lines 25, 28, and 32 (1040) and line 17 (1040A) are less than the contribution limits, you’re missing out on tax savings.
For 2016, you can contribute up to $3,350 to an HSA as an individual and up to $6,750 for family coverage, plus an extra $1,000 if you’re 55 or older. The contribution limit for a SEP or Solo 401(K) plan is 25% of net earnings from self-employment or $53,000, whichever is lower. For SIMPLE IRAs, the employee contribution limit is the lower of your net earnings from self-employment or $12,500 ($15,500 if you’re 50 or older), plus an employer contribution of either 2% or a 3% matching contribution. And for a traditional IRA, you can contribute up to $5,500, or $6,500 if you’re age 50 or older. (Note, however, that while nearly everyone can make a traditional IRA contribution, you may lose the ability to deduct your IRA contribution if you’re also a participant in a workplace plan.)
|6.||Alternative minimum tax (AMT): line 45 (1040); line 28 (1040A)|
The AMT was designed to prevent high-income individuals from avoiding income tax by piling up deductions. It is essentially a parallel method for calculating your income tax. If you see an amount entered on line 45 (1040) or line 28 (1040A), it means that you were subject to the AMT in 2015. Congress has increased income thresholds to limit the AMT’s impact on middle-income families, but there are still certain situations that can push unsuspecting taxpayers into AMT territory.
Two areas that may place a taxpayer into the AMT are exercising incentive stock options and having a large amount of tax-exempt interest income, say from private activity municipal bonds. Substantial deductions for state and local income taxes, personal exemptions, mortgage interest, and other items could also trigger the AMT. If you were hit by the AMT in 2015, look at Form 6251 to see what caused your exposure.
- To help reduce your exposure to the tax in 2016, read Viewpoints: “The AMT and you.”
|7.||Federal income tax withheld from Forms W-2 and 1099: line 64 (1040); line 40 (1040A); line 7 (1040 EZ)|
For most taxpayers, this line will show how much of their income was withheld by their employer for taxes. If your employer withheld too much or too little, based on the information you provided on Form W-4, you might have had either a large refund or a large amount of tax to be paid with your return, or even an underpayment penalty.
A one-time income event, such as a bonus, could have been responsible for a significant mismatch between your tax liability versus what you paid during the year, or it could have been caused by an improperly completed Form W-4. To bring your withholding more in line with the tax you will actually owe, tell your employer you want to revise your W-4.
Similarly, self-employed taxpayers or those with significant investment income should review line 65 to determine whether their estimated tax payments closely matched their total tax liability—and possibly adjust their estimated payments accordingly in 2016.
It’s worth it
While these items on your 2015 tax return might offer some of the most significant opportunities for future tax savings, H&R Block’s Charney recommends that you take the time to review every line on your tax return and become generally familiar why it’s there. And if you see an amount in a box that doesn’t make sense, dig into it further, and consider asking a tax professional for help. Your questions just might save you some money on your 2016 tax bill.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
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