The end of the year is fast approaching. A little preparation for tax season now could help reduce your 2021 tax bill. No matter whether you live in Massachusetts, New Hampshire or any state that has some form of income tax. Read on for some strategies you can implement before we ring in the new year.
Timing of Income and Deductions
When considering the timing of income and deductions, think about two years minimum. It is generally sound planning to defer income until next year and accelerate deductions into this year. However, if you anticipate your income will be substantially higher next year, the opposite would be true.
If you are a W-2 employee, you may have the ability to defer a year-end bonus or commission to next year. If you are self-employed, consider invoicing late in December to defer receipts until next year.
The decision to hold or sell a security is based on many factors including the long-term quality of the security and how it fits into your overall investment strategy. Once the decision has been made to sell
a security, consider the tax impact of selling now vs. at some point in the future. Net short-term capital gains (securities held less than one year) are taxed as high as 37% Federal and 12% Massachusetts while net long-term capital gains are taxed at 0%-20% Federal and 5% Massachusetts.
A net capital loss for the year can be used to offset up to $3,000 of regular income on your Federal tax return. Any net capital losses above $3,000 will carry forward to future years. Keep in mind that there are rules in place to prevent you from claiming a loss on the sale of a security if you purchase the same security within 30 days before or after the sale – even if the purchase is in a different account.
Mutual Fund Distributions:
Most mutual funds distribute ordinary and capital gain dividends to shareholders between October and December. These distributions are essentially an accounting entry for income and net capital gains. These distributions do not increase the value of the investment – only the tax bill to the shareholders!
If you decide to sell a mutual fund, you will want to do so before the record date for year-end distributions. If you plan to invest in a mutual fund that has an impending distribution, don’t buy until after the dividend record date or you will be buying a tax liability with no economic benefit.
If you are a cash-basis taxpayer, you can deduct any purchases charged to your bank credit card (not a store charge card) by year-end. If you anticipate any major purchases (equipment, furniture, etc.), there are several provisions that will allow you to deduct up to 100% of the cost in the year purchased rather than depreciating the cost over several years.
If you are among the few taxpayers who still itemize deductions, you will generally want to pay these expenses by December 31st. Keep in mind that you may not always get an incremental benefit by accelerating an expense.
- Qualified medical expenses are deductible to the extent the total exceeds 7.5% of your adjusted gross income (AGI). If that one additional medical expense is not going to be enough to push you over the 7.5% of AGI threshold, there is no benefit to accelerating it into 2021.
- Only the first $10,000 of state and local taxes (income or sales tax plus property taxes) is deductible. If your state and local taxes paid during the year already total $10k, you won’t get any tax benefit from moving additional taxes into this year. If you DO have room under the $10,000 ceiling, it makes sense to accelerate the payment of your state income tax, your already assessed property taxes, or your excise taxes to get you up to the $10,000 maximum.
- Mortgage interest is deductible on up to $750k of acquisition indebtedness ($1M if purchased prior to 12/16/17) so it pays to make that January 2021 mortgage payment early.
- Charitable contributions are deductible in the year they are paid. While the maximum amount you can deduct is ordinarily 20%-60% of your income, this limit has been increased to 100% for 2021. Consider donating appreciated stock held long term (>1 year) to a charity. You get a deduction for the current fair market value and avoid paying taxes on the appreciation. Make sure your contributions are either completed online or postmarked by December 31st.
If you find yourself unable to itemize every year, consider a strategy of bunching your expenses together every other year or every few years to claim itemized deductions periodically. See our blog post Group Your Itemized Deductions for Real Tax Savings for more details.
Charitable Contribution Deduction for Non-Itemizers:
If you don’t itemize, you can take advantage of a special provision for 2021 allowing taxpayers who claim the standard deduction to deduct up to $300 of cash contributions to qualified charities ($600 for married individuals filing joint returns).
Retirement Plans Considerations
Your traditional or Roth IRA contribution for 2021 must be made by April 15, 2022. The maximum contribution allowed is $6,000 for those under age 50 and $7,000 for those age 50 or older. Whether to contribute to a traditional or Roth IRA depends on your tax situation. If you are unsure, please ask Bartley Financial or your tax preparer.
Employer Retirement Plans:
Check your most recent pay stub to make sure you will maximize your workplace retirement deferrals for the current year. If your contributions will fall short and you have the cash flow to do so, increase your deferral for the remaining pay periods in order to maximize your contributions for the year.
- The 2021 limit for 401k/403b/457b contributions is $19,500. This limit increases to $26,000 if you are age 50 or older.
- For 2022 the limit will be $20,500 ($27,000 if you are age 50 or older)
- The 2021 limit for SIMPLE plan deferrals is $13,500 for those under age 50 and $16,500 for those age 50 and older.
