Year-End Moves Can Cut Retirees' 2015 Tax Bills

The holiday season is just around the corner, so your to-do list is probably growing exponentially. Still, one more task can pay off nicely: year-end tax planning.

Owners of stock mutual funds should be especially zealous in their search for ways to trim their tax tab. This year may deliver a painful "double whammy" to mutual fund owners: a drop in share value in many funds combined with large taxable distributions to shareholders, says Tom Roseen, head of research services for Lipper, a firm that specializes in mutual fund analysis.

Mutual funds are required to distribute to shareholders the capital gains realized on the sale of holdings within the fund, as well as dividends earned on securities the fund owns. In 2014, Roseen says, funds paid out a record $709 billion in interest, dividends, and short- and long-term capital gains -- with investors' payments to Uncle Sam rising by 38% from 2013.

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Although 2015 is unlikely to beat last year's record, Roseen expects distributions to be substantial. During months of volatility this year, he says, fund managers were forced to sell stocks to pay off shareholders who were bailing -- and those capital gains will be passed on to investors who stayed. "It's possible that the value of your shares has declined, but you still have a tax bill to pay," he says.

Year-end tax-trimming moves will help taxpayers of all income levels, but those with higher incomes have the most to gain. Investors with taxable income of more than $413,200 for singles ($464,850 for joint filers) owe 20% on long-term capital gains and qualified dividends, and face an ordinary income tax rate of 39.6% on income above those levels. Taxpayers with lower incomes will owe 0% or 15% on long-term capital gains.

Those taxpayers and anyone with modified adjusted gross income that exceeds $200,000 for singles ($250,000 for joint filers) could also be hit with a 3.8% surtax on "net investment income," which includes interest, dividends, capital gains, annuity payments, rents and royalties. (AGI is your gross income with a few adjustments, while taxable income is your AGI minus personal exemptions and deductions.)

Over the next weeks, you should scour your taxable portfolios for any shares that can be sold at a loss -- to be sure, a difficult chore considering the run-up in share prices over the past few years. Harvesting your capital losses will offset gains dollar for dollar. If you're close to hitting the thresholds for the 20% capital-gains tax rate or the 3.8% surtax, you can limit your AGI and taxable income by stashing more pretax money in retirement funds, boosting charitable contributions, or prepaying state and local income and property taxes due in 2016 (although the tax deductions do not count under the alternative minimum tax).

Keep mutual fund distributions in mind if you're planning year-end Roth IRA conversions, says Martin James, a certified public accountant in Mooresville, Ind. It's common for a taxpayer to convert enough to take her to the top of her tax bracket. "But if a mutual fund kicks out capital gains, it could throw you above that," James says.

Look for the unintended consequences of year-end moves. For example, even if you're careful to stay within your tax bracket, a large IRA withdrawal or Roth conversion will boost AGI, perhaps raising income-related Medicare premiums or boosting the tax bite on Social Security benefits.

Zero capital gains. New retirees in particular may find themselves eligible for a sweet deal: the 0% long-term capital-gains rate. To qualify, you must be in the 10% or 15% bracket, so your taxable income cannot exceed $37,450 for singles and $74,900 for joint filers.

Taxpayers who need income and qualify for the 0% rate should consider selling stocks held more than a year rather than withdrawing from an IRA. (You pay ordinary income tax on IRA distributions.) If you need to take required minimum distributions, you can supplement that income by selling stocks and take advantage of the 0% rate.

If you don't want to part with an appreciated asset, you can sell shares, pay 0% tax on the gain, and then buy back shares, James says. Your basis will be reset at the higher value, he says, "so if you have to liquidate the stock in another year, the gain will be smaller, and the sale could be tax free," assuming you're still eligible for the 0% rate.

