By David Frederick, J.D., LL.M., SVP/Director of Wealth Planning, First Bank Wealth Management

The end of the year is a time for holidays, celebrations, family gatherings, and New Year’s resolutions. It is also the last opportunity to save on yearly taxes. There are a number of year-end tax strategies and maneuvers that taxpayers can use to potentially save themselves substantial tax, lower their tax bill, or raise their refund next spring. The following are a dozen tips that can help individual taxpayers save on taxes before the year ends.

  1. Maximize Retirement Savings
    Individual Retirement Accounts (IRAs) and Qualified Retirement Plans, like the 401(k), offer substantial present tax savings. A taxpayer may deduct current contributions to these savings plans and benefit from their investments growing tax-deferred, paying tax only when the plans distribute income in retirement. For 2018, an individual may deduct up to $18,500 in contributions to a Qualified Retirement Plan with an additional “catch-up” contribution of $6,000 allowed for individuals over 50 years old. If someone does not have access to another retirement plan, he or she may generally contribute up to $5,500 to an IRA with a $15,000 catch-up contribution. Maximizing contributions to these plans is an effective way to reduce present tax. It may already be too late for some participants in Qualified Retirement Plans to make additional contributions for the current year; individuals should check with their plan administrator for options.
  2. Qualified Charitable Distribution
    For taxpayers in retirement, distributions from an IRA or Qualified Retirement Plan often provide a needed source of income. However, if the income is not needed, required minimum distributions offer an unneeded income tax. Individuals with unnecessary required minimum distributions may direct their distributions to a charity instead of themselves. Such Qualified Charitable Distributions can be an effective way to both support a favorite charity and avoid taxes from unneeded income.
  3. Contribute to a Health Savings Account
    A Health Savings Account (HSA) is an effective way to save for health expenses and reduce income tax. Much like an IRA or a Qualified Retirement Plan, an HSA allows a taxpayer to deduct current contributions and enjoy tax-free investment growth. An HSA holder can withdraw funds to pay for qualified medical expenses tax-free. When the HSA holder turns 65, he or she may use the funds for anything without penalty, though the funds will be taxed when taken out for non-medical purposes. HSAs are only available to individuals covered by a High-Deductible Health Plan. HSA holders can deduct up to $3,450 for themselves or up to $6,900 for their family for annual contributions.
  4. Harvest Losses
    The silver lining to the recent market downturn, may be the availability of capital losses. Capital losses are valuable because they can offset other sources of income, effectively reducing taxable income and thus reducing income tax. Capital losses can be used to deduct up to $3,000 of ordinary income (such as salary from a job) and an unlimited amount of capital gains taken in 2018. Any capital loss not used in the current year can be carried forward to be used in later years. To take advantage of capital losses, an investor need only to “harvest the losses” by selling assets that have lost value. The proceeds from such loss sales can be reinvested.
  5. Bundle Charitable Contributions
    The charitable deduction has long been a staple of effective income tax mitigation, but its role has changed since the passage of a new tax law in 2017. While the new tax law did not lower the charitable deduction directly, it did increase the standard deduction, making the charitable deduction somewhat less effective. To increase the effectiveness of the charitable deduction, a taxpayer can consider giving charitably less often, but in larger amounts. That is, a taxpayer can make a large charitable gift and take a large charitable deduction in one year and make no charitable gifts in the following year and simply use the standard deduction. The taxpayer can then follow a pattern of going back and forth between using the charitable deduction and the standard deduction. This pattern would be especially effective if the taxpayer is making large charitable gifts of appreciated assets into a Donor Advised Fund (DAF).
  6. Defer Earned Income
    Most taxpayers must pay tax on income in the year they receive it, not necessarily the year they earn it. This may allow taxpayers to mitigate their taxes through timing strategies. Some employers will allow employees to defer annual recurring payments, such as year-end bonuses. Some employers may also allow highly-compensated employees to defer large amounts of salary until retirement. Deferral opportunities differ based on plans offered by employers, but these opportunities should be explored as a means to potentially save substantial tax in the present year.
  7. Start a Donor Advised Fund
    A Donor Advised Fund is a special type of charitable organization designed to manage, invest, grow, and distribute charitable gifts. When a donor makes gifts to a DAF, he or she will establish an account into which the gifts will be deposited. The DAF will manage the account, invest the proceeds, and then distribute portions of the account to operating charities as the donor directs. From a tax perspective, the donor will get an income tax deduction when the gifts are made to the DAF, regardless of how long they may stay in the DAF account. A DAF is an excellent tool to use with other charitable strategies, such as charitable gift bundling, gifting appreciated assets, and making Qualified Charitable Distributions.
  8. Make Annual Gifts
    Most Americans do not have to pay the Gift Tax. However, for affluent taxpayers the Gift Tax—and its closely related sister, the Estate Tax—can greatly disrupt estate planning, business succession planning, and related transfers of wealth. One of the best ways to mitigate the Gift Tax is by following an annual gifting regimen. The Gift Tax allows all taxpayers to transfer up to $15,000 per person ($30,000 per married couple) to anyone they want, and as many people as they want, every year without triggering a tax consequence. Wealthy taxpayers who may face the Estate Tax should strongly consider making a 2018 annual gift before the end of the year.
  9. Contribute to a 529 Plan
    Saving for higher education is an important, and potentially expensive, aspect of family wealth planning. A 529 plan is a tax-preferred account that may help with education savings. Assets within a 529 account grow tax-deferred, and when a beneficiary takes money out of the account to pay for qualified education expenses (such as tuition, school supplies, etc.) the proceeds come out tax-free. While there is no federal income tax deduction for contributions made to a 529 plan, many states (including Missouri and Illinois) offer modest deductions to their state income taxes for annual contributions. Families planning for higher education should investigate the possibility of starting a 529 plan.
  10. Make an Extra Mortgage Payment
    The Mortgage Interest Deduction (MID) is a hallmark of effective tax mitigation. With the MID, a taxpayer can deduct all interest paid on a mortgage, up to a certain loan value. The new tax law of 2017 restricted the MID somewhat by lowering the acceptable loan value and excluding interest paid on home equity loans and lines of credits from the deduction in most circumstances. However, for most homeowners, the MID remains a powerful tool to lower income taxes. Some homeowners may be able to take a little extra advantage of the MID in 2018 by pre-paying their January mortgage payment in December.
  11. Gift Appreciated Assets to Charity
    A taxpayer with a portfolio of appreciated assets faces a special problem. He or she may want to take advantage of the increased value of the assets, but will have to pay taxes when the assets are sold. The taxpayer in this position may consider another option - giving the appreciated assets to charity. Such a maneuver has a double tax advantage. First, the taxpayer avoids selling the assets and realizing the tax that comes from the capital gain. Second, the taxpayer may be able to take a charitable deduction for the market value of the assets donated. Taxpayers who combine this option with a Donor Advised Fund and a strategy of bundling charitable gifts can take advantage of a powerful system of tax mitigation while supporting a good cause.
  12. Pursue the Section 199A Deduction
    Small business owners often face tough income taxes passing through their S Corp, LLC, disregarded entity, or partnership business structures. Relief from these taxes can be hard to find. But in the new tax law of 2017, Congress created a new 20% deduction for small business owners with a “pass-through” business structure. This new deduction, known as the Section 199A Deduction, is complex and may not be available to all business owners. However, small business owners in need of tax relief would be well-advised to investigate this new deduction with their accountant or tax adviser. This new deduction can offer substantial savings to business owners, but professional guidance is likely required.