As the year comes to an end, it’s important to start planning your 2021 taxes to reduce your obligations wherever possible. Thinking about your taxes before it’s time to file will allow you to make the most of the deductions and strategies available to you so you can minimize your tax burden. After another unprecedented year of the continued pandemic and an uncertain economy comes to a close, it’s important to keep up with policy changes that could affect your tax rates in the future.
President Biden’s Build Back Better plan has yet to be finalized, but the current version includes several provisions that will impact taxes for both higher and lower-income Americans. The expanded Child Tax Credit will continue in 2022, as will expanded eligibility for the Earned Income Tax Credit. The limit for the state and local tax deduction will increase substantially from $10,000 to $80,000, and this increase will apply to the 2021 tax year as well. Those with high incomes should be aware of the proposed 5% surcharge on income greater than $10 million. The plan also includes decreased contributions and increased minimum distributions for IRAs with balances greater than $10 million.
With these proposed tax changes in mind, here are 6 year-end tax planning tips to consider at the end of 2021 to reduce your tax obligations in the new year.
The various options for tax-deductible accounts are important tools for both saving for the future and reducing your tax bill now. You can only contribute to a 401(k) for this tax year until December 31st, so make sure to contribute as much of the current $19,500 limit as possible now. Those over 50 can contribute an additional $6500. Contributions to traditional IRAs can be made until April 15th.
For those with high-deductible health insurance plans, health savings accounts allow $3600 for individuals and $7200 for families in deductible contributions. Using a 529 plan to save for future education expenses can help you save on state taxes. There’s no federal deduction, but states will usually allow you to deduct these contributions. In addition, 529 plans grow tax-free, and the funds can be withdrawn tax-free for qualifying educational expenses.
The 2020 CARES Act provision that allowed $300 in charitable donations to be deducted without itemizing has been extended to 2021. The deduction limit is per person, so couples filing jointly can deduct up to $600 total. If you itemize, you can deduct up to 100% of your adjusted gross income for charitable contributions in 2021.
If you have stocks or cryptocurrency that have lost value, you can sell them and deduct up to $3000 in losses. For stocks, you need to be aware of the wash sale rule, which prohibits buying the same stock again within 30 days of selling. This rule does not yet apply to cryptocurrency, but that is likely to change in 2022. Therefore, if you’ve lost on cryptocurrency, this is a good opportunity to take advantage of this deduction.
Converting some of your retirement savings from a traditional to a Roth IRA could be a smart move if you expect your taxes to increase in the future. Roth IRAs use post-tax money and don’t have required minimum distributions, so they can be a good way to save on taxes during retirement. This is also something to consider if you have a large traditional IRA with a balance of over $10 million. Upcoming tax changes could limit contributions and increase required minimum distributions to these accounts.
Consider Capital Gains
In some cases, selling stocks that have increased in value and paying capital gains taxes is a good strategy. If you’re in a low federal tax bracket, you may not need to pay capital gains tax. Even if you’re in a higher tax bracket, selling stocks that are doing well and then re-buying them can be a good long-term tax move. The sale resets the baseline price of the stock, which can reduce capital gains taxes in the future. In addition to the potential tax benefits, selling can benefit your overall investment strategy by allowing you to rebalance your portfolio.
Remember Required Minimum Distributions
If you’re retired, age 72 or older, and have a 401(k) or traditional IRA, you need to take a required minimum distribution (RMD) from your retirement accounts each year and pay income taxes on that money. This requirement was suspended in 2020, but it is in place for 2021. If you haven’t already taken this year’s RMD, make sure to do so before the end of the year. The size of the RMD depends on the size of the retirement account, so the amount and the resulting tax obligation can be significant for some. However, failing to take the required distribution leads to paying a penalty of 50% of the shortage.
Combining these strategies will help you save as much on your 2021 taxes as possible, while also maximizing your savings and ensuring that your investments are in good shape. Preparing for tax season now will make sure that you can enjoy as much of your 2021 income and earnings as possible and that you’ll feel prepared to focus on your continued success in 2022.
Brian Menickella is a co-founder and managing partner at The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, PA.
Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available in investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.