November 11, 2021
10 Tax-Saving Strategies to Consider Before Year-End
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There are a number of smart tax-advantaged moves available. Though you may not be eligible to utilize all of them, it’s a good idea to take a break from holiday shopping to make sure you’ve done all that you can to minimize your tax burden and get all of the write-offs and deductions possible. Here are ten of the most popular, most effective strategies available, including some important reminders that may save you from having to pay penalties:
Make the Most of Education Tax Credits: Both the Lifetime Learning education credit and the American Opportunity Tax Credit allow qualified taxpayers to prepay 2022 tuition bills for an academic period that begins by the end of March 2022, including the tuition payments when figuring the 2021 credit. That means that if you are eligible to take the credit and you have not yet reached the 2021 maximum for qualified tuition and related expenses paid, you can bump up your credits by paying for early 2022 tuition before ringing in the New Year. This may not apply to you if you’ve been paying tuition expenses for the entire 2021 tax year, but if your student just started school this fall, it will probably provide you with some additional help.
Convert a Traditional IRA to a Roth IRA: When a traditional IRA is converted to a Roth IRA, generally the amount converted is taxable in the conversion year. Taxpayers whose incomes have been very low in 2021 may be able to move the assets currently in their traditional IRA into a Roth IRA at a much lower tax rate than if they waited to make the conversion in a higher-income year.
Avoid Required Minimum Distribution (RMD) Penalties: Once U.S. taxpayers reach the age of 72, they are required to take what is known as a “required minimum distribution” from their qualified retirement plan or IRA every year. If this is the first year that this rule applies to you and you haven’t withdrawn the required amount yet, there’s no need to panic – you don’t have to do so until sometime during the first quarter of next year. Of course, if you wait until 2022 to take your 2021 distribution, you’re going to end up having to take two distributions in one year – one for 2021 and one for 2022. For those who have fallen into this category before 2021, you only have until December 31st to take the required distribution if you want to avoid penalties.
Charitable Deductions: Many people who itemize take advantage of the ability to take a deduction for their donations to their favorite charity or house of worship. Did you know that you can choose to pay all or part of your 2022 planned giving in 2021 in order to increase the amount you deduct in 2021? Though this may not be appealing to those who itemize every year, if you alternate between taking the standard deduction one year and itemizing the next, this can give you a big boost.
For 2021 only, even if you use the standard deduction and don’t itemize your deductions, you will be eligible to claim a tax deduction of up to $300 ($600 if you file jointly with your spouse) for cash contributions you make to qualified charities during 2021. Cash includes payments by check and credit card. Donations to donor advised funds and private foundations aren’t eligible for this non-itemizer deduction.
Charitable contributions are deductible in the year in which you make them. If you charge a donation to a credit card before the end of the year, it will count for 2021. This is true even if you don’t pay the credit card bill until 2022. In addition, a check will count for 2021 as long as you mail it in 2021.
Qualified Charitable Distributions: Those who are age 70½ or older are allowed to transfer funds (up to $100,000) from their IRA to qualified charities without the transferred funds being taxable, provided the transfer is made directly by the IRA trustee to a qualified charitable organization other than a private foundation or a donor-advised fund. If you are required to make an IRA distribution (i.e., you are age 72 or older), you may have the distribution sent directly to a qualified charity, and this amount will count toward your RMD for the year.
Although you won’t get a tax deduction for the transferred amount, this qualified charitable distribution (QCD) will be excluded from your income, with the result that you may get the additional benefit of cutting the amount of your Social Security benefits that are taxed. Also, since your adjusted gross income will be lower, tax credits and certain deductions that you claim with phase-outs or limitations based on AGI could also be favorably impacted.
If you plan to make a QCD, be sure to let your IRA trustee or custodian know well in advance of December 31 so that they have time to complete the transfer to the charity. If you have contributed to your traditional IRA since turning 70½, new rules may limit the amount of the QCD that isn’t taxable, so it is a good idea to check with this office to see how your tax would be impacted.
Optimize Your Contributions to Your Health Savings Account: Did you become eligible to make contributions into a Health Savings Account this year? If so, then you can make deductible contributions into that account up to the annual maximum amount, regardless of when you became eligible during the year.
Prepay State Income and 2022 Property Taxes: You probably know that if you are not subject to the alternative minimum tax and you itemize your deductions, you are eligible to deduct both your property taxes and state income (or sales) tax up to a maximum of $10,000. But did you know that in some cases, you can increase the amount that you deduct on your 2021 return by prepaying some of the taxes by December 31, 2021? You can ask your employer to boost the amount of your state withholding by a reasonable amount; or, if you are self-employed, pay your 4th-quarter state estimated tax installment in December (due in January) and increase your deduction. The same is true for your real estate taxes: if you pay your first 2022 installment in 2021, you can take it as part of your 2021 deduction. But be mindful of the so-called SALT limit – the maximum deductible amount of state and local taxes of all types is $10,000. So, don’t electively prepay state taxes if you are at or above the $10,000 cap.