The 0% capital-gains rate only applies until your income breaks into the 25% income tax bracket. You'll pay the 15% capital-gains tax for profits that exceed the 15% income tax bracket. Say you're a married couple with earned income of $60,000. You sell stock for a $30,000 long-term gain. You'll pay 0% tax on the first $14,900 of the gain (the amount that takes you to the top of the 15% income tax bracket), and you'll pay a 15% capital-gains tax for the $15,100 balance.

Such a strategy is not always pain-free. Capital gains count toward AGI, and a higher AGI could reduce or eliminate your ability to deduct medical expenses, for instance. And if you're buying health insurance on the federal or state exchanges, check that the higher AGI won't disqualify you from getting federal tax credits that subsidize premium costs. Also, if your state has an income tax, watch how the added income will affect your state's levy. The states don't offer that 0% rate.

Giving appreciated stock. Despite recent market gyrations, it's likely your portfolio is filled with stocks that have appreciated over the past few years. Investors who give appreciated stock to charity avoid the capital-gains tax on appreciation and can deduct the stock's full market value at the time of the gift.

When you're identifying stocks to donate, pay attention to asset classes in which you're overweighted and need to cut back anyway. And only consider appreciated stock that you've held for more than a year. Taxpayers who donate short-term-gain property get a deduction only on the original cost. Say you bought stock for $3,000 and donate it to charity 11 months later when it's worth $5,000. You can only deduct $3,000. If you wait a month, you can take a $5,000 write-off.

And do not donate stock that has lost value. Your write-off is limited to its fair market value. You're better off selling the shares to realize the loss to offset gains in your portfolio, and then donating the cash to earn your charitable deduction.

If you are providing financial help to your children or parents, consider giving them appreciated stock rather than selling the stock and handing over cash. "You won't have to pay capital-gains tax on the sale," says Michael Eisenberg, a certified public accountant at Miller Ward & Company, an accounting firm in Encino, Cal. Instead, he says, your kids or parents, who presumably are in a lower bracket, will pay tax at a lower rate when they sell the stock.

Congress has yet to extend a tax break that enables IRA owners who are 70 1/2 and older to send a tax-free distribution of up to $100,000 directly to charity and satisfy their required minimum distribution. But you can ask your IRA custodian to transfer the money now, so you're prepared if lawmakers come through.

Deducting medical expenses. If your income took a big hit, perhaps because of retirement, it may be time to get some dental work or other elective medical procedures performed. If you or a spouse are 65 years or older in 2015, you can deduct medical expenses that exceed 7.5% of your adjusted gross income. The threshold is 10% for younger taxpayers. Starting on January 1, 2017, the 10% threshold will apply to all taxpayers.

Other expenses could push you above the threshold. You can deduct the cost of certain medically related home improvements, such as widening doorways for a wheelchair or installing entrance ramps. (Your write-off is the amount by which the cost of the improvement exceeds the added value to your home.) If you moved into a continuing-care retirement community, you can deduct the portion of the entrance fee that the facility allocates to future medical expenses.

Taxpayers in nursing homes or assisted-living facilities can deduct the charges. You can also write off premiums for Medicare Parts B and D, as well as some travel expenses related to medical treatment. Check IRS Publication 502, Medical and Dental Expenses, for a list of all medical deductions.

Taking your first RMD. If you turned 70 before July 1, you will need to take your first required minimum distribution from your IRA. Because it's your first RMD, you can either take it this year or you can hold off to as late as April 1, 2016. If you delay until April 1, you will need to take two RMDs in 2016, since your second payout will be due by the end of next year.

You need to decide which works best tax wise. If you will be in a lower bracket next year, consider taking two RMDs. "It could make sense to double up next year if your income will go down and you had a big capital gain this year," Eisenberg says.

But take note of the possible impact on Medicare premiums and the Social Security tax bite. Perhaps by spreading out the payments over two years, you can keep a lid on AGI and avoid higher premiums and higher taxes on benefits for both years. But if you incurred deductible medical expenses this year, deferring the RMD could make sense.