Tax Planning

22 Tax Moves to Make Before Year End

22 Tax Moves to Make Before Year End

With just a few weeks left in 2021, you may think you're too late to optimize your tax savings. The truth is that there are literally dozens of smart steps you can take to either reduce the amount that you owe or to set yourself up to do so in 2022. 

We've assembled a list of top tax strategies that you still have time to put into motion. They're in no particular order, but take note that in some cases, the next month or so represents the last opportunity you'll have to use them, as they expire at the end of 2021. Others may not apply based on your income, age, or individual circumstances. All are worth a quick read so that you can be sure you've put yourself in the best possible position once April 15th rolls around. 

Make Sure You've Paid What You Owe – One of the most frustrating bits of news that any taxpayer can get is that they owe penalties because they didn't withhold or prepay the amount that they owed. This can happen to W-2 employees who used the wrong filing status for withholding purposes or whose circumstances changed, or even whose employers have withheld the wrong amount. For the self-employed, it is a matter of failing to submit estimated quarterly taxes, or not having paid enough. One way or another, if you check the amount you've withheld to date, and find that it falls short of your anticipated 2021 tax, then there is still time to reduce the penalty you'll be subjected to. If you're self-employed you can only reverse your fourth-quarter penalty because it is applied quarterly to the estimated payments, but withholding is a different story. If you ask your employer to withhold more for the rest of the year you can balance out your shortfall, or depending on what you owe, it may be worthwhile to take the 10% penalty hit (plus tax owed) on a non-qualified distribution from your pension plan. 

Lower Your Federal Tax by Prepaying State and Local Obligations – If you pay estimated quarterly taxes to your state, in most cases the fourth-quarter payment for 2021 is due in January. You can send in your fourth-quarter payment before the end of 2021 and deduct the amount you've pre-paid on your 2021 federal taxes. The same is true for W-2 employees who ask their employer to increase the amount they're withholding on their state income tax in the last quarter of the year. You can also pay some of your 2022 real estate tax bill early to the same effect. However itemized personal state and local tax deductions are currently limited to no more than $10,000. Pending legislation, expected to pass before the end of the year, may substantially increase that limitation.

Double-Check Your Qualified Tuition Credit Amount – Does the amount you've paid in 2021 for qualified higher-education tuition and related expenses fall short of the maximum credit for the Lifetime Learning Credit (LLC) or American Opportunity Tax Credit (AOTC)? You can pre-pay any amount of the tuition for an academic period that begins in the first three months of 2022 in 2021 and apply the amount to bring the 2021 credit up to the max. 

Consider Actively Cutting Your 2021 Income – It may sound like a crazy idea … after all, the goal is always to make more money. But with the amount you're taxed directly tied to the amount that you earn, it may be worth pushing some of your 2021 income into 2022 if you've had a particularly good year – and especially if you think that next year won't be as good. If you're planning on retiring next year or have some other reason to expect a big drop in your income that will result in a lower tax bracket in 2022, then asking your company to delay paying its year-end bonus until January (or if you're self-employed sending your statements out late so that you don't get paid until 2022) may make good sense. You can also cut your 2021 income by waiting to take capital gains until next year.

Optimize the Value of Your Health Savings Account – The Health Savings Account is one of the most underappreciated ways of saving taxes and growing a supplemental retirement plan, and should be included in your tax considerations every year. If you're new to your HSA, make sure that you've contributed the maximum amount allowed for the year – even if you just became eligible in the last few weeks, you're able to contribute the full years' worth, and your contributions are deductible. Contributions made by your employer (within IRS-prescribed limits) are nontaxable and the earnings in the HSA account are both tax-deferred and tax-free if they're used for qualified medical expenses. This includes prescription medications, menstrual products, and over-the-counter medications, and other covered medical expenses if they were incurred after the HSA was in place. Unused contributions and earnings carry over indefinitely and can even be used as a supplemental retirement fund, and although taxable when withdrawn for other than medical purposes, would not be subject to a penalty after reaching age 65.

Check Your Health Spending Account Coverage – A Flexible Spending Account is a great employee benefit, but its value is limited by the amount that you've taken advantage of it. The program allows you to set aside up to $2,750 in 2021 to cover expenses for covered medical expenses and care, which includes menstrual care products and unprescribed (or prescribed) over-the-counter medications. If you spent more than you set aside, consider changing your contribution amount for next year. But be careful, since 2021 plans can only allow either a 2½ month carryover of unused contributions from one year to the next or a $550 carryover. 