Pay Outstanding Medical or Dental Bills: Taxpayers who itemize their deductions are able to deduct qualified medical and dental expenses that exceed 7.5% of their adjusted gross income. If you have reached that threshold or are close, then it may make sense for you to pay off any of those types of bills that are still outstanding rather than paying them over time. If you are near or above the limit, it may also make sense to look at what your medical and dental expenses will likely be for the next year and move those that you can into 2021 to increase the deduction. These expenses could include dental work or eyeglasses. An additional important issue: if you are thinking of doing this by paying using a credit card and you’re not going to pay the balance immediately, make sure that you’re not paying more in interest than you’re saving with the increased deduction.
Remember the Annual Gift Tax Exemption: Though gifts to individuals are not tax deductible, each year, you are allowed to make gifts to individuals up to an annual maximum amount without incurring any gift tax or gift tax return filing requirement. For tax year 2021, you are able to give $15,000 each to as many people as you want without having to pay a gift tax. If this is something that you want to do, make sure that you do so by the end of the year, as you are not able to carry the $15,000 over into 2022. Such gifts need not be in cash, and the recipient need not be a relative. If you are married, you and your spouse can each give the same person up to $15,000 (for a total of $30,000) and still avoid having to file a gift tax return or pay any gift tax.
Check the Payments You’ve Made to Date: If you think there’s a chance that the income taxes you’ve paid to date for 2021 are insufficient, it’s a good idea to increase your withholding in the time that’s left to make up for it. Underpaying taxes makes you vulnerable to an underpayment penalty that is assessed quarterly. The good news is that even if you have underpaid for any or all of the first three quarters of the year and will owe taxes when you file your 2021 return, you can make up for it by boosting your year-end withholding, since federal withholding is deemed paid ratably throughout the year. Plus, increased withholding and possible payment of estimated taxes can also reduce the fourth quarter underpayment penalty.
Every taxpayer’s situation is unique, and the suggestions offered here may not apply to you. The best way to ensure that you are putting yourself into a tax-advantaged position is to seek advice from an experienced, qualified tax professional. Please contact this office if you need assistance.
- Taking Stock of Tax Strategies
- Education Tax Credits
- Converting a Traditional IRA to a Roth IRA
- Minimum Required Distributions
- Charitable Contributions
- Qualified Charitable Distributions
- Health Savings Accounts
- Prepaying State Taxes
- Paying Medical/Dental Bills
- Gifting
- Avoiding Underpayment Penalties
There are a number of smart tax-advantaged moves available. Though you may not be eligible to utilize all of them, it’s a good idea to take a break from holiday shopping to make sure you’ve done all that you can to minimize your tax burden and get all of the write-offs and deductions possible. Here are ten of the most popular, most effective strategies available, including some important reminders that may save you from having to pay penalties:
Make the Most of Education Tax Credits: Both the Lifetime Learning education credit and the American Opportunity Tax Credit allow qualified taxpayers to prepay 2022 tuition bills for an academic period that begins by the end of March 2022, including the tuition payments when figuring the 2021 credit. That means that if you are eligible to take the credit and you have not yet reached the 2021 maximum for qualified tuition and related expenses paid, you can bump up your credits by paying for early 2022 tuition before ringing in the New Year. This may not apply to you if you’ve been paying tuition expenses for the entire 2021 tax year, but if your student just started school this fall, it will probably provide you with some additional help.
Convert a Traditional IRA to a Roth IRA: When a traditional IRA is converted to a Roth IRA, generally the amount converted is taxable in the conversion year. Taxpayers whose incomes have been very low in 2021 may be able to move the assets currently in their traditional IRA into a Roth IRA at a much lower tax rate than if they waited to make the conversion in a higher-income year.
Avoid Required Minimum Distribution (RMD) Penalties: Once U.S. taxpayers reach the age of 72, they are required to take what is known as a “required minimum distribution” from their qualified retirement plan or IRA every year. If this is the first year that this rule applies to you and you haven’t withdrawn the required amount yet, there’s no need to panic – you don’t have to do so until sometime during the first quarter of next year. Of course, if you wait until 2022 to take your 2021 distribution, you’re going to end up having to take two distributions in one year – one for 2021 and one for 2022. For those who have fallen into this category before 2021, you only have until December 31st to take the required distribution if you want to avoid penalties.
Charitable Deductions: Many people who itemize take advantage of the ability to take a deduction for their donations to their favorite charity or house of worship. Did you know that you can choose to pay all or part of your 2022 planned giving in 2021 in order to increase the amount you deduct in 2021? Though this may not be appealing to those who itemize every year, if you alternate between taking the standard deduction one year and itemizing the next, this can give you a big boost.
