Take a big tax hit in 2013? Prepare for next year now

My 2013 tax liability was much greater than expected. What can I do this year to decrease it for next year?

With tax season behind us, now is the perfect time to be proactive for the 2014 tax year. By taking steps this year, you can avoid the situation of sitting down with your accountant next year and finding that it’s too late to reduce your tax liability. Here are some items to consider.

Offset capital gains and losses. Currently, the maximum tax rate for long-term capital gains is 15% for most taxpayers but 20% for those in the top regular income tax bracket. For 2014, the top bracket is 39.6%. In addition, a 3.8% surtax applies to certain upper-income investors, so the top effective federal tax rate on long-term gains is 23.8%. Now is a good time to review your situation. Depending on the results, you might want to realize tax losses in the next few months to offset gains or vice versa. Remember that capital losses for the year offset capital gains plus up to $3,000 of ordinary income. Any remaining loss is carried over to the next year.

Make the most of charitable donations. As a general rule, you can deduct the fair market value (FMV) of property you donate to a qualified charitable organization if you have owned the property for more than a year. Many organizations provide guidelines for establishing FMV of used property. Also, any one item with a value over $500, or any aggregation of like items in a year with a value over $5,000, must have a qualified appraisal attached to the return.

Give generous gifts to “grads and dads.” If your child graduated from college this year, you may still be entitled to a $3,950 dependency exemption for the child if you provide more than half of his or her support in 2014. Figure out how much more support you must give to push you over the halfway mark, and give it as a gift. This is likely the last time you will qualify for the exemption. For an elderly parent, you may claim the exemption only if the parent does not have more than $3,950 in gross income, and you pass the half-support test.

Sell real estate on installment sale basis. Generally, you can defer tax on the sale of real estate if you receive payments over a period of 2 years or longer. Not only do you stretch out the tax liability over time but you might also reduce the effective tax rate if you stay below the thresholds for capital gains and its accompanying 3.8% surtax, if applicable.

Contribute to retirement plans. You might reduce your 2014 tax liability by systematically increasing contributions to a 401(k) plan. For 2014, you can elect to defer as much as $17,500 to your account or $23,000 if you are age 50 or older.

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Split income with the family. When it otherwise makes sense, you can transfer income-producing property such as securities or real estate from the highly taxed older generation to the lower-taxed younger generation. This not only reduces the regular income tax bill but it might avoid or reduce the 3.8% surtax for investors. Furthermore, taxpayers in the lowest two income tax brackets of 10% and 15% can benefit from a 0% tax rate on long-term capital gains. Watch out for the “kiddie tax” that may apply if the unearned income of certain dependent children exceeds $2,000 in 2014.

These are just some of the tax-saving ideas to contemplate during the year. Other strategies specific to your own situation may also be available. Consider arranging a meeting with your tax advisers to work out the details of a proactive plan that is appropriate for your particular situation.

How much and what should be kept in an emergency fund?

As a rule of thumb, your emergency fund should consist of liquid assets (eg, cash, savings, certificates of deposit with a maturity date of less than a year) and should be equal to the amount of 3 to 6 months’ worth of both fixed and variable expenses.

Fixed expenses consist of your monthly mortgage including real estate tax, health/auto insurances, student or other loan payments, and funds necessary for food and utilities. Variable expenses consist of expenses incurred for travel, entertainment, household items, and amounts placed in your savings or investment accounts.

The basic purpose of creating an emergency fund is to give you access to a sufficient amount of available funds without the hassle of liquidating investments at an inopportune time. An emergency fund also permits you to use your resources during a crisis without getting further into debt.UT

Want more Money Matters? Check out these recent installments:

Second marriage: Know the financial implications

Real estate: Know your investment options

Save estate tax costs with exemption portability

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