Roth Vs Traditional IRAs - Did you know that a Roth IRA offers tax-free accumulation and tax-free distributions at retirement? This is a considerable advantage over a traditional IRA, but the tax hit of transitioning from one to the other can be prohibitive if you're in a high tax bracket. Conversely, if your income is significantly lower this year — as has been the case for many — use the drop to reduce the tax hit and make the move. You'll be glad you did.

Turned 72 This Year? Welcome to the Age of Minimum Required Distributions – Remember all those years you struggled financially but refused to touch your IRA or 401K? Saving assiduously for retirement is a good thing, but once you hit the age of 72 you are required to begin taking distributions over your lifetime or face a 50% penalty on the difference between the amount that you were supposed to withdraw and what you did withdraw. Though you could postpone your first distribution if you turned 72 during 2021, you only have until the first quarter of 2022 – and waiting ‘til then may not be smart considering you'll also have to take the 2022 distribution before the end of 2022 – potentially doubling your tax that year.

Maximize Itemized Deductions By “Bunching” – The big boost that the standard deduction got a few years ago had a significant impact on the ability to itemize and take tax deductions, but that doesn't mean that it's impossible. One way to get over the hurdle is to time your deductible items (whether charitable contributions, medical expenses, or any other itemized deduction) so that they are all bunched together every other year. This bunching strategy allows you to alternate between the standard deduction and taking itemized tax deductions.

Take the Loss on Your Loser Stocks – Even with a booming stock market, there's a good chance you have a couple of stinkers in your portfolio. If you need to lower your income (and therefore your income taxes) consider selling off the losers so that the decline in value can offset some of your gains. Taxpayers are limited to just $3,000 per year of net capital losses that can be used to reduce ordinary income (half that if married filing separately), but any loss that's left over can be applied in the future. If you have an interest in continuing to own the stock, you can always repurchase it thirty-one or more days after your sale and still get the benefit of the loss. 

Use the Zero Capital Gains Rate, If You Can - If your 2021 taxable income fell below the 15% capital gains tax threshold (taxable income of $80,800 if filing joint, $54,100 if head of household or $40,400 for others) but the securities you've owned for over a year grew in value, now would be a smart time to sell them. That's because your income level provides you with a zero long-term capital gains rate as long as you held the stock over one year. How great would it be to realize a big gain without having to pay any taxes on the gain?

Maximize Your Retirement Savings – No matter what your financial position, tax-deferred retirement accounts should be used to the greatest extent possible, and this is especially true for 401(k) plans with employer-provided matching contributions. Not only do they represent free money (with your company putting in whatever amount they choose for every dollar that you contribute), but they also grow and compound over time without being taxable until you withdraw the funds after retirement – and presumably when you're at a lower income tax bracket. The maximum amount of money that you can put into a 401(k) for 2021 is $19,500 unless you're over the age of 50, in which case it is $26,000. Though not everybody can afford to set aside that much of their income, you should put away as much as possible, or at least contribute up to the maximum amount that your employer will match.

Of course, 401(k) plans are not the only retirement option. Taxpayers with earned income can also contribute up to $6,000 ($7,000 if age 50 or older) to either a Traditional IRA or a Roth IRA. Traditional IRA contributions can be tax deductible, even for taxpayers who are active participants in an employer plan, but the deductibility phases out for higher income taxpayers who also are part of an employer's retirement plan. Traditional IRAs, except for amounts not deductible, are taxable when withdrawn.  On the other hand, Roth IRA contributions are never deductible, but the distributions are tax free after age 59½ and a 5-year holding period is met. IRA contributions for 2021 can be made up to April 15, 2022.

Self-employed individuals can establish a variety of retirement plans including SEPs, Keoghs, and 401(k)s, the most common being SEPs for those without employees.   

Remember, Your Kids' Investment Income Can Be Taxed at Your Rate

We all want to help our children, but parents who've set aside stock in their kids' names may be doing them more harm than good if they sell at a big profit. That's because of the “kiddie tax” that Congress enacted to stop wealthy parents from trying to evade their own tax bills by putting their investments into their kids' names. The end result is that if you sell your kids' investments and their income is over $2,200, they're going to be taxed at your tax rate, even if they don't have any other source of income.

