With Halloween now behind us, we enter the winter “holiday-plex” that spans from now to New Year’s Day. Before we know it, the 2021 tax year will be ending, and the hours are ticking away for taxpayers who want to minimize the tax bill they will pay in the spring. To be effective, any money-saving tax strategy needs to be implemented by December 31st.
There is no single strategy that will work for everyone. Real tax planning is specific to each individual taxpayer. However, you may want to get a jump on things by using these tax tips to minimize the amount of your 2021 federal income tax:
• Max out your HSA and 401(k) contributions
• Determine if you have RMDs for 2021
• Take a hardship withdrawal if you need it
• If you can pay the tax bill now, you can convert funds in a traditional IRA to a Roth IRA
• You may want to hold off on mutual fund purchases
• Take advantage of capital losses by “harvesting” them for tax purposes
• If you find yourself in a low tax bracket situation, pick up your capital gains
• Consider making purchases for your business
• Combine your charitable contributions to create a larger tax deduction
• Meet with your tax and/or financial advisor
1. Max Out 401(k) and HSA Contributions
If you can make tax-deductible contributions to your health savings account (HSA) and 401(k), contribute as much as you can up to the maximum before April 15, 2022.
The HSA contribution limit depends on the type of high deductible health plan (HDHP) coverage you have. If you have self-only coverage under an HDHP, you can contribute up to $3,600, a $50 increase from 2020. If you have family coverage, the new limit is $7,200, a $100 annual increase over 2020.
You can contribute to your 401(k) up to $19,500 for 2021. If allowed by your 401(k)-plan document, and you are 50 or older, you can contribute additional elective salary deferrals of $6,500 in 2021. These contributions are tax-deductible. If you are 50 and older, you may also be able to make an additional catch-up contribution of $6,500.
2. Determine If You Have RMDs for 2021
If you are retired and have a traditional 401(k) or IRA, you must take an RMD annually once you reach age 72. Depending on the size of a person’s 401(k), this may result in a significant tax bill. If you turned 72 during 2021, you don’t have to take your first RMD until April 1, 2022.
3. Convert Money from a Traditional IRA to a Roth IRA
If you withdraw funds from traditional IRAs, the distributions are taxable. At the same time, withdrawals from a Roth IRA are tax-free. Roth IRAs don’t have RMDs, which can also be helpful for individuals looking to reduce taxes in retirement.
However, if you move money from a traditional IRA to a Roth account, the transferred amount is taxable as income. You should be careful that the amount you convert doesn’t move you into a higher tax bracket.
4. Hold Off on Mutual Fund Purchases
Investors should be careful when buying mutual funds at year-end. If the plan is to hold the funds in a taxable account, you may want to avoid buying a mutual fund shortly before it makes its year-end distribution. Doing so can increase your tax bill right before year-end, which can be unexpected.
Even more concerning is that you’ll be paying taxes on the income you didn’t see. Before making a purchase, be sure to find out when year-end distributions are made, as each fund may be different.
5. Harvest Your Capital Losses
If you hold stocks that are down in price, you can sell them and deduct up to $3,000 on your federal taxes. This can offset gains on other stocks or be applied to regular income taxes.
Be careful not to run afoul of the wash-sale rule, which would preclude the deduction. This rule states that you cannot purchase the same or a substantially similar stock within 30 days of your loss harvesting sale.
6. Pick Up Capital Gains if You’re in a Low Tax Bracket
For those that find themselves in a low tax bracket, year-end is a good time to sell stocks that have appreciated significantly. Some are very successful in reducing their taxable income. This can be a particularly good strategy for those in the lower tax brackets who may be subject to zero capital gains taxes. If you want to repurchase the stocks, you will reset the cost basis and limit future capital gains.
7. Make Purchases for Your Business
If you are a business owner, you can save some tax money next spring by purchasing supplies or equipment before year-end. Business owners may also be able to claim a home office deduction if they qualify. The IRS limits home office deductions to those who are self-employed. Employees who have switched to working remotely aren’t eligible for this federal tax deduction.
8. Combine Your Charitable Contributions
In 2021, if you were married and filing jointly the standard deduction increased to $25,100. For single taxpayers, the standard deduction grew to $12,550.
With higher standard deductions, many could find it difficult to come up with deductions to itemize unless they have a significant charitable contribution this year. People in this situation have the option to group two years’ worth of contributions into a single year. This would result in only claiming itemized deductions every other year.
For those with more substantial financial means, you may want to consider arranging to set up a donor-advised fund. Donor-advised funds allow charitable contributors to make significant tax-deductible (in the current year) deposits into a fund and make the actual gifts to charities over time.
9. Meet with Your Tax Advisor and/or Financial Advisor
Typically, November is a good month to meet with advisory professionals, as it is after October tax filings but before the busy tax season that starts in the new year. These advisors should have time to dedicate to your tax planning needs.
Your advisors can identify strategies to reduce taxable income either through retirement contributions or through itemized deductions. If the deductions are significant enough, you may be able to ensure you remain eligible for some income-based tax incentives like deductions for student loan interest.
Regardless of your personal financial situation, these considerations could be useful for reducing your income tax. Investing time exploring these different options now could result in more money in your pocket.
Insight Wealth Strategies, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Insight Wealth Strategies, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Insight Wealth Strategies, LLC unless a client service agreement is in place.
Insight Wealth Strategies, LLC (IWS) and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.