For 2021 only, even if you use the standard deduction and don’t itemize your deductions, you will be eligible to claim a tax deduction of up to $300 ($600 if you file jointly with your spouse) for cash contributions you make to qualified charities during 2021. Cash includes payments by check and credit card. Donations to donor advised funds and private foundations aren’t eligible for this non-itemizer deduction.
Charitable contributions are deductible in the year in which you make them. If you charge a donation to a credit card before the end of the year, it will count for 2021. This is true even if you don’t pay the credit card bill until 2022. In addition, a check will count for 2021 as long as you mail it in 2021.
Qualified Charitable Distributions: Those who are age 70½ or older are allowed to transfer funds (up to $100,000) from their IRA to qualified charities without the transferred funds being taxable, provided the transfer is made directly by the IRA trustee to a qualified charitable organization other than a private foundation or a donor-advised fund. If you are required to make an IRA distribution (i.e., you are age 72 or older), you may have the distribution sent directly to a qualified charity, and this amount will count toward your RMD for the year.
Although you won’t get a tax deduction for the transferred amount, this qualified charitable distribution (QCD) will be excluded from your income, with the result that you may get the additional benefit of cutting the amount of your Social Security benefits that are taxed. Also, since your adjusted gross income will be lower, tax credits and certain deductions that you claim with phase-outs or limitations based on AGI could also be favorably impacted.
If you plan to make a QCD, be sure to let your IRA trustee or custodian know well in advance of December 31 so that they have time to complete the transfer to the charity. If you have contributed to your traditional IRA since turning 70½, new rules may limit the amount of the QCD that isn’t taxable, so it is a good idea to check with this office to see how your tax would be impacted.
Optimize Your Contributions to Your Health Savings Account: Did you become eligible to make contributions into a Health Savings Account this year? If so, then you can make deductible contributions into that account up to the annual maximum amount, regardless of when you became eligible during the year.
Prepay State Income and 2022 Property Taxes: You probably know that if you are not subject to the alternative minimum tax and you itemize your deductions, you are eligible to deduct both your property taxes and state income (or sales) tax up to a maximum of $10,000. But did you know that in some cases, you can increase the amount that you deduct on your 2021 return by prepaying some of the taxes by December 31, 2021? You can ask your employer to boost the amount of your state withholding by a reasonable amount; or, if you are self-employed, pay your 4th-quarter state estimated tax installment in December (due in January) and increase your deduction. The same is true for your real estate taxes: if you pay your first 2022 installment in 2021, you can take it as part of your 2021 deduction. But be mindful of the so-called SALT limit – the maximum deductible amount of state and local taxes of all types is $10,000. So, don’t electively prepay state taxes if you are at or above the $10,000 cap.
Pay Outstanding Medical or Dental Bills: Taxpayers who itemize their deductions are able to deduct qualified medical and dental expenses that exceed 7.5% of their adjusted gross income. If you have reached that threshold or are close, then it may make sense for you to pay off any of those types of bills that are still outstanding rather than paying them over time. If you are near or above the limit, it may also make sense to look at what your medical and dental expenses will likely be for the next year and move those that you can into 2021 to increase the deduction. These expenses could include dental work or eyeglasses. An additional important issue: if you are thinking of doing this by paying using a credit card and you’re not going to pay the balance immediately, make sure that you’re not paying more in interest than you’re saving with the increased deduction.
Remember the Annual Gift Tax Exemption: Though gifts to individuals are not tax deductible, each year, you are allowed to make gifts to individuals up to an annual maximum amount without incurring any gift tax or gift tax return filing requirement. For tax year 2021, you are able to give $15,000 each to as many people as you want without having to pay a gift tax. If this is something that you want to do, make sure that you do so by the end of the year, as you are not able to carry the $15,000 over into 2022. Such gifts need not be in cash, and the recipient need not be a relative. If you are married, you and your spouse can each give the same person up to $15,000 (for a total of $30,000) and still avoid having to file a gift tax return or pay any gift tax.
Check the Payments You’ve Made to Date: If you think there’s a chance that the income taxes you’ve paid to date for 2021 are insufficient, it’s a good idea to increase your withholding in the time that’s left to make up for it. Underpaying taxes makes you vulnerable to an underpayment penalty that is assessed quarterly. The good news is that even if you have underpaid for any or all of the first three quarters of the year and will owe taxes when you file your 2021 return, you can make up for it by boosting your year-end withholding, since federal withholding is deemed paid ratably throughout the year. Plus, increased withholding and possible payment of estimated taxes can also reduce the fourth quarter underpayment penalty.
Every taxpayer’s situation is unique, and the suggestions offered here may not apply to you. The best way to ensure that you are putting yourself into a tax-advantaged position is to seek advice from an experienced, qualified tax professional. Please contact this office if you need assistance.
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