Haste makes waste, especially in the increasingly complex and often counterintuitive world of taxes.
As the year draws to a close, many taxpayers scramble to take advantage of popular, time-honored tax-saving techniques. Be careful, though. Even small missteps can result in costly blunders, particularly for taxpayers making gifts to charity.
“It’s easy to forget about some of the technicalities involved” and to overlook valuable tax-saving opportunities, says Martin Hall, a partner at the law firm of Ropes & Gray LLP in Boston and chair of the firm’s private-client group.
TIMING DEDUCTIONS: Around this time, tax advisers often urge clients to accelerate as many deductions as possible into the current year. But in some cases, the reverse strategy works better. For example, don’t rush to make charitable donations now if you are sure that you’ll be claiming the standard deduction for 2016 but probably will itemize deductions for the 2017 tax year. Reason: You can’t deduct charitable gifts for a year in which you take the standard deduction, as nearly two-thirds of all taxpayers do each year. “If the person cannot itemize and the charitable contributions aren’t enough when added to the rest of their potential itemized deductions to exceed their standard deduction, they should defer the charitable contribution to the following year,” says Stephen W. DeFilippis, an enrolled agent and owner of DeFilippis Financial Group, a wealth-management and tax firm in Wheaton, Ill.
Many people who itemize may be tempted to prepay state and local taxes this year even though those payments aren’t due until 2017. That can be a great idea—unless you are among the millions of people ensnared by the alternative minimum tax for 2016 and might not be next year. “If you will be subject to the AMT (for 2016), accelerating these deductions into the current tax year might have no tax benefit,” Mr. DeFilippis says.
DONATING STOCK TO CHARITY: This is a very popular technique among many taxpayers, especially around this time of year. Here is how it typically works: Investors choose shares that they have owned for more than one year and that have risen sharply in value since they purchased them. Donating these “highly appreciated” shares to their favorite charities can be a smart move because it generally enables those taxpayers to deduct the fair market value of the shares and avoid capital gains tax on the long-term profits.
Caution: Don’t make the mistake of donating shares that have declined in value since you purchased them. Instead, consider selling those losers to nail down valuable capital losses. Then, donate the proceeds to charity.
Note: If you want to take advantage of this for the 2016 tax year, don’t procrastinate, Mr. Hall says. Donating shares can take time.
WASH SALES: Selling securities at a loss to cancel out capital gains is another popular year-end technique. But to avoid losing the benefits of so-called “tax-loss harvesting,” investors need to pay attention to the “wash-sale” rules.
A wash sale occurs “when you sell or trade stock or securities at a loss and within 30 days before or after the sale” you buy “substantially identical stock or securities,” the IRS says in Publication 550. Note that this rule says “30 days before or after,” not just 30 days after.
A wash sale also occurs when an investor acquires “a contract or option to buy substantially identical stock or securities”—or when you “acquire substantially identical stock for your individual retirement account or Roth IRA,” the IRS says.
The IRS mentions another key issue: “If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale.”
Caution: Note that the rule applies not only to buying the same stock or securities but to stock or securities that are “substantially identical.” What does that mean? Lawyers say this can be a gray area. “It’s unclear,” says Mr. Hall of Ropes & Gray.
RENTAL INCOME: Thinking about renting out your home over the holidays? Taxpayers who rent out their homes typically owe tax on the rental income they receive—but not if their total of rentals for the year comes to 14 days or less.
Some wealthy homeowners rent out their homes for exactly 14 days each year. The so-called “14-day rule” is also sometimes known as the “Masters exception,” since it is popular in Augusta, Ga., home of the Masters golf tournament each year.
Caution: Keep good records and don’t exceed 14 days.
DONATIONS FROM IRAS: Late last year, Congress agreed to make permanent a provision designed to encourage taxpayers to donate money to charity directly from their IRAs.
Caution: In Washington, permanent means permanent unless Congress changes its mind.
This typically allows investors 70½ or older to transfer as much as $100,000 a year directly from an IRA to qualified charities without having to count any of that money as income. If done correctly, the transfer counts toward the taxpayer’s required minimum distribution for that year.
To be sure, such a transfer doesn’t count as a tax-deductible charitable donation. Even so, it can be a smart move.
“Many taxpayers do not need the income from their RMDs and this provision allows them to direct their RMD to a qualified charity,” says Mr. DeFilippis. The exclusion can “favorably impact many things such as the taxability of their Social Security benefits and deductibility of medical expenses.”
Caution: The transfer must be done directly from the IRA to a qualified charity. Curiously, donor-advised funds don’t qualify.
JOB SEEKERS: Looking for a new job in your present occupation? Job-hunting expenses, such as travel, résumé preparation and outplacement agency fees, may be tax-deductible whether or not you find your dream job.
Caution: Taxpayers can’t deduct job-hunting expenses if looking for work in a “new occupation,” or if there has been a “substantial break between the ending of your job and your looking for a new one,” the IRS says. Also, those expenses aren’t deductible if you are “looking for a job for the first time.” See Publication 529 (“Miscellaneous deductions”) for details.
Don’t forget about moving expenses. “Moving expenses for a new job at least 50 miles away from your home may also be deductible,” the IRS says.
GIFT-TAX EXCLUSION: Feeling generous? You can give away as much as $14,000 this year to anyone you want—and to as many people as you wish—without any tax considerations. The giver needn’t file any forms and no tax is owed by anyone (assuming it is a genuine gift and not an attempt to disguise payment for goods or services). The dollar amount will remain $14,000 in 2017.