Community Investment Can Defer Capital Gains – Did you know that if you realize a capital gain from selling property, you can defer the tax implications by investing the gain into a qualified opportunity fund? These funds aim at developing areas in need of investment, and as long as you move your gains into the fund within 180 days of your sale or exchange, your taxes on the original gain will be deferred until 2026 or the year that the QOF gets sold – whichever comes first. If you keep your money in the QOF for the full period of time your gain will be discounted by 10%, and if you hold it for ten years you won't pay any tax at all on any additional gain.

Take Advantage of the Annual Gift Tax Exemption –You have until the end of 2021 to take advantage of the year's annual gift tax exemption, the maximum of which is currently set at $15,000 each for as many recipients as you wish to give to. This amount applies to each spouse of a married couple, bringing the potential total available for each recipient to $30,000, and likewise the same amount of income is then eliminated from your estate.  But there is no opportunity to carry over unused exemptions.

Maximize Transfers from Your IRA to a Charity –Once you reach age 70½ you can eliminate the taxes on an IRA distribution by asking the fund's trustee to transfer the monies directly to a charity. Though you will not be able to itemize the distribution as a charitable deduction, if you are 72 or over you can classify it as part of your annual required minimum distribution.  Despite losing the itemized deduction, making a direct transfer to the charitable organization has the advantage of reducing your AGI, and that may mean lower income taxes. There is an annual maximum of $100,000 that you can transfer, and those who are 72 or over may need to check with their tax professional if they have wages or self-employment income and contribute to their IRA in the same year.

It May Make Sense to Pay Off Your Medical Bills – If your medical expenses for 2021 come close to or are already over the itemization threshold of 7.5% of your adjusted gross income, then it makes sense to pay off any remaining medical or dental bills, even if they are not yet due. Even if you can't afford to pay them right away, putting them on a credit card that you can pay off in 2022 may be a smart move if the amount you'll pay in interest is lower than the benefit you'll realize by being able to deduct the expenses from your 2021 taxes. But keep in mind that there isn't a tax benefit in doing this unless your overall itemized deductions total is more than the standard deduction for your tax filing status.

Expedite Your Business Expenses – If you want to lower your business's tax liability for 2021, consider buying office equipment, machinery, vehicles, or tools in order to take advantage of Sec. 179 expensing or the 100% bonus depreciation available. In order to do this, you must use the acquisitions by December 31, 2021, and no business acquisitions should be pursued without giving consideration to how doing so will impact your Sec. 199 20% pass-through deduction and your taxable income.

Disaster-Related Losses Lead to Additional Claims – Hurricanes, wildfires, and other natural disasters are all-too-common, and though tax refunds can't make up for grief and suffering, they can help to replace much of what has been lost. If you suffered a significant disaster-related loss, make sure you have help identifying the tax return year that will provide you with the greatest benefit, and don't forget that insurance compensation will offset the deductible amount to which you are entitled.

Understand the Ins and Outs of Charitable Contributions – Almost all American income tax return filers do not itemize, but even so, in 2021 they are permitted to deduct up to $300 individually or $600 on a joint return for charitable cash contributions when they do not itemize. This is also the last year that cash contributions up to 100% of adjusted gross income (increased from 60%) can be deducted.

Green Credits Can Be Significant – The government offers a green credit of 26% of the cost of a functional solar energy system installed in 2021 if its installation is complete by year's end, as well as a specific credit for electric vehicles that depends upon vehicle make and model and the cumulative number of vehicles sold by the manufacturer. Pending legislation in Congress may enhance these credits starting in 2022.

Even at this late point in the year, there are many opportunities available for tax savings. For a complete review of the strategies available to you, contact our office today.

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Steward Financial

Steward Financial

Jon Osborn is a tax preparer based in San Dimas, California. His company, Steward Financial Services, offers a broad range of tax preparation, accounting and business consulting for small businesses. He loves to work with clients who are looking for answers to complex tax and business planning issues. He has owned several small businesses and worked with over one hundred small business owners. He helps his individual and business tax clients find the best ways to spend their money in order to minimize IRS tax. Small businesses looking to grow, sell or just increase cash flow are one of Jon's specialties.

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