Year-End Tax Planning Strategies for Individuals
With the end of the year fast approaching, now is the time to take a closer look at tax planning strategies you can use to minimize your tax burden for 2021.
General Tax Planning Strategies
General tax planning strategies for individuals include accelerating or deferring income and deductions, as well as careful consideration of timing-related tax planning strategies concerning investments, charitable gifts, and retirement planning. For example, taxpayers might consider using one or more of the following strategies:
Investments. Selling any investments on which you have a gain (or loss) this year. For more on this, see Investment Gains and Losses, below.
Year-end bonus. If you anticipate an increase in taxable income this year, in 2021, and are expecting a bonus at year-end, try to get it before December 31. Contractual bonuses are different, in that they are typically not paid out until the first quarter of the following year. Therefore, any taxes owed on a contractual bonus would not be due until you file your 2022 tax return in 2023. Don’t hesitate to call the office if you have any questions about this.
Charitable deductions. Bunching charitable deductions (scroll down to read more about charitable deductions) every other year is also a good strategy if it enables the taxpayer to get over the higher standard deduction threshold under the Tax Cuts and Jobs Act of 2017 (TCJA). Under the CARES Act of 2020, this year (2021) eligible individuals may take an above-the-line deduction of up to $600 in cash for charitable contributions made to qualified charitable organizations. Cash contributions are those that are paid with cash, check, electronic fund transfer, or payroll deduction. Taxpayers can claim the deduction even if they do not itemize on their 2021 taxes.
Medical expenses. Medical expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income (AGI), therefore, you might pay medical bills in whichever year they would do you the most tax good. To deduct medical and dental expenses in 2021, these amounts must exceed 7.5 percent of AGI. By bunching medical expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing the deduction.
Stock options. If your company grants stock options, then you may want to exercise the option or sell stock acquired by exercising an option this year. Use this strategy if you think your tax bracket will be higher in 2021. Generally, exercising this option is a taxable event; the sale of the stock is almost always a taxable event.
Withholding. If you know you have a set amount of income coming in this year that is not covered by withholding taxes, there is still time to increase your withholding before year-end and avoid or reduce any estimated tax penalty that might otherwise be due.
Accelerating or Deferring Income and Deductions
Strategies that are commonly used to help taxpayers minimize their tax liability include accelerating or deferring income and deductions. Which strategy you use depends on your current tax situation.
Most taxpayers anticipate increased earnings from year to year, whether it’s from a job or investments, so this strategy works well. On the flip side, however, if you anticipate a lower income next year or know you will have significant medical bills, you might want to consider deferring income and expenses to the following year.
In cases where tax benefits are phased out over a certain adjusted gross income (AGI) amount, a strategy of accelerating income and deductions might allow you to claim larger deductions, credits, and other tax breaks for 2021, depending on your situation. Roth IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest are examples of these types of tax benefits.
Accelerating income into 2021 is also a good idea if you anticipate being in a higher tax bracket next year. This is especially true for taxpayers whose earnings are close to threshold amounts that make them liable for the Additional Medicare Tax or Net Investment Income Tax ($200,000 for single filers and $250,000 for married filing jointly). See more about these two topics, below.
Examples of accelerating income include:
• Paying an estimated state tax installment in December instead of at the January due date. However, make sure the payment is based on a reasonable estimate of your state tax.
• Paying your entire property tax bill, including installments due in 2022, by year-end. This does not apply to mortgage escrow accounts.
• Paying 2022 tuition in 2021 to take full advantage of the American Opportunity Tax Credit, an above-the-line tax credit worth up to $2,500 per student that helps cover the cost of tuition, fees, and course materials paid during the taxable year. Forty percent of the credit (up to $1,000) is refundable, which means you can get it even if you owe no tax.
Property, as well as money, can be donated to a charity. You can generally take a deduction for the fair market value of the property; however, for certain property, the deduction is limited to your cost basis. While you can also donate your services to charity, you may not deduct the value of these services. You may also be able to deduct charity-related travel expenses and some out-of-pocket expenses, however.
Keep in mind that a written record of your charitable contributions - including travel expenses such as mileage - is required to qualify for a deduction. A donor may not claim a deduction for any contribution of cash, a check, or other monetary gift unless the donor maintains a record of the contribution in the form of either a bank record (such as a canceled check) or written communication from the charity (such as a receipt or a letter) showing the name of the charity, the date of the contribution, and the amount of the contribution.
Other Year-End Moves
Roth Conversions. Converting to a Roth IRA from a traditional IRA would make sense if you’ve experienced a loss of income (lowering your tax bracket) or your retirement accounts have decreased in value. Please call if you would like more information about Roth conversions.
Maximize Retirement Plan Contributions. If you own an incorporated or unincorporated business, consider setting up a retirement plan if you don’t already have one. It doesn’t need to be funded until you pay your taxes, but allowable contributions will be deductible on this year’s return.
If you are an employee and your employer has a 401(k), contribute the maximum amount ($19,500 for 2021), plus an additional catch-up contribution of $6,500 if age 50 or over, assuming the plan allows this, and income restrictions don’t apply.
If you are employed or self-employed with no retirement plan, you can make a deductible contribution of up to $6,000 a year to a traditional IRA (deduction is sometimes allowed even if you have a plan). Further, there is also an additional catch-up contribution of $1,000 if age 50 or over.
Health Savings Accounts. Consider setting up a health savings account (HSA). You can deduct contributions to the account, investment earnings are tax-deferred until withdrawn, and any amounts you withdraw are tax-free when used to pay medical bills.
In effect, medical expenses paid from the account are deductible from the first dollar (unlike the usual rule limiting such deductions to the amount of excess over 10 percent of AGI). For amounts withdrawn at age 65 or later not used for medical bills, the HSA functions much like an IRA.
To be eligible, you must have a high-deductible health plan (HDHP), and only such insurance, subject to numerous exceptions, and you must not be enrolled in Medicare. For 2021, to qualify for the HSA, your minimum deductible in your HDHP must be at least $1,400 for self-only coverage or $2,800 for family coverage.
529 Education Plans. Maximize contributions to 529 plans, which can now be used for elementary and secondary school tuition as well as college or vocational school.
Don’t Miss Out.
Implementing these strategies before the end of the year could save you money. If you are ready to save money on your tax bill, please contact the office today.