Updated: Feb 18
As the end of the year approaches, all eyes are on potential new legislation that would appear to have the biggest impact on individuals. With increases to the individual and capital gains tax rates, changes to grantor trust rules, and an accelerated reduction of the gift and estate tax exclusion, planning ahead is more important than ever. Thriving in today’s environment is all about understanding the current rules, staying on top of potential changes, and preparing for what’s next. As you start your year-end tax planning, keep in mind these six tips to help you maximize your deductions and reduce your exposure to future taxes.
Maximize contributions to your retirement account
Tax-advantaged retirement accounts can be great for two reasons. The first is that contributions to a traditional IRA or a 401k plan are made with pre-tax dollars, allowing you to get the most bang for your buck. The second is that those contributions also lower your taxable income. So if you’re not currently taking full advantage of these benefits, consider increasing your contributions to your retirement account.
There are limits set on how much you can contribute to a traditional IRA or a 401k plan each year. If you are on pace to contribute less than the maximum, consider adding to your contributions before the end of the year. And if you can’t reach the maximum, try to at least contribute the amount your employer is willing to match. The more you contribute, the more you could lower your taxable income. Not only are you building for your future, but you could also potentially end up owing less in taxes come April.
Spend the funds in your Flexible Spending Account
Flexible spending accounts have become popular for people who want greater control over their healthcare contributions. But what happens to the leftover funds in your Flexible Spending Account at the end of the year? Typically, after December 31st, any funds in your FSA are subject to taxes. However, you may be eligible to roll over all your leftover funds into 2022 if your employer has amended the plan documents to follow “The Consolidated Appropriations Act.”
Meaning you may have the option to carry over all or part of your unused balances into 2022. Carrying over funds from 2021 does not affect your annual contributions for 2022. You can still elect to contribute up to the annual limit set by the IRS. If your employer did not amend your plan and does not allow any rollovers, you could lose access to the money altogether.
To make the most of the remaining funds in your FSA, schedule year-end checkups, such as eye exams or physicals. Fill prescriptions for you or a family member if possible. You can also check your FSA documentation to see which items are covered under your plan. Many FSA plans cover costs for contact lenses, eyeglasses, over-the-counter medicines, and testing devices. Stocking up before the year ends allows you to fill your medicine cabinet while maximizing your FSA funds.
Consider donating to charity
Each year, the IRS allows taxpayers to deduct charitable donations from their tax filing. Typically, this benefit was reserved for itemized deductions (those calculated by adding up all eligible exemptions), but not standard deductions (those that lower your income by one fixed amount). However, for the 2021 tax year, you can claim a deduction for both. Married couples who file jointly for a standard deduction can claim up to $600 for charitable contributions, while individuals can claim up to $300 in charitable contributions.
Don’t like taking your Required Minimum Distribution (RMD), consider donating all or a portion for a tax benefit. This is also known as Qualified Charitable Distribution (QCD). This can be excluded from in but you must be 70 ½ or older to qualify.
But donations must meet certain criteria in order to be claimed as a deduction. It must be a cash donation made within 2021. The receiving charity must also qualify under IRS standards. Note that crowdfunding sites like GoFundMe often host a lot of personal campaigns, which wouldn’t qualify for a deduction. Make sure you look for the “Certified Charity” designation, which means it qualifies for deductions according to section 501(c)(3) of the Internal Revenue Code. When you do, you’re able to give back in a way that cuts you a break.
Adjust your paycheck withholdings
Paycheck withholdings are essentially a way to proactively pay the taxes you expect to owe come April. By designating an amount to be withdrawn from your paycheck throughout the year, you can get ahead of paying those taxes by paying what you owe more evenly throughout the year versus writing a big check come tax time. This also makes them applicable to your 2021 tax filing.
If you need to make adjustments, work with your employer to alter your withholding amount before the end of the year using a W-4 form. In increasing the withholdings for your final paychecks of 2021, you could select an amount that will cover what you anticipate you will owe. You can also use this strategy to make up for low or missing quarterly estimated tax payments.
Take advantage of tax-loss harvesting
If you profit from selling an asset that you’ve held for a year or less, this may be recognized as a short-term capital gain in your tax filing. Short-term capital gains can be taxed at a higher rate than long-term capital gains and can be the source of unwanted surprises in what you owe in taxes.
To combat this, tax-loss harvesting is a strategy used to offset what you may owe in taxes due to capital gains. This tactic involves the selling of assets at a loss, counterbalancing your gains, and potentially lowering your taxable income. For example, if you invested in stocks that have since decreased in value, then selling those stocks before the end of the year would lock in a loss on your investment. This loss has the potential to offset any gains you may have made in other investments and ultimately lower your taxable capital gains.
Pro tip: tax-loss harvesting is best reserved for investments you expect to continue to lose value in order to avoid locking in a loss on an asset you believe will improve over time. When executed properly, this strategy can help balance your portfolio in addition to lowering what you owe in taxes.
Contribute to a 529 plan
If you have a family, saving for education may already be a part of your financial planning. So why not take advantage of a 529 savings plan? A 529 savings plan works like a Roth IRA, providing tax benefits by allowing you to invest after-tax funds into a savings account for education. Your investment in a 529 grows on a tax-deferred basis and the funds can be withdrawn tax-free when used on qualifying expenses.
Much like a retirement savings plan, contributions to a 529 plan can lower your taxable income. Any contributions made before December 31st can qualify for tax deductions for the 2021 tax year. If you already have a 529 savings plan, be sure you’ve hit the maximum contribution for the year allowed for your plan.
K Wealth Advisors If you’re looking for personal guidance as you start your year-end tax planning, contact K Wealth Advisors to schedule a GoodFit meeting and discuss your goals and options today. #KWA