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Tax Prep: 6 Ways to Get a Head Start on Tax Season

Tax filing season may be months away, but there are a few simple steps you should consider taking before the end of the year to help you get organized and to potentially minimize your tax bill.

Here are six steps to consider now:

Double-check your withholding and estimated tax payments: Many people think getting a big tax refund is a good thing. Unfortunately, the IRS does not pay you interest on the refund they send you. Having too much money withheld from your paycheck—or overpaying your quarterly estimated tax payments—means you’re forgoing the potential interest or returns that money could have generated . On the other hand, withholding too little can lead to a large bill at tax time, an unpleasant surprise if you haven’t planned for it. Avoid both scenarios by checking that your withholding is appropriate.

Contribute to your retirement account: Even though you have until Tax Day (April 17th in 2018) to make your annual contribution to a traditional or Roth IRA for the current tax year, early contributions will give your money more time to benefit from potential long-term compound growth. So consider making your 2017 contribution now, and your 2018 contribution early next year.

Take required minimum distributions (RMDs): If you’re age 70½ or older and have to take RMDs from your retirement accounts, you must do so before the end of the year; otherwise, you may have to pay a 50% tax on the amount not distributed. If you turned 70½ this year, you have until April 1st of next year to take your first RMD. However, if you wait until next year to start, you will have two distributions in the same year—which might bump you into a higher marginal tax bracket.

Know your costs before you sell: Savvy investors know that managing cost basis can help them save on taxes. Your cost basis is essentially what you paid for an investment, including brokerage fees and any other trading costs. Your capital gain (or loss) will be the difference between the cost basis and the price at which you sell your securities. In a simple transaction, the cost basis should be easy to calculate.

However, if you buy over time—such as through a dividend reinvestment plan—each block of shares purchased is likely to have a different cost and holding period. Thus, you can pick and choose among the high- or low-cost and long- or short-term shares when you sell, and make the sale work to your best tax advantage. Alternatively, you can go with the default method, which requires zero effort or calculation on your part—but could cost you more in taxes.

Invest tax-efficiently: Make sure your assets are located in the most tax-efficient investment accounts. For example, it makes sense to hold long-term investments in a taxable account, because any gains will be taxed at the lower capital gains rate. The same is true for tax-efficient investments, such as stocks or funds that pay qualified dividends, municipal bonds, and most index funds and ETFs. On the other hand, you’re better off holding short-term investments in tax-advantaged accounts, such as a 401(k) or IRA. Remember, gains on short-term investments are taxed as ordinary income, which is subject to a higher tax rate than capital gains. The same is true for actively managed mutual funds that may generate significant short-term capital gains, corporate bonds, and real estate investment trusts.

Qualified withdrawals from Roth IRAs and Roth 401(k)s are tax-free, so it usually makes sense to use these accounts for assets that you expect will appreciate the most. Of course, tax-efficient placement presumes you have different account types. The overall asset allocation decision comes first. If most or all of your portfolio is in tax-deferred accounts, then just focus on your asset allocation strategy.

Try to limit your exposure to alternative minimum tax (AMT). Every year more and more taxpayers are facing AMT, particularly those in households that have over $200,000 of taxable income,  those who claim multiple dependents or who in live states with high taxes. If you’re one of these taxpayers, consider deferring payment of state and local taxes and accelerating income to the point where you’re no longer subject to the AMT. Also, multiyear planning is a must, so talk to a tax professional.

These are just a few of the steps you can take to prepare for tax season and potentially minimize your tax bill. A qualified tax professional can help you find the best way to navigate tax season, given your personal situation.

After you decide what to do this year, resolve to make financial planning a year-round exercise going forward. That way, it will be easier to check your progress, update your plan and, if necessary, take action long before the tax filing deadline.

What you can do next

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, Financial Planner or Investment Manager.


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