As 2021 draws to a close, it's time to start thinking about tax moves that will help decrease your overall tax burden come April, especially since most tax deductions and credits are based on actions you take before Dec. 31. With the end of the year approaching rapidly, here are some money-saving and housekeeping moves to consider.
Donating to a charity doesn't just help a worthy cause; it provides a tax deduction for itemizers. So long as donations go to a 501(c)(3) organization, "a taxpayer can now deduct cash donations up to 60% of adjusted gross income, which is up from 50% in 2017," says Andrew Cohen, senior tax manager at Friedman, a New York accounting firm. That goes up to 100% of AGI if the gifts you make are in cash. (Taxpayers who don't itemize can still take $300 for an individual or $600 for a couple filing jointly.) For property donations, the deduction is generally 60% of your adjusted gross income, but beware the exceptions. Some rules are in place only through 2021 because of a pandemic-inspired Taxpayer Certainty and Disaster Tax Relief Act.
The tax code still allows for preferential treatment on the sale of capital assets. "The maximum capital gains rate is currently 20% plus the 3.8% Net Investment Income Tax," Cohen says. "Take advantage of these low rates now, as there's a possibility that the capital gains rate may increase in the years to come." The rate for most taxpayers is typically even lower, at 15%, and there are some instances when capital gains may not be taxed at all (if an individual’s taxable income is less than $40,400 or a couple’s is less than $80,800). The 20% tax rate on net capital gains applies to individuals earning more than $445,850 a year and married filing jointly with income over $501,600.
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The Tax Cuts and Jobs Act of 2018 created Qualified Opportunity Zones, a program allowing taxpayers to defer payment of capital gains tax until the 2026 tax year if those gains are invested in specific "opportunity zones" that would benefit from economic development and job creation. Opportunity zones exist in all 50 states as well as the District of Columbia and some U.S. territories and weren't changed by the Census — but make those investments by the end of 2021 to qualify for five-year benefits that will be calculated in at the end of 2026.
If you're self-employed, you can contribute up to $58,000 to a SEP IRA before year's end. "The amount of the contribution to a SEP is a reduction to income, which has an effect of reducing the taxpayer's adjusted gross income dollar for dollar by the amount of the contribution," Cohen says.
One of the most popular and simplest ways to reduce taxable income before year's end is to max out allowable 401(k) contributions. "Of course, this will provide a boost for your retirement, but as a bonus, qualified contributions will lower your taxable income for the year," says Scott Butler, financial planner at Klauenberg Retirement Solutions in Laurel, Maryland. For 401(k), 403(b), and many 457 plans, as well as the federal government's Thrift Savings Plan, the annual contribution limit is $19,500. (People 50 or older can put in an an additional $6,500 in catch-up contributions.)
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Rather than waiting to find out from your accountant what your tax bill might be for this year, use the IRS' withholdings estimator to estimate how much you will owe or get on your tax return. "The estimator will also give you a suggestion for your future withholdings," Butler says.
Freelancers or independent contractors may want to consider holding off on invoicing clients for work until December. "If individuals delay any billing until December, they generally do not receive the income until January," says Logan Allec, a CPA and owner of the website Money Done Right. This would delay paying taxes on the income for another year.
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If capital gains from investments are moving your gross income into a higher tax bracket, consider tax loss harvesting before the end of the tax year, says tax analyst Eileen Maki of FitSmallBusiness.com. An investment that will experience a net loss can be sold, resulting in a capital loss that offsets other capital gains during the same tax year.
If you don't contribute enough to charities in one calendar year to make it worthwhile to itemize, consider making several years' worth of contributions all at once, Allec suggests. By bunching charitable contributions into one year, your itemized deductions may be more likely to exceed the standard deduction — for married filing jointly, $25,100; for single taxpayers, $12,550; and for heads of households, $18,800.
Compiled by the Congressional Joint Committee on Taxation, the list of expiring tax provisions is fairly easy to interpret for non-tax professionals and good to review regularly , says George Birrell, creator of Taxhub, a virtual tax prep platform. "It can give you a lot of new ideas for future spending. It will also give you a chance to review some tax credits that you may have not taken in the past and may still be able to take," Birrell says.
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Donating valuable stocks to charity provides two tax benefits in one. "You avoid the capital gains tax of the stock, and you get an itemized deduction for the appreciated value of the stock," Birrell says. "Just remember that this is limited to 30% of your adjusted gross income."
If you have a qualified high deductible health plan, are not enrolled in Medicare, and are not claimed as a dependent on someone else's tax return, you may contribute up to $7,200 to a health savings account as part of a joint tax return ($3,600 for single filers) to lower your taxable income. The money you put into a health savings account can be used in the current year or saved for retirement, says Ben Watson, a CPA and the CFO of DollarSprout. The key takeaway is that no matter when you use it, the contributions are tax-deductible, meaning they will reduce your federal income taxes owed.
