For most people, January is the month to take charge: make New Year’s ears resolutions, start eating healthier, plan to exercise more, and get your finances in order. While the beginning of the year may seem like a great time to plan for the year, the best time to take charge of your life (and taxes) is now. Come tax time in April, I often get asked by clients what they can do to pay less taxes. The unfortunate truth is that you don’t have many options once the tax year ends, and the time to take advantage of tax-saving strategies is during the year (before December 31st).
As this year comes to an end, it is important to be aware of which tax-saving strategies apply to your financial situation. Since it can take 4-6 weeks to fully implement these strategies (i.e., submitting paperwork, opening accounts, transferring funds and positions), it’s best to start taking action no later than November. Most financial institutions and banks will stop taking requests received after December 15th, leaving many stuck with a higher tax bill.
Here are some strategies to take advantage of to lower your tax bill before the year ends (and no, these are not only for the wealthy):
Retirement Savings
Contribute more to your employer-sponsored retirement plan
If you’re like most people, you’ve probably only contributed enough to receive your company match for your 401(k). If you are expecting a year-end bonus or have enough cash in your savings account, you can increase your retirement savings contributions for the remainder of the year. Money contributed to a 401(k) is with pre-tax dollars, meaning that you receive a tax deduction. The maximum amount you can contribute to a 401(k), 403(b), and most 457 plans is $19,500 for 2021 (increasing to $20,500 for 2022). If you’re aged 50 and over, you can contribute an additional $6,500 catch-up contribution.
Contribute to an IRA
Whether you chose not to contribute to your 401(k) or there wasn’t one available to you, there are still options to save for retirement. If your income was under $66,000 (for single filers) and $105,000 (for married filers), then you may be eligible to contribute to an IRA (Individual Retirement Account) and receive a full tax deduction. The higher your income, the lower your tax deduction! The maximum amount you can contribute to an IRA is $6,000 for 2021 (and 2022). If you’re aged 50 and over, you can contribute an additional $1,000 catch-up contribution.
Tax Withholding
Increase your paycheck tax withholding
Remember those forms you filled out when you first got hired? Besides your background check and direct deposit information, you also completed a Form W-4 (Employee’s Withholding Certificate). Depending on your marital status and number of dependents, this will determine what withholding rate is used on your paychecks. The more you withhold throughout the year, the less you will need to pay at tax time in April. The good news is that you are able to update this information at any time, increasing or decreasing your withholdings as needed.
Make an estimated tax payment
For taxpayers that have rental real estate income, gains from stock sales, or significant RSU vests, you will likely be required to make estimated tax payments. Estimated tax payments are direct payments made to the IRS to help pay your tax liability during the year. These tax payments are due quarterly and cover the following periods: April 15th (January to March), June 15th (April to May), September 15th (June to August), and January 15th (September to December).
Charitable Donations
Donate cash or property
Are you sick of staring at that bag of old clothes that have been sitting in the trunk of your car? If so, it’s time to finally make that trip to the Goodwill or Salvation Army to donate them. For any contribution of $250 or more, you must obtain and keep a contemporaneous written acknowledgment (letter or receipt) from the qualified organization indicating the amount, description, and estimate of the value of those items donated. You may be able to claim a tax deduction for your charitable contributions if you itemized your deductions.
Donate stock to a Donor-Advised Fund
If you own any stock that has significantly appreciated in value (whether you purchased or inherited them), you may be able to donate them to a special type of account called a Donor-Advised Fund (DAF). This is a charitable investment account for the sole purpose of supporting charitable organizations that are important to you. When you contribute stock to a DAF, you generally receive an immediate tax deduction that year and can invest the funds. You can then recommend grants from the fund over time to qualified charities.
Investments
Harvest tax losses
While the average investor might consider selling stocks at a loss a cardinal sin, it’s actually an important tax-saving strategy. When you sell a stock at a higher value than what you paid, you will typically realize a capital gain and owe taxes. But selling stock at a lower value than what you paid, you will realize a capital loss, which can offset your capital gains and lower your tax bill. You are also able to deduct up to $3,000 of capital losses against your ordinary income per year.
Wait to sell stock with high gains
Now that your stock options or RSUs have vested, it can seem like a great time to sell off your positions. If you’ve already realized a large amount of capital gains for the year or you expect to have less income next year, it can be more tax-efficient to delay selling until then to take advantage of lower tax brackets. For 2021, the capital gains tax rate increases from 0% to 15% at incomes of $40,401 (for single filers) and $80,801 (for joint filers), and up to 20% at incomes of $445,851 (for single filers) and $501,601 (for joint filers).
Small Business
Start a business
If you have a business idea or are considering taking your side gig to the next level, starting a business can offer access to certain write-offs not available to the average taxpayer. When starting a business, you can deduct up to $5,000 of your start-up costs and $5,000 of your organizational costs in the year your business begins. Eligible expenses include market research, marketing, and advertising, employee training, and certain fees associated with establishing your business structure and organization. If your business has a loss for the year, you may be able to deduct it from your personal income.
Open a solo 401(k)
As a small business owner or independent contractor, you may think that you are not able to save for retirement. Fortunately, there are options available to open retirement savings accounts and also reduce your tax bill. If you are self-employed and have no employees (excluding your spouse), you are able to open a solo (individual) 401(k) account. Money contributed to a solo 401(k) is with pre-tax dollars, meaning that you receive a tax deduction. The maximum amount you can contribute is $58,000 for 2021 (increasing to $61,000 for 2022). If you’re aged 50 and over, you can contribute an additional $6,500 catch-up contribution.
There are many factors to consider when evaluating which tax-saving strategy is best for you. As the year comes to an end, it’s important to take action while you still have time. If you would like to work with a financial planner to walk you through your options, I would love to help you!
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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.