Benjamin Franklin once said nothing in this world is certain except death and taxes. As we round out the year, there are some things you can do to keep your tax burden in check. In this post, we cover 10 year-end tax planning strategies to help you minimize your taxes in 2021.
- Tax-loss harvesting – Ah yes, perhaps the most used tactic within an investment portfolio. Toward the end of the year, each investor should review their investment portfolio for any losses they could take on investments that didn’t pan out during the year. While no one likes losing money, the reality of investing is that not every investment will go up each year. By selling the investment at a loss, you can offset gains in other areas of your portfolio. If you do not have any taxable gains for the year, you can write off up to $3,000 worth of losses against your income. The only caveat here is that you cannot sell the investment, realize the loss, and then immediately buy back the investment. This would be a violation of what is called the “wash sale rule”. This rule states that if an investment is sold at a loss, you must not purchase it again for 30 days if you want to claim that loss.
- Taking capital gains – the opposite of “harvesting losses” would be “harvesting gains”. But why would anyone want to take gains and pay taxes? The answer lies in the structure of the capital gains tax brackets. If you have held an investment for longer than one year, you can qualify for long-term capital gains rates if you sell this asset. The rate of tax you pay is determined by your tax bracket. If you are single and have a taxable income of $40,000 or less (80,800 or less for married filing joint), you will pay a long-term capital gains rate of 0%. Therefore, if you sell the investment, take the gain, and buy it right back, you will not owe any taxes on that gain. This is advantageous because it will reset your “cost basis” and thus only future gains, from this point on, may be taxable. If you are expecting to enjoy higher income in future years, this reset on the cost basis can save you taxes in the future.
- Gifting to charity – the holidays are a time for giving, and for some, this means giving to charity. Many people will give cash, or write a check, to their favorite charity and be on their way. However, this could lead to a tax inefficiency with your portfolio, especially if you withdraw from your portfolio to write that check to charity. Many charities will accept donations in the form of stocks, mutual funds, bonds, and other securities. If you have stocks that have appreciated, instead of selling and paying capital gains taxes to give to charity, you can donate the appreciated stock directly. The charity will not pay capital gains and you get a tax deduction for the FULL fair market value of the stock.
- Setting up a Donor Advised Fund – have you had a good year in terms of your income? Perhaps you sold your business or a piece of rental property? Or maybe you exercised a large chunk of your stock options? If your income is high in the current year, and it is important to you to gift to charity, then you may consider a Donor Advised Fund. With these funds, you can donate an appreciated asset today and get a tax deduction for the full fair market value of that asset (subject to AGI limitations). If you are unable to use the full tax deduction in the current year, you can carry it forward for up to 5 years. Once the asset is inside the donor advised fund, you can sell it without any capital gains consequences. You can then either gift the proceeds in the current year or gift them over time as you see fit. The advantage of the donor advised fund is that you can get a tax deduction upfront for your donation, while gifting to charity over time.
- Qualified Charitable Distributions – are you over the age of 72? If so, you may be aware that the government makes you take a distribution from your IRA or 401(k). For some people, this is added income they do not use during their retirement. Fortunately, the IRS allows you to donate up to $100,000 of your Required Minimum Distribution to charity without having to show this income on your tax return. For many people, this could lower their Adjusted Gross Income allowing some tax deductions to come back into play that were previously phased out.
- Accelerating income – did you have a rough year at your job? Perhaps your sales numbers weren’t what you expected, or your business didn’t grow like you thought, which put you in an “artificially low” tax bracket. If this happens to be you, perhaps selling an asset, recognizing capital gains, or exercising stock options can accelerate some of your income into the current year where you will be paying a lower rate of income tax.
- Contribute to an HSA – if your health insurance deductible is at least $1,400 ($2,800 for a family) and your out-of-pocket max is no more than $7,000 ($14,000 for a family) then your plan will qualify as a High Deductible Health Plan (HDHP). If you have an HDHP, you can contribute to a health savings account pre-tax (like an IRA). The funds in the health savings account can be used for qualified medical expenses without tax consequences. Any unused funds are kept in the account and can be used for retirement expenses once you reach age 65. The maximum contribution to an HSA for 2021 is $3,600 ($7,200 for a family). If you have not done so already, max those contributions out before December 31st!
- Maximize retirement contributions – do you find yourself with a little extra cash toward the end of the year? If so, be sure to max out your retirement plan contributions. The current maximum contribution allowed to a 401(k) is $19,500 ($26,000 if age 50 or older), while the maximum contribution allowed to an IRA is $6,000 ($7,000 if age 50 or older).
- Annual gift tax exclusion – Are you looking to gift money to your children or grandchildren? Wondering if there are any tax consequences? The good news is you can gift up to $15,000 per person without filing a gift tax return or using your lifetime gift tax exclusion. If you are married, you and your spouse can each gift $15,000 per giftee (for a combined total of $30,000). Looking to do more than this, but don’t want to use your lifetime gift tax exclusion? You could divide up the gifts between 2021 and 2022. For instance, gift $15,000 in December and then another $15,000 in January of next year for a total of $30,000 in a month’s time ($60,000 if you are married and your spouse elects to give as well).
- Roth conversion – like “accelerating income”, if you find yourself in a low tax bracket this year, you should consider a Roth conversion. Often, this happens for those who are newly retired. At the onset of retirement, your work-related income drops, and consequently so will your tax bracket. This being the case, consider converting some of your 401(k) or IRA to a Roth. This allows you to pull funds out of these accounts at a lower rate of tax. Further, any distributions from the Roth IRA will be tax-free (including any growth!). Should tax rates rise in the future, this tax-free income will be even more valuable.
While these ten tips are certainly a good start, there are many tax planning strategies that may make sense for your specific situation. Contact us today to find out how we can help you create a plan to minimize your taxes and maximize your wealth.