How to Reduce Your 2016 Taxes Before the New Year

2016 has been quite a year for investors. On the one hand, we’ve seen a long-running bull market continue to new highs. On the other, we’ve seen financial and political turmoil across the world. There’s still a few days left before this crazy year ends. And that means you have one last opportunity to reduce your 2016 taxes.

There are a variety of year-end tax tips that you can use to reduce your liabilities come April. These simple tricks will help you get a bigger return on your 2016 payments to Uncle Sam. Let’s look at a few of the easiest.

Max Out Your Retirement Accounts
401(k) and IRA contributions are some of the simplest ways to reduce your 2016 taxes.

[ad#Google Adsense 336×280-IA]Payments are fully deductible.

That means that if you set aside the maximum 401(k) contribution of $18,000, that’s $18,000 off your 2016 taxes.

If you’re 50 or older, the maximum goes up to $24,000.

This is one of the most profitable tax deductions in the book.

Most other write-offs involve nonrefundable costs like healthcare copays or investment losses.

But with 401(k) contributions, you’re just saving the money for your future self. And it will grow tax-free while you wait to retire.

Avoid Triggering Penalties
Our tax code is long, complicated and tricky. It’s full of hidden penalties and obscure rules. That means you have to be careful about the income you claim and the costs you deduct. Because, believe it or not, filing too many deductions (or the wrong ones) could actually make your 2016 taxes go up.

In particular, you must be vigilant to avoid getting hit with the alternative minimum tax (AMT). It’s a flat percentage tax designed to prevent upper- and middle-class people from deducting their way out of taxes. And if you’re paying the AMT, you are locked out of many common deductions. These include local tax payments and healthcare expenses.

If your adjusted income is between $51,000 and $400,000, you are at risk of triggering the AMT. Taking a lot of miscellaneous deductions could further increase this risk. Exercising stock options and claiming business depreciation are also risk factors. If these conditions apply to you, consider just taking the standard deduction in order to minimize your AMT risk.

Another penalty to be aware of is the so-called “kiddie tax.” At one time, a common tax avoidance strategy involved opening investment accounts in your child’s name. This really simplifies estate planning. Plus, since kids don’t have taxable incomes, they would qualify for a 0% capital gains rate.

Unfortunately, the government caught onto this practice in the ‘80s and implemented the kiddie tax. Under this provision, a child’s income above $2,100 is taxed at their parent’s rate. “Child” is defined in this law as under 24 for full-time students and under 19 otherwise.

If you’re sheltering investments in your child’s name, be prepared for the Feds to see through the trick. What’s more, there are legal and tax-exempt ways to set aside investments for your children. Consider setting up a tax-advantaged college savings account like a 529.

Offset Realized Capital Gains
The postrecession bull market has continued throughout 2016, and that’s great news for investors. However, it also means that capital gains will be a big concern in reducing your 2016 taxes. If you’re in a high income tax bracket and you sell stocks frequently, your rate might be near 40%.

That’s why it’s so important to offset any realized capital gains using other parts of your portfolio. One simple way to do this is to strategically realize losses. This technique is called tax-loss harvesting, and we’ve written a whole article about it.

But did you know that you can reduce your capital gains rate using stocks that have increased in value?

Well, there’s a catch. You have to give them to charity. Donating stock instead of cash allows you to deduct the fair market value of your stock. It might not sound sensible to get rid of a winner stock in order to reduce your 2016 taxes. But if you’re looking for an opportunity to divest from a company you disapprove of, consider donating that investment to charity.

As New Year’s Eve approaches, we’re all reflecting on what a wild ride 2016 has been. This aggressive bull market has delivered substantial profits to investors. But it’s also saddled a lot of folks with a big 2016 tax bill. We hope these tips will help you take back what’s yours from Uncle Sam.

And here’s to hoping that 2017 is a little less crazy.

— Investment U Research Team

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Source: Investment U