- For 2022 the limit will be $14,000 ($17,000 if you are age 50 or older)
Required Minimum Distributions (RMDs)
- If you are 72 or older by the end of the year, you must take RMDs from your IRA accounts by December 31st or face a 50% penalty. There is an exception that allows those turning 72 during the current year to defer the RMD to no later than April 1st of next year. If you qualify and elect to defer your RMD until next year, note that you will be doubling up on RMDs next year.
- No distributions are required from Roth IRAs
- If you have an inherited IRA (traditional or Roth), there are deadlines for distributing the funds. Please see our recent blog post, How Do Beneficiary IRAs Work? for planning strategies. An overview:
- If you are age 70.5 or older, consider making a gift to a qualified charity from your IRA account. These distributions are not taxable and if you are age 72 or older, they can be used to satisfy all or part of your RMD for the year. See our blog post Tax Savings on Qualified Charitable Distributions From IRAs for more details on using this strategy.
- If the original account owner passed away prior to 2020, the inherited IRA funds can be distributed over your lifetime. Remember to take your RMD prior to year-end or face a penalty of 50% of the amount that was required to be distributed.
- If the original account owner passed away in 2020 or later, check with your tax preparer or Bartley Financial so see if you can stretch withdrawals over your lifetime or if you must withdraw all assets from the inherited IRA with 10 years of death. If you are subject to the 10-year distribution requirement, there is no set amount to distribute each year. If your income is variable, plan to take distributions during years in which you are in a lower tax bracket.
The annual gift tax exclusion is $15,000 per individual recipient. If you and your spouse make a joint gift, the limit is $30,000 per recipient. Note that the recipient must receive the gift AND deposit it by
December 31 for it to be considered a completed gift this year. Consider gifting appreciated stock. You avoid paying the capital gains tax on the appreciation. Assuming the gift recipient has less income than you, he/she may be able to pay low or no capital gains tax when they sell the stock.
Education Funding Considerations:
If you are a Massachusetts resident, you can deduct up to $1,000 ($2,000 if married filing jointly) in contributions to a Massachusetts college savings plan.
Contributions to a 529 plan are treated as completed gifts to the named beneficiary. Special rules allow you to make up to five years’ worth of gifts to a 529 account in one year. Your gift of up to $75,000 ($150,000 if you and your spouse make a joint gift) is treated as being made ratably over the
current year and the next four years.
To maximize frontloading, consider making a $15,000 ($30,000 joint gift) by the end of the year and a $75,000 ($150,000 joint gift) contribution next January. Since the overall cap of $15,000 per recipient applies each year, no additional annual exclusion gifts can be made to the same beneficiary over the 5-year period – unless the annual exclusion amount is indexed in later years for inflation.
Health Savings Accounts (HSAs):
If you have a high deductible health plan and contribute to an HSA (either through payroll deferral or an account you have established as a self-employed individual), review your contributions year-to-date to determine whether you will maximize for the current year.
If your contributions will fall short and you have the cash flow to do so, increase your payroll deferral or get your deposits in by year end to maximize your contributions for the year.
- The 2021 contribution limits are $3,600 for individual coverage and $7,200 for family coverage.
- For 2022 these limits increase to $3,650 for individual coverage and $7,300 for family coverage.
- Once you reach age 55, you can contribute an additional $1,000 annually.
Flexible Spending Accounts (FSAs):
If you have a balance remaining in your FSA, check your plan rules so you don’t lose any funds. While your plan may have adopted a special provision for 2021 allowing for an unlimited carryover of funds to 2022, not all employers are on board.
Standard IRS rules allow plans to either 1) offer you a grace period of up to two and a half months after the plan year to incur and pay for eligible expenses, or 2) let you carryover up to $550 of unspent funds to the following year. Some plans have adopted neither provision so you need to clean out your account by December 31 or lose any remaining funds.
It is not too early to set up a folder for tax documents. You can get a jump on organizing receipts needed for deductions. When tax documents start arriving in the mail in January, add them to your folder as soon as they arrive. No more misplaced tax documents!
At Bartley Financial, our financial advisors can help you prepare for the 2021 tax season. Importantly, we care about way more than your finances. We care about the life you’re trying to live; finances are just a piece of that. Contact us anytime if you need fresh ideas for your finances or help in achieving your goals. We are happy to help!
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Bartley Financial has an experienced team of CPAs and CFPs® (Certified Financial Planners®) that help clients manage their investment portfolios, plan for retirement, strategize taxes, or execute any other initiatives in pursuit of optimum financial health and minimal financial stress. From our offices in Andover, MA, and Bedford, NH, we work to ease clients’ financial concerns, strengthen their portfolios, and assuage their worry that they don’t know what they don’t know.
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