As we head into the last month of 2021, consumers still have enough time to do some year-end tax planning.
Making some proactive moves in December can help lower your 2021 tax bill, says a Cari Weston, a CPA and the director of tax practice and ethics with the American Institute of Certified Public Accountants. Here are six year-end tax tips that apply to federal returns.
One good way to lower your tax bill is to make charitable contributions, says Weston. Even if you're taking the standard deduction, which 90% of filers do, you can deduct up to $300 in cash donations for 2021. Married couples filing jointly can claim up to $600 in cash donations.
"The key is just making sure your donation is to a qualified organization," she says.
You don't need to limit your donations to cash. Many nonprofits accept stock as a type of donation, which can be an especially smart move when your portfolio has appreciated. "A stock donation can generate a big deduction since the deduction is at fair market value," says Howard Samuels, a certified public accountant at Samuels & Associates in Florham Park, New Jersey. You'll need to itemize to claim that break.
If you itemize, Weston suggests donating old electronics, books, clothes, or furniture. Make sure to take pictures and price out the cost of each item by using resources like the Goodwill's valuation chart, which shows the fair value of each piece donated, she says.
Many people forget to update their W-4, the tax document you use to tell your employer how much federal tax you want withheld from your paycheck, Weston says. If you don't have enough taxes taken out, you may owe the IRS money when you file in the spring, and you may even receive an underpayment penalty.
"If you think you might be in a position to owe tax, there's one more month for you to go in and adjust your withholding exemptions down, or to make an estimated payment so you don't have a penalty," says Weston.
Concerned you underpaid? You can see what you might owe online by entering the information from your most recent paystub into the IRS Tax Withholding Estimator tool.
The final deadline for 2021 estimated tax payments is January 18, 2022, but this deadline is waived if you file your return by January 31, 2022, and pay the entire balance due with your return.
Any money that you contribute to a pre-tax retirement account such as a 401(k) or an IRA can help lower your annual income and reduce your tax burden. For 2021, workers under 50 can contribute up to $6,000 to an IRA, and up to $19,500 to a 401(k).
To lower your tax bill, "max out your 401(k) through work, if you have a W-2 salary job," says Samuels. "Especially if your employer matches some of your contributions."
If you're self-employed, "max out your Simplified Employee Pension or Solo 401(k) plan contributions," Samuels says. "Technically, you have until April 15, 2022 to do this and have it count for 2021 taxes."
Max out your contributions to your traditional IRA, too, he says. Again, you have until April 15, 2022, to do this for 2021. "Even if you get no tax deduction, due to your income level, or because you have a 401(k) [or other retirement plan] through your employer, the money still grows tax-deferred, and the earnings are taxable once it comes out upon retirement since you received no tax deduction when you contributed it," Samuels says.
If you sold an investment and realized a gain in 2021, you may owe taxes on the money you made. If you held that investment less than a year, you'll pay your normal income tax rate on the gain. But if you sold after more than a year, you could owe long-term capital gains tax of 0% to 20, depending on your filing status and your tax bracket.
To offset capital gains tax, "go in now and try to sell something at a loss," Weston says. While she recommends speaking to a CPA for guidance, it's helpful for taxpayers to understand what tax-loss harvesting means. It involves selling an investment that has lost value and replacing it with a similar investment. Once you've swapped, at tax time you can use the investment sold at a loss to offset any realized gains.
Tax-loss harvesting only works for taxable investment accounts, not tax-advantaged accounts like a 401(k) or IRA. A tax consequence shouldn't be the driving factor in selling an investment, so be sure to think through the potential advantages and costs first, Weston says.
There are new tax brackets coming in 2022, so it might be smart to delay income if you can, says Samuels. That's not likely for a recurring paycheck but may be possible if you receive a bonus. "Consider postponing any bonuses until 2022 if your income is already high this year. The tax brackets are being adjusted upward for inflation for 2022 so you might save a few tax dollars by pushing the bonus to 2022," he says.
Samuels suggests consulting with a CPA first to see if delaying is a good idea based on your personal tax situation.
If you run your own business or if you're self-employed, remember that the IRS allows you to deduct expenses that are both ordinary and necessary for your business. "Buy things and pay for expenses you might have to pay for in 2022 by December 31, 2021, to secure the deduction," says Samuels.
"Rumor has it that tax laws might be changing again in 2022," he says. President Joe Biden's Build Back Better Act has not been signed into law. It is expected to be by year end, but that's not certain. If enacted, it may affect how income and expenses are treated by the IRS in certain cases.
Disclaimer: This is intended as general education and for informational purposes only, it is not intended as specific tax or investment advice. Please consult with a qualified professional for advice based on your personal situation.
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