The end of the year is a time for celebration and reflection. It’s also the last chance to make some tax moves that could save you money. This week we’ll look at five ways you can reduce next year’s tax bill if you act now.
Defer Income and Accelerate Deductions
Normal year-end tax planning includes looking for opportunities to defer income until next year. This strategy works particularly well if you think you may be in a lower tax bracket next year. For example, you may be able to defer a year-end bonus or delay the collection of business debts, rents, and payments for services. Doing so may enable you to postpone the tax payment on the income until next year.
You might also look for opportunities to accelerate deductions into the current tax year. If you itemize deductions, making payments for deductible expenses such as medical expenses, qualifying interest, and state taxes before the end of the year (instead of paying them in early 2022) could make a difference on your 2021 return.
Make Deductible Charitable Contributions
In most years, deductions for charitable contributions are limited to a certain percentage of your adjusted gross income. The exact limits depend on the type of property you give and the type of organization to which you contribute. For 2021 charitable gifts, the normal rules have been enhanced: The limit is increased to 100% of AGI for direct cash gifts to public charities. And even if you don’t itemize deductions, you can receive a $300 charitable deduction, or $600 if you file a joint return with your spouse. This special deduction is only available for direct cash gifts to public charities.
Bump Up Withholding to Cover a Tax Shortfall
If it looks as though you will owe federal income tax for the year, consider having your employer withhold additional tax from your paychecks before the end of the year. There may not be much time for employees to request a Form W-4 change and for their employers to implement it in time for 2021. The biggest advantage in doing so is that withholding is considered as having been paid evenly throughout the year. This strategy can be used to make up for low or missing quarterly estimated tax payments and can help you avoid tax penalties.
Maximize Retirement Savings
Deductible contributions to a traditional IRA and pre-tax contributions to an employer-sponsored retirement plan such as a 401(k) can reduce your 2021 taxable income. If you haven’t already contributed up to the maximum amount allowed, consider doing so. For 2021, you can contribute up to $19,500 to a 401(k) plan or $26,000 if you’re age 50 or older. The limits for traditional and Roth IRAs combined are $6,000, or $7,000 if you’re age 50 or older. The window to make 2021 contributions to an employer plan generally closes at the end of the year, while you have until April 15, 2022, to make 2021 IRA contributions.
Weigh Year-End Investment Moves
You shouldn’t let tax considerations drive your investment decisions. However, it’s worth considering the tax implications of any year-end investment moves that you make. For example, if you have realized net capital gains from selling securities at a profit, consider offsetting those gains by selling losing positions. Any losses over and above your gains can be used to offset up to $3,000 of ordinary or carried forward to reduce your taxes in future years.
The possibility of tax hikes next year makes these questions more complicated. For now, the best advice is to do your planning for the rules we have now and be willing to adjust your plan if the tax rules change. Many of these tax moves could save you a considerable amount of money next year. The deadline for most of them is December 31st, so don’t delay. If you have questions about whether you are eligible for these deductions, and how they will fit into your financial plan, contact a CPA Financial Planner today.
Matthew A Treskovich | CFA, CPA/PFS, CITP, CMA, CFP®, AEP®, MBA, CLU, ChFC
Chief Investment Officer