Many people only pay attention to taxes twice a year: in the run-up to April 15 and in late December. But a quick mid-year tax check-in can make a difference in how much tax you will owe for the year.
“Getting a handle on your tax situation gives you time to make changes, implement strategies, and help prepare for significant tax events,” says Mark Luscombe, principal federal tax analyst for accounting research and software provider Wolters Kluwer, CCH. “It’s also a good time to look for a tax adviser—well before the year-end tax crunch.”
Here’s a list of items for your mid-year checkup:
1. Assess any impact of major life changes.
Getting married or divorced? Having children or emptying the nest? Getting a job or losing one? These can have a significant impact on your tax situation. If you’ve already had a big change this year, or if you anticipate one before the end of the year, now is the time to see whether it will affect your tax picture.
If you’re getting married, for example, you’ll want to estimate your combined income and what your tax bill may be as a couple. Similarly, if you had an addition to the family, you should evaluate the tax impact of having another dependent. When you’ve determined what the effect of the change will be, you can consider adjusting your tax withholding accordingly.
2. Check and adjust your tax withholding rate.
If you received a large refund on your 2013 taxes, or had to pay a large amount to the IRS, you may want to consider adjusting your withholding rate. Ideally, you should fine-tune your withholding to pay just as much as necessary to avoid giving the IRS a free loan (which is really what overwithholding amounts to) or owing a penalty for underpayment.
Barring any of the aforementioned life events or significant income changes, a quick way to evaluate where you stand is to look at your tax liability from 2013 and compare it with what you’re on track to have withheld in 2014 (based on the year-to-date figure on your most recent pay stub). If the two numbers aren’t close, consider making changes to the Form W-4 you have on file with your employer. For a more complete explanation of how to adjust your withholding, read Viewpoints “Are you giving the IRS an interest-free loan?”
3. Evaluate the impact of capital gains—especially if you have a large gain.
If you have—or plan to have—significant capital gains from selling stocks or another type of asset this year, you’ll need to consider how you’ll pay the taxes. In addition to making sure you put aside enough money to pay the tax on your gain, you’ll want to avoid the possibility of a penalty for underpayment. The IRS requires you to make quarterly estimated payments if you expect to owe at least $1,000 in tax for the year and you expect your withholding and refundable credits to be less than 90% of your estimated tax for this year or 100% of the tax you owed last year.
The rules are a bit different for high-income taxpayers. If your adjusted gross income in 2013 was more than $150,000 (married couple filing jointly and single taxpayers) or $75,000 (married taxpayers filing separately), you have to withhold at least 110% of last year’s tax liability to avoid an underpayment penalty.
See whether you have gains or losses in your Fidelity accounts by reviewing your year-to-date tax information on your nonretirement accounts. Go to Fidelity.com, "Accounts & Trade"; then, log on to "Portfolio," and select “Tax Info (Year-to-Date)” from the “Select Action” drop-down menu for the desired Fidelity account.
4. Determine whether you should sell losing investments.
By selling losing investments to offset some of the winners, known as tax-loss harvesting, you may be able to help manage your tax bill. Many people wait until late in the year to sell their losing stock or mutual fund, but there are good reasons to consider doing it sooner.
One reason is that the flurry of late selling by tax-loss harvesters tends to push stock prices lower toward the end of the year. Another reason is that selling early would allow you to wait the required 30 days before buying back the stock (to avoid the wash-sale rule) and then time your repurchase to coincide with a favorable market. Identify opportunities with our Tax Loss Harvesting Tool.
5. Start planning optional deductions.
If you itemize your deductions, you may be in much better shape to maximize their value if you do some planning before the end of the year. For example, you could look into taking a more organized and tax-effective approach to your charitable giving with a donor-advised fund.
You might also start planning now to bunch two years’ worth of certain deductions such as unreimbursed employment expenses and sales tax on large purchases, so they can have a bigger impact on your tax bill. For unreimbursed employment expenses, it may help you get over the 2% adjusted gross income (AGI) threshold for miscellaneous itemized deductions. For sales tax, you might want to claim the state income tax deduction in a different year from when you claim your bunched sales tax deductions.
6. Contribute more to certain tax-advantaged retirement accounts.
Was this going to be the year you maximized your contributions to your 401(k), IRA, or another tax-advantaged retirement plan? Many people start the year with that intention, or resolve to do it when they see their tax bill for the previous year—but it somehow gets put off.
Now is the time to make good on your intention. The longer you wait, the more difficult it will be to contribute the maximum amount and get the maximum tax benefit. For 2014, you can contribute up to $17,500 in pretax dollars to a 401(k) or similar plan ($23,000 if you’re 50 or older), up to $5,500 to an IRA ($6,500 if you’re 50 or older), and the lessor of $52,000 or 25% of income for a Simplified Employee Pension (SEP) plan. For 2014, individuals can contribute up to $3,300 to a health savings account (HSA), and families up to $6,550. Plus, there is a $1,000 catch-up provision for those age 55 or older.
7. See whether you’ll benefit from a Roth IRA or 401(k) conversion.
This is another item that often falls victim to procrastination. Many taxpayers believe they could benefit from diversifying their retirement tax situation with a Roth IRA or 401(k) conversion (if their plan permits one), which can provide tax-free retirement income. But converting a portion of your traditional pretax IRA or 401(k) savings means having to pay tax on the amount you convert in the current year.
If you wait until the end of the year to do the conversion, you don’t have much time to put aside money for the tax bill. On the other hand, if you convert now, you could put aside something every month until the tax is due. There are some potential advantages to converting late in the year, too, so you’ll want to consider your options carefully. Start by reading Viewpoints: “Answers to common Roth conversion questions.”
8. Check your tax rate and bracket for changes.
For people with large incomes, a new top tax bracket, a higher capital gains tax, and a new net investment income tax all went into effect in 2013. If you fell below the thresholds last year but expect your 2014 earnings to increase significantly, you might want to bump up your withholding or estimated payments to be prepared for the higher rates. For 2014:
- The top tax bracket is 39.6% on taxable income above $406,750 for single taxpayers and $457,600 for married couples filing jointly.
- The top rate on qualified dividends and long-term capital gains is 20% for taxpayers in the top tax bracket.
- A 3.8% net investment income tax is applied to the lesser of net investment income or modified AGI above $200,000 (singles) and $250,000 (couples).
- An additional Medicare surtax of 0.9% is due on earned income above $200,000 (singles) and $250,000 (couples).
9. Look for a tax adviser.
If your tax situation is becoming too complex to handle yourself, now is the time to look for a tax professional. By interviewing potential candidates when they’re not up to their elbows in other clients’ tax returns—and you’re not scrambling to file your own taxes on time—your search can be much more relaxed and productive.
Everybody’s tax situation is unique, but one piece of advice that applies to everyone is that the sooner you plan and implement your tax strategies, the more likely you will be to have a lower tax bill come next April.
- Evaluate how much tax you should have withheld from your paycheck, with the IRS withholding calculator.
- Watch “Defer, manage & reduce: How to invest tax efficiently.”
- Read Viewpoints special report: Take on taxes.
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