Retirees, Get a Jump-Start on Your 2014 Tax Bill

The beach chair is beckoning, but isn’t it also tempting to save a wad of cash? Hold off on the sand and surf for just a bit, and take some time for your midyear tax review. By getting a head start on your 2014 planning, you’re likely to find many strategies to shave your payments to Uncle Sam.

To get started, take out your 2013 return. “Note what is changing for 2014 regarding your income and deductions,” says Martin James, a certified public accountant in Mooresville, Ind. “You need to look at every line item.”

It’s also crucial, according to James and other tax experts, for taxpayers to take a multi-year approach to their annual tax review. James says a move that could trim taxes one year could “create a tax nightmare in the future.” For instance, he says, a taxpayer who reduces her tax tab each year by pulling money from a taxable account—rather than withdrawing from an IRA and paying taxes—could find herself in a higher tax bracket later when it’s time to take required minimum distributions from a large IRA.

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The bottom line of your 1040 from 2013 could be sending a loud message if it shows you got a big refund this year or sent Uncle Sam a big check. In either case, you should change the amount of tax withheld from your paycheck or paid quarterly. You also should re-evaluate your withholding if you believe your income will change much from last year, says Rebecca Pavese, a certified public accountant with Palisades Hudson Financial Group, in Atlanta. By making the move now, “you won’t have a large bill due or give the government your money all year long,” she says.

While taxpayers like tax refunds, you’re better off getting bigger paychecks for the rest of this year. “Let that money work for you,” Pavese says, perhaps by investing it or paying off credit-card debt. Withhold too little, though, and you could end up owing a penalty.

If you’re employed, file a revised W-4 with your employer. The more allowances you claim, the less tax will be withheld. If your income will be similar to last year’s, you can figure the appropriate number of allowances to claim with Kiplinger’s Easy to Use Tax Withholding Calculator.

Top off your retirement accounts. You can reduce your adjusted gross income and taxable income by maximizing pretax contributions to tax-deferred retirement accounts. Taxpayers who will be 50 or older by year-end can contribute up to $6,500 to a traditional IRA. If your spouse isn’t working, you can contribute up to the same amount to a spousal IRA as long as you have enough earned income to cover the contribution. If you are covered by a 401(k) at work, you can contribute to a traditional IRA but, depending on your income, you may not be able to deduct the IRA contributions.

Pavese suggests that taxpayers not wait until the last days of the year to make contributions. “The longer your money grows tax deferred, the better,” she says.

If you’re newly retired yet still bringing in income as a consultant or from a small business, be sure to set up one of several types of retirement accounts designed for the self-employed. Jeffrey Cutter, a certified public accountant in East Falmouth, Mass., says one of his clients who retired with a federal pension did not need the income from a new consulting job that paid $85,000 a year. He opened an individual 401(k), which allows him to sock away and deduct up to $52,000 of that income in 2014.

Reduce taxes on investments. Your investments can open a treasure trove of tax-trimming opportunities. Finding tax-trimming gems in your portfolio became especially important when higher tax rates—as well as a new 3.8% surtax on “net investment income”—took effect in the 2013 tax year. As you probably realized during the last tax year, each rate kicks in at a different income threshold.

If you can, try to keep your income below certain tax triggers or from crossing into higher brackets. If you’re planning a Roth conversion, for example, be sure to consider the 3.8% surtax, which kicks in for singles with modified adjusted gross income above $200,000 and for joint filers with AGI above $250,000.

Also keep in mind, James says, that you will pay higher Medicare Part B and Part D premiums if your modified AGI exceeds $85,000 for singles and $170,000 for married couples. And you could be eligible for a tax credit to help pay for health insurance purchased on the new health exchanges if your modified AGI is less than $46,680 for a single and $62,690 for a couple. Those on the cusp of those thresholds should stagger Roth conversions over several years—rather than taking all of the income in a single year. You need to “look at the stealth taxes that happen when AGI goes up,” James says.

Taxpayers who are selling a business, real estate or rental property might consider an installment sale, James says. By deferring the sales proceeds over more than a year, you can defer annual gains subject to the surtax and reduce your AGI, he says. (Net investment income includes interest, dividends, capital gains, annuity payments, rents and royalties.)

Also start your tax loss “harvesting” now, looking “for the dogs in your portfolio” to sell, Cutter says. Once you bank your losses, “see if it makes sense to sell any of your appreciated stock,” he says. You can take the profits for living expenses and use the capital losses to offset the gains dollar-for-dollar.

Taxpayers in the 10% and 15% tax brackets—up to $36,900 for singles and $73,800 for joint filers—are once again eligible for the 0% tax rate on long-term capital gains. Consider this maneuver: If you have appreciated stock you like, you can sell it and pay no capital-gains tax if you stay within the 15% bracket. Then buy back the shares. In the future, when you sell, you’ll only pay tax on the appreciation on the current higher value.

Whether you’re in the crosshairs of the surtax or not, you can trim your tax tab, in both the long and short terms, by keeping an eye on the location of your assets (read Boost Your After-Tax Investment Returns). As a rule of thumb, assets that generate a lot of ordinary income, such as real estate investment trusts and high-yield bond funds, should be placed in tax-deferred accounts where earnings can compound without annual interruptions by the IRS. Taxable brokerage accounts should hold tax-exempt municipal bonds and stock index funds, which generate tax-favored long-term capital gains and then primarily only when you sell. Actively managed funds, which tend to generate ordinary income and short- and long-term gains even if you don’t sell shares, should be in your tax-deferred account.

Save cash on your charitable intent. Congress has yet to extend the popular tax break that allows individuals 70½ and older to transfer up to $100,000 tax-free from an IRA directly to charity. The donation can count toward a required minimum distribution. You can’t deduct the contribution, but this maneuver lowers your AGI compared with taking a taxable distribution and donating it to the charity.

It’s likely that lawmakers will revive this provision but not until after the November elections. For seniors who want to make an IRA charitable transfer, it makes sense to wait on your RMDs and charitable gifts until later in the year. You cannot use this strategy to contribute to a donor-advised fund.

A midyear tax review is a good time to scour your taxable portfolio for appreciated stock that could be used for a charitable donation. “An appreciated security is a very tax-efficient gift,” Pavese says. “If you sell the stock and give the cash to the charity, you’ll have to pay tax on the gain. And you’ll have less money to give to the charity.” If you donate the stock itself, though, you’ll get an income-tax deduction for the market value of the securities, assuming you’ve owned them for more than one year. You can place the shares in a donor-advised fund if you want. That way, you get the deduction this year, but you can decide at a later date which charities will get your money.

Ask your favorite charities if they will take artwork, antiques or real estate. Gifts of tangible personal property worth more than $5,000 must be independently appraised, so line up an appraiser before the year-end dash.

Keep track of what you spend on charitable work. For example, you can deduct the costs of fund-raising activities. If you drive your car for charitable work, you can deduct 14 cents per mile. Read IRS Publication 526, Charitable Contributions for more information.