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For those who are self-employed, it's a good idea to sit down and review your business income before year-end. "Subtract your deductible expenses from your total income to find your taxable net income, and then do a projection for the final months of the year to come up with a rough idea of what you might end up owing or receiving as a refund," says Dave Du Val, chief customer advocacy officer for TaxAudit. "If it looks like you're going to owe, you can start making estimated payments now — or make higher estimated payments to make up the difference if you're currently making estimated payments."
If you're retired, take a careful look at your financial needs for the rest of the year. Then, withdraw only what you need from retirement accounts to keep your tax bracket as low as possible and minimize the amount you'll owe in taxes. "Retirement plan funds that are distributed from tax-deferred accounts, such as traditional IRAs and traditional 401(k) plans, are taxed at ordinary income tax rates, and the tax bracket you're in depends on all of your taxable income for the year," Du Val says. "This is why it makes sense to take only what you need, so that your distributions don't push you up into a higher tax bracket."
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Did you pay for college or school expenses this year? There may be credits available to you. The IRS provides tax credits for qualified education expenses incurred by you, your spouse, or a dependent. There are two types of tax credits available — the American Opportunity Tax Credit (for students during the first four years of higher education) and the Lifetime Learning Credit, which applies to undergraduate, graduate, and professional degree courses and related expenses. Be sure to keep receipts and be on the lookout for a 1098-T form from the educational institution. "You'll need this to do your taxes when the time comes, as well as receipts for required supplies and equipment," Du Val says.
If you have the free cash available, make an extra mortgage payment before the end of 2021. For instance, by making the mortgage payment that's due Jan. 1 before the end of December instead, you can include the interest payment as part of your itemized deductions for 2021's tax returns. "If you wait until the new year to pay the January payment, it will be included in next year's deductions," Watson says. "This is essentially borrowing a future deduction and using it this year, but could be helpful if you're right on the line of qualifying for other tax breaks by staying under a certain taxable income."
Want to be more environmentally conscious and score a tax break in the process? Consider installing solar panels on your property. Those who do so may be eligible for a tax credit. The Energy Policy Act of 2005 began the practice of allowing eligible consumers to earn a tax credit of up to 26% of the cost you paid to have solar panels installed on your property, says tax analyst Eileen Maki of FitSmallBusiness.com. Known as the Investment Tax Credit, the measure was an incentive provided by the government to help trigger installation of solar systems nationwide. Review the information on the IRS website to see if you quality.
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Taxpayers who are 72 and older should review the Required Minimum Distributions associated with their retirement accounts to avoid steep tax penalties, Du Val says. That penalty can be as much as 50% for those who fail to take required distributions, which are the minimum amount the IRS requires individuals to withdraw from retirement funds in a calendar year. Some of the accounts covered by this rule include IRAs, SEP IRAs, and SIMPLE IRAs. Roth IRAs do not require such withdrawals until after the owner of the account has passed away.
If you have health insurance through a state or federal marketplace, you may be getting the advance premium tax credit. The amount is based on the income estimates you made when signing up, explained Nathan Rigney, lead tax research analyst at The Tax Institute at H&R Block. If your income has changed throughout the year, the amount of the credit you qualify for may no longer be accurate. "To avoid having to repay the advance credit, notify the marketplace of any changes to household or income," Rigney says.
Who doesn't love a bonus at year's end? But if that extra money bumps you into a higher tax bracket, the bonus may not be so wonderful. "It's common for the employee to request that the bonus not be paid out until January of the next year," Birrell says. "Doing this will essentially defer the taxes due on this bonus for a whole year." This particular approach is useful for those who might see their income decline somewhat in the year ahead.
Have you paid a ton of out of pocket medical expenses this year? The IRS allows taxpayers to deduct qualified unreimbursed medical expenses, Birrell says — this year for in excess of 7.5% of adjusted gross income Taxpayers may want to try to bundle medical expenses into one year by prepaying some expenses to maximize the benefit of this tax code provision.
If you're a small business owner, consider ditching worthless equipment or property rather than selling it for a nominal loss — the IRS allows for taking an ordinary loss on your annual return rather than a capital loss. "Ordinary losses are losses from activities that the taxpayer actively engages in, such as starting a business, versus capital losses, which are generated from passive investments such as purchasing land hoping it will increase in value," Birrell says. "From a tax perspective, ordinary losses are always preferred because they can be used to offset ordinary income, which is taxed at much higher rates. Capital losses can only be used to offset capital gains."
