As the end of the year approaches, it’s time to consider strategies that can help you reduce your tax bill. But most tax tips, suggestions, and strategies are of little practical help without a good understanding of your current tax situation. This is particularly true for year-end planning. You can’t know where to go next if you don’t know where you are now. As one of San Francisco’s top CPA firms, we work hard for our clients throughout the year so that they know where they stand. This helps immensely with tax planning!
Regardless of how prepared you are, take a break from the usual fall chores and pull out last year’s tax return, along with your current pay stubs and account statements. Doing a few quick projections will help you estimate your present tax situation and identify any glaring issues you’ll need to address while there’s still time. If you are a San Francisco resident, feel free to give us a call at 415-742-4949 or email us for a free phone consult.
Withholding and San Francisco: Don’t Shortchange Yourself
San Franciscans love to live in their city, despite its expense. But living here is expensive, and many have to have a very high income to live a nice lifestyle; so that high income creates a need (unfortunately) to pay relatively higher taxes. If you’ve recently moved into the Bay Area and boosted your income, you might now be witholding enough.
If you project that you’ll owe a substantial amount when you file this year’s income tax return, ask your employer to increase your federal income tax withholding amounts. If you have both wage and consulting income and are making estimated tax payments, there’s an added benefit to doing this: Even though the additional withholding may need to come from your last few paychecks, it’s generally treated as having been withheld evenly throughout the year. This may help you avoid paying an estimated tax penalty due to underwithholding.
Of course, if you’ve significantly overpaid your taxes and estimate you’ll be receiving a large refund, you can reduce your withholding accordingly, putting money back in your pocket this year instead of waiting for your refund check to come next year. If you get a nice tax refund, then you can go splurge on one of the many wonderful restaurants San Francisco has!
AMT Taxes and the High Cost of San Francisco Bay Area Living
Originally intended to prevent the very rich from using “loopholes” to avoid paying taxes, the alternative minimum tax (AMT) snags more and more middle-income taxpayers every year, since (unlike regular income tax) it doesn’t keep pace with inflation. Unfortunately, because we live in the high tax state of California and the cost of living is so high in San Francisco, many residents have artificially high incomes and artificially high taxes paid to state and local govenrments. This may put you in the land of AMT. We’d need to look at your returns, and there are smart ways to tax plan to try to avoid, or minimize, the damage of the dreaded AMT.
The AMT is governed by a separate set of rules that exist in parallel to those for the regular income tax system. These rules disallow certain deductions and personal exemptions that you are allowed to include in computing your regular income tax liability, and treat specific items, such as incentive stock options, differently. As a result, AMT liability may be triggered by such items as:
- Large numbers of personal exemptions
- Large deductible medical expenses
- Large deductions for state, local, personal property, and real estate taxes (This one especially hits Californians hard!)
- Home equity loan interest where the financing isn’t used to buy, build, or improve your home
- Exercising a large incentive stock option
Large amounts of miscellaneous itemized deductions such as unreimbursed employee business expenses
So when you sit down to project your taxes, calculate your regular income tax on Form 1040, and then consider your potential AMT liability using Form 6251. If it appears you’ll be subject to the AMT, you’ll need to take a very different planning approach during the last few months of the year. Even some of the most basic year-end tax planning strategies can have unintended consequences under AMT rules. For example, accelerating certain deductions into this year may prove counterproductive since AMT rules may require you to add them back into your income. See a tax professional for information on your specific tax situation.
Timing is Everything in the Bay Area
The last few months of the year may be the time to consider delaying or accelerating income and deductions, taking into consideration the impact on both this year’s taxes and next. If you expect to be in a different tax bracket next year, doing so may help you minimize your tax liability. For instance, if you expect to be in a lower tax bracket next year, you might want to postpone income from this year to next so that you will pay tax on it next year instead. At the same time, you may want to accelerate your deductions in order to pay less tax this year.
To delay income to the following year, you might be able to:
- Defer year-end bonuses
- Defer the sale of capital gain property (or take installment payments rather than a lump-sum payment)
- Postpone receipt of distributions (other than required minimum distributions) from retirement accounts
To accelerate deductions into this year:
- Consider paying medical expenses in December rather than January, if doing so will allow you to qualify for the medical expense deduction
- Prepay deductible interest
IRS Circular 230 Notice
The Internal Revenue Service requires Safe Harbor LLP to inform the reader that any tax advice contained in this correspondence cannot be used for the purpose of avoiding penalties under the Internal Revenue Code or for promoting, marketing or recommending to another party any transaction or matter addressed.