There’s still time to make some smart tax moves before we say farewell to 2020. What 2021 has in store for us is a mystery. However, legislative and tax law changes are always a possibility. Year-end is the perfect time to do some strategizing where taxes are concerned. So, if you are hoping to cut your tax bill by reducing your 2020 income taxes, consider these 6 smart tax moves.
Make contributions to your retirement accounts
Contributing to your 401(k) can save you a substantial amount of money on your 2020 return, but you must contribute to your plan by December 31st. The 401(k)-contribution limit for 2020 is $19,500. Those age 50 and older can contribute an additional $6,500 catch-up contribution. These additions to your plan could decrease your 2020 tax bill significantly.
Money contributed to your IRA may be partially or entirely tax deductible (depending on your situation) thereby reducing your taxable income, and the interest earned while the money is in the account is tax free. The deduction amount you can take is dependent on your modified adjusted gross income (MAGI), as well as your filing status and whether you or your spouse are covered by a retirement plan such as a 401(k) at work. There are also income phaseouts to note. Typically, you have until April 15th to contribute to your IRA. Although in 2019, the tax filing and payment deadline was extended to July 15th due to the effects of the pandemic. For 2020, you can contribute a total of up to $6,000 to all your IRAs (traditional and ROTH). If you’re age 50 or older, you can make a catch-up contribution of another $1,000.
Check your withholding
No one wants an unexpected tax bill! If you switched jobs, earned more due to a raise or bonus, lost your job and received unemployment benefits, or started a side gig, you could be in for a tax surprise if you didn’t adjust your withholding. Are you self-employed? If so, did you pay enough in quarterly taxes during the year? Typically, taxpayers must pay at least 90% of the current year’s tax owed or 100% of last year’s tax liability to avoid penalties and interest. If your adjusted gross income is over $150,000, you are required to pay 110% of the prior year’s taxes owed.
There is still time to ask your HR department to withhold an extra amount from your remaining 2020 paychecks or send additional money to the IRS for estimated quarterly payments if you are short. You can also check your withholding with the IRS withholding estimator on the IRS website.
Review tax loss harvesting opportunities
Do you have realized capital gains in taxable accounts this year? This year was especially suitable for tax loss harvesting with the market’s plunge in March and recovery to record highs. You can sell positions at a loss to offset those gains. You can realize up to $3,000 in short-term losses to offset up to $3,000 of regular income each year. You can also carry forward short-term losses for future use. Investors must be aware of the wash rule, which prohibits selling an investment for a loss and replacing it with the same or similar investment 30 days before or after the sale. If you do have a wash sale, the IRS will not allow you to write off the investment loss.
Make charitable donations
Thanks to the CARES Act, in 2020, taxpayers who itemize deductions can deduct up to 100% of their adjusted gross income for cash donations to public charities. The act also provides a $300 deduction from income for charitable giving on your 2020 tax return, whether you itemize or claim the standard deduction. If you are close to the itemizing threshold, you could either add another charitable contribution or if you have the financial means, consider “bunching.” With this strategy, you consolidate tax-deductible contributions into a single year rather than spreading them out over multiple years.
Yet another strategy is the Donor-advised fund. This is a dedicated account for charitable giving purposes. You are eligible for an immediate tax deduction when you contribute to a charity that sponsors a donor-advised fund. You can recommend grants to IRS – qualified public charities and invest the funds for tax-free growth. These funds provide benefits regarding income, capital gains and estate taxes.
Take advantage of the RMD reprieve in 2020
Passing on taking your RMD in 2020 is a gift because it could mean reduced federal income tax for the year. For example, if your 2020 RMD is $100,000 and your tax rate is 40%, the total amount you net after tax is $60,000. If you don’t take the RMD, $100,000 stays in your account. This also gives your funds the ability to potentially continue to recover value as the markets improve. So, if you don’t NEED the money, consider forgoing the RMD.
Consider a ROTH IRA Conversion
Low income tax rates coupled with the impact of the economic downturn may make a ROTH IRA conversion attractive to many. The lower income tax rates are set to expire in 2025 but could rise even sooner. The RMD reprieve in 2020 may cause some retirees into a lower tax bracket. With a ROTH, you pay taxes on your conversion amounts up front, rather than when you withdraw the money like in a traditional IRA. If your withdrawals are qualified, you will owe no tax on future earnings. You also will not be subject to RMDs with a ROTH. If you have the funds available to cover the tax obligation at the time of conversion, and your income is lower, you may want to discuss this strategy with your financial advisor and tax professional.
It is almost time to close the books on 2020. Now is the time to take advantage of tax smart moves that can reduce your 2020 taxable income and position you for tax success in 2021 and beyond.
Sources: CNBC/ Fidelity/ Forbes/ U.S. News & World Report/ Kiplinger
© Geier Asset Management, Inc. December 2020. Dan Mules, CPA is a Client Manager and Tax Planning Professional for Geier Asset Management, Inc., a Registered Investment Advisor. The articles & opinions expressed in this material were gathered from a variety of sources, but are reviewed by Geier Asset Management, Inc. prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of December 2020 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual circumstances. In all cases, please contact your investment professional before making any investment choices. Geier Asset Management, Inc. is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.