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There’s still some time left

December is here, the holidays are in full swing, and so should your tax planning and prepping before the year ends. While tax planning is not as fun as shopping and other festivities, saving on taxes should also put a smile on your face.

Increase your 401K contributions

Many think that taxes are filed in the following year (up to April 15) and that there is not much to do now, right? Well, wrong, the tax planning work is different from tax prepping work that happens the following year when you file your taxes. Planning, as the word implies, is about making sure you make changes under your control that can affect and lower your taxes when you file next year. Many of those potential benefits need action by the end of the year, or they can be completely gone as opportunities. 

One big way to reduce your taxes is to increase your 401K work contributions. Increasing your contributions will reduce your taxable income and thus reduce your taxes. Given that you’d take less take-home pay, but that’s a significant way to reduce your income taxes. You can check with your Human Resources department if they allow a larger contribution for this last month, or if you can increase contributions to affect future year taxes down the road.

Max IRAs if possible

Another way to reduce your taxes, if increasing 401K contributions is not possible, is to increase your IRA contributions. If you contribute to a Traditional IRA that would be tax-deductible and reduce your taxes for the year. The 2021 limit for an IRA is $6,000 and is a sure way to put money aside for retirement and lower your taxes even if your employer doesn’t offer a 401K. Alternatively, you can also fund a ROTH IRA. This won’t lower your taxes this year, but when the funds (and earnings) are withdrawn for retirement they will come out completely tax-free. Maxing or contributing to IRAs also have additional time up until you file your taxes next year, but it's best not to wait till the last minute. If you’re self-employed or have a side gig you can even fund a SEP-IRA where the contribution limits are much higher.

HSAs

Another account that can help reduce your taxes is an HSA or a Health Savings Account. You can be eligible to have one only if you have a High Deductible Health Plan (minimum deductibles of $1400 individual or $2800 for family). If you have such a health care plan, you can have and open an HSA account, which has great tax benefits. The HSA was designed to cover the health care deductibles if you need to use the health insurance, but if you don’t use it much besides regular check-ups that money can be saved and even invested and rolled over for future years. In 2021 you can put as much as $3600 if you have an individual High Deductible Health Plan or up to $7200 if you have a family plan. The benefits of an HSA account are that the money is tax-deductible in the year of contribution, thus lowering your taxes in that year. In addition, the earnings (if any from investing) are not taxed while in the account, and when you take the money out, they’re completely tax-free if used for healthcare expenses. This is one of the rare investment accounts that have triple tax benefits, and many people that have HSAs let them grow and invest for their later years when their healthcare expenses will potentially be higher.

Tax-loss harvesting or tax gain harvesting

A tax-saving strategy is to use what is known as tax-loss harvesting. This is when you sell some of your stocks/funds that have unrealized losses and then substitute them with similar funds. Realizing losses will offset any capital gains you may have, thus reducing your taxes for the year. In addition, such losses can even offset your regular income up to $3000 for the year, and any further additional losses (if any) can be carried forward to be used in future years. While this seems complex, we make it easy and automatic under our investment platform. You get to keep a similar investment allocation, not worry about complex wash-sale rules while at the same time reducing your taxes, all done automatically.

Due to the nature of how investment gains are taxed, there’s potential for harvesting gains too, tax-free – especially in a year like this where most investments have gone up. While typically if you have investment gains you need to pay taxes, for long-term gains (held more than 1 year) you pay 0% capital gains tax if you have a taxable income of roughly $40K if single and $80K if filing jointly. The taxable income is after your deductions (standard or itemized) or other subtractions like IRA/401K contributions, thus you can make gross annual income much higher than the above-mentioned limits and still not pay any capital gains tax. This opens the way to planning and selling for capital gains since the gains will not be taxed. You can then repurchase the same stock/fund(s) if you would like, maintaining the exposure while paying no taxes on the gains and increasing the cost base of your stock/fund, which helps with future lower taxes.

Saver’s tax credit

IRS code incentivizes low- and mid-income households to save for their retirement. Many do not know, but you could get up to a 50% tax credit on the contributions you make toward your retirement investments. While the tax credit goes down from 50% to 20% and then 10% of contribution if your income is higher, you can still get something if you contribute to your retirement accounts and your AGI (Adjusted Gross Income) is lower than $66K for married couples or half of that if you’re single.

Fund 529 plans which could be state-tax deductible

The 529 educational investment accounts don’t have any federal tax deductibility for the contributions. But many 529 plans, which are sponsored by the individual states have state tax deductibility benefits. Each 529 plan is unique so first check with your residing state if such a 529 plan exists and if it has any state tax benefits. In Maryland, as an example, you can get up to $2500 Maryland state tax deduction per year per each beneficiary that you have an account for. Also, when 529 plan funds are used for educational purposes there are no taxes to be paid on gains, either on the federal or state level.

If you have a business, review & plan your business expenses

Many more people are now creating small businesses or work-from-home businesses. This opens new opportunities to reduce your taxes by deducting work-related business expenses that reduce overall net income and thus reduce your taxes. While taxes won’t be filed for at least a few months from now, it’s good practice to review all your business transactions and make sure you’re getting all the business deductions you deserve. Certain software like QuickBooks (for self-employed) or similar can help track business transactions and categorize them properly. Familiarize yourself with all the categories of business expenses and utilize them properly to reduce your taxes. In addition, businesses that are organized as partnerships, sole-proprietors, LLCs, and alike where income flows to your taxes can also take advantage of the new 20% tax deduction on their qualified business net income.

Bunch your deductions

While the majority of people now take the standard deduction after the 2017 law change significantly increased it, few can still itemize their deductions if they’re higher than the standard deduction. One way to make such itemized deductions higher than the standard one is by ‘bunching’ or making certain contributions you’d typically make in 2-3 years, all at once in one year. Charity contributions or any elective medical procedures can be accumulated and done in one year vs. spread out in 2-3 years. This way your itemized deductions would be higher than your standard deduction and you’d effectively further lower your federal and state taxes. Lastly, in 2021, even if you don’t itemize your deductions, you can still take a charitable contribution deduction of up to $300 for individuals or $600 for couples if you contribute to a qualified charity.