In the midst of your summer fun, taking time for a midyear tax checkup could yield rewards long after your vacation photos are buried deep in your Facebook feed.
Personal and financial events, such as getting married, sending a child off to college, or retiring, happen throughout the year and can have a big impact on your taxes. If you wait until the end of the year or next spring to factor those changes into your tax planning, it might be too late.
“Midyear is the perfect time to make sure you’re maximizing any potential tax benefit and reducing any additional tax liability that result from changes in your life,” says Gil Charney, director of the Tax Institute at H&R Block. “Plus it doesn’t look like there are going to be a lot of changes to the tax code this year, so it’s an especially good opportunity to shift from being reactive to proactive in your tax planning.”
Here are nine questions to answer to help you to be prepared for any potential impacts on your tax return.
|1.||Did you get a raise or are you expecting one?|
The amount of tax withheld from your paycheck should increase automatically along with your higher income. But if you’re working two jobs, have significant outside income (from investments or self-employment), or you and your spouse file a joint tax return, the raise could push you into a higher tax bracket that may not be accounted for in the Form W-4 on file with your employer. Even if you aren’t getting a raise, ensuring that your withholding lines up closely with your anticipated tax liability is smart tax planning. Use the IRS Withholding Calculator, then, if necessary, tell your employer you’d like to adjust your W-4.
Another thing to consider is using some of the additional income from your raise to increase your pretax contribution to a 401(k) or similar qualified retirement plan. That way, you’re reducing your taxable income and saving more for retirement at the same time.
- Read Viewpoints: "How much should I save each year?"
|2.||Is your income approaching the net investment income tax threshold?|
If you’re a relatively high earner, check to see if you’re on track to surpass the net investment income (NII) tax threshold. The NII, often called the Medicare surtax, is a 3.8% levy on the lesser of net investment income 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. In addition, taxpayers with earned income above these thresholds will owe another 0.9% in Medicare tax on top of the normal 2.9% that’s deducted from their paycheck.
If you think you might exceed the Medicare surtax threshold for 2016, you could consider strategies to defer earned income or shift some of your income-generating investments to tax-advantaged retirement accounts. These are smart strategies for taxpayers at almost every income level, but their tax-saving impact is even greater for those subject to the Medicare surtax.
- Read Viewpoints: “The Medicare taxes and you.”
|3.||Did you change jobs?|
If you plan to open a rollover IRA with money from a former employer’s 401(k) or similar plan, or to transfer the money to a new employer’s plan, be careful how you handle the transaction. If you have the money paid directly to you, 20% will be withheld for taxes and, if you don’t deposit the money in the new plan or an IRA within 60 days, you may owe tax on the withdrawal, plus a 10% penalty if you’re under age 55.
- Read Viewpoints: “What to do with an old 401(k).”
|4.||Do you have a newborn or a child no longer living at home?|
It’s time to plan ahead for the impact of claiming one more or less dependent on your tax return.
Consider adjusting your tax withholding if you have a newborn or if you adopt a child. With all the expenses associated with having a child, you don’t want to be giving the IRS more of your paycheck than you need to.
If your child is a full-time college student, you can generally continue to claim him or her as a dependent—and take the dependent exemption ($4,050 in 2016)—until your student turns 25. If your child isn’t a full-time student, you lose the deduction in the year he or she turns 19. Midyear is a good time to review your tax withholding accordingly.
- Read Viewpoints: "Got young kids? Five ways to manage costs."
|5.||Do you have a child starting college?|
College tuition can be eye-popping, but at least you might have an opportunity for a tax break. There are several possibilities, including, if you qualify, the American Opportunity Tax Credit (AOTC). The AOTC can be worth up to $2,500 per undergraduate every year for four years. Different college-related credits and deductions have different rules, so it pays to look into which will work best for you.
Regardless of which tax break you use, here’s a critical consideration before you write that first tuition check: You can’t use the same qualified college expenses to calculate both your tax-free withdrawal from a 529 college savings plan and a federal tax break. In other words, if you pay the entire college bill with an untaxed 529 plan withdrawal, you probably won’t be eligible for a college tax credit or deduction.
- Read Viewpoints: “How to spend from a 529 college plan.”
|6.||Is your marital status changing?|
Whether you’re getting married or divorced, the tax consequences can be significant. In the case of a marriage, you might be able to save on taxes by filing jointly. If that’s your intention, you should reevaluate your tax withholding rate on Form W-4, as previously described.
Getting divorced, on the other hand, may increase your tax liability as a single taxpayer. Again, revisiting your Form W-4 is in order, so you don’t end up with a big tax surprise in April. Also keep in mind that alimony you pay is a deduction, while alimony you receive is treated as income.
|7.||Are you saving as much as you can in tax-advantaged accounts?|
OK, this isn’t a life-event question, but it can have a big tax impact. Contributing to a qualified retirement plan is one of the most effective ways to lower your current-year taxable income, and the sooner you bump up your contributions, the more tax savings you can accumulate. For 2016, you can contribute up to $18,000 in pretax dollars to your 401(k) or 403(b). If you’re age 50 or older, you can make a “catch-up” contribution of as much as $6,000, for a maximum total contribution of $24,000. Self-employed individuals with a simplified employee pension (SEP) plan can contribute up to 25% of their compensation, to a maximum of $53,000.
This year’s IRA contribution limits, for both traditional and Roth IRAs, are $5,500 per qualified taxpayer under age 50 and $6,500 for those age 50 and older. Traditional and Roth IRAs both have advantages, but keep in mind that only traditional IRA contributions can reduce your taxable income in the current year.
- Get more information about IRA rules and income thresholds for eligibility.
|8.||Are your taxable investments doing well?|
If you’re investments are doing well and you have realized gains, now’s the time to start thinking about strategies that might help you reduce your tax liability. Tax-loss harvesting—timing the sale of losing investments to cancel out some of the tax liability from any realized gains—can be an effective strategy. The closer you get to the end of the year, the less time you’ll have to determine which investments you might want to sell, and to research where you might reinvest the cash to keep your portfolio in balance.
- See whether you can offset some of your capital gains by selling currently losing investments with our tax-loss harvesting tool (login required).
|9.||Are you getting ready to retire or reaching age 70½?|
If you’re planning to retire this year, the retirement accounts you tap first and how much you withdraw can have a major impact on your taxes as well as how long your savings will last. A midyear tax checkup is a good time to start thinking about a tax-smart retirement income plan.
If you’ll be age 70½ this year, don’t forget that you may need to start taking a minimum required distribution (MRD) from your tax-deferred retirement accounts, although there are some exceptions. You generally have until April 1 of next year to take your first MRD, but, after that, the annual distribution must happen by December 31 if you want to avoid a steep penalty. So if you decide to wait to take your first MRD until next year, be aware that you’ll be paying tax on two annual distributions when you file your 2017 return.
- Get answers to frequently asked MRD questions.
- Read Viewpoints: “Withdrawing from your retirement accounts: the basics.”
No significant changes in your life situation or income?
Combined with a relatively quiet year for changes in the federal tax code, having an uneventful year in your personal and financial life offers a good opportunity to think more carefully about your tax planning. You might look into ways you can save more toward retirement, gift money to your children and grandchildren to remove it from your estate, or manage your charitable giving to increase its tax benefits and value to beneficiaries. A little tax planning now can save a lot of headaches in April—and maybe for years to come.
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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