TAX PLANNING TIPS FOR FALL 2021
There are two certainties in life. Death. And taxes. We all hate them, we all pay them, and we all wonder what on earth they get spent on. Whatever your personal stance on politic is, I am a believer that you should pay absolutely every cent you legally owe in taxes. But I also believe you have an obligation to not pay MORE than a single cent that you legally owe. This article goes over what you should be doing now, before they year is over, to make sure you get the most out of the tax code.
Make sure you take your required minimum distributions
If you have any tax deferred retirement accounts (401k’s IRA’s 403b’s etc) AND you are over 72, the IRS has officially run out of patience. While they did recently bump this age up from 70, they still want to make sure that eventually that tax bill gets paid. The reason this is first on my list is because the 202 CARES act eliminated the required minimum distribution (RMD) requirement for 2020, so many investors may have forgotten that this is something they need to do. (Why the government thought eliminating the requirement to withdraw money from a retirement account would help fight covid is another question altogether.)
If you have not taken your distribution this year, reach out to your financial advisor to determine the amount you need to take out, or use this calculator to come up with the figure. If you are someone who is required to take this distribution, and you don’t necessarily need it, take a look at the next bullet point to learn how you can make the distribution tax deductible.
Consider making a Qualified Charitable Distribution
The qualified charitable distribution, or QCD, is one of the most underappreciated, and underused opportunities the current tax code allows investors. Interestingly enough, while the IRS recently raised the age for RMD’s, they did NOT raise the age one becomes eligible for QCD’s. That means anyone over 70.5 with a tax deferred retirement account is eligible to use them.
The reason they are underutilized is because prior to the tax cuts and jobs act, a large portion of people were itemizing deductions, and were already deducting any charitable contributions, so they didn’t need to use them. When the standard deduction for a married couple was bumped up to around 25K that changed for a lot of people. All of the sudden, a married couple making a 10K charitable donation, was unable to deduct it from their income because without any other deductions they were still under the standard deduction. The QCD changes that.
By using a QCD a taxpayer can still claim the standard deduction AND claim their charitable donations as an additional deduction. Meaning that same married couple above can claim the standard deduction of 25K, and claim their entire 10k charitable contribution. To claim a QCD the contribution MUST come from a retirement account, MUST go directly to the charity, and MUST be documented properly on your tax return. It’s not as difficult as it sounds, but you want to make sure you do it completely right, or you will likely end up getting a mismatch letter from the IRS.
Taxpayers are allowed to make QCDs up to the amount of $100,000 per year, so these can be very powerful, for individuals over 70, who are charitably minded.
Convert IRA accounts to Roth IRAs
If you would prefer to just avoid having to jump through all the hoops mentioned above, this item is for you. Everything I talked about earlier applies only to pre-tax retirement accounts. What’s the best way to avoid dealing with all of that? Turn your pre-tax retirement accounts into after-tax accounts.
The process for changing from pre to post tax is known as a Roth conversion. Now, fair warning here, doing a Roth conversion WILL create a tax bill for you right now. Effectively when you do a Roth conversion you are voluntarily electing to pay the taxes on your retirement money right now. That may be a good move for a couple of reasons. I add importance to the word may because this is not for everybody, and you will want to talk with your accountant and your financial advisor before you do it.
The first reason this can be a good move is if you are young. Paying the taxes now, on a smaller balance, could potentially be a significantly lower overall tax bill, than letting your account grow for 30 years, and then paying.
The second reason is a little more in depth and involves looking at your current tax bracket and looking for opportunities to take advantage of current low tax rates.
Education tax credits
If you have kids, and you intend to help them pay for college this is the section for you. Many states offer tax credits and incentives for utilizing their college savings (529) accounts. While this particular credit will not be massive, I am always looking for little ways to add some cream to the coffee. Every state is different, so you will need to talk to your advisor, or speak directly with your states plan officials to determine what is available.
Using my state (Utah) as the example. Utah residents who use the Utah 529 plan can claim a tax credit of 5% of contributions up to $2070 per person ($4,140 for a married couple), per beneficiary. Meaning that a married couple that saves $3000 into a college account can reduce their Utah state taxes by $150. Like I said, it’s not huge, but it’ll pay for a fun night out.
HSA and FSA Contributions
Fall is likely open enrollment season at your job, which means you have the opportunity to change your contributions to FSA and HSA accounts. If you ended up spending more on childcare, medical services, dentist visits etc, consider changing your contributions so that you can maximize the tax savings.
Be careful with FSA accounts as they operate in a use it or lose it type of arrangement. With your HSA though if you have the money to do so, it may be wise to max it out even if you have no medical expenses. Essentially, once you retire, HSA’s can be used as regular IRA accounts on a tax deferred basis.
Solar and Electric vehicle tax credits
If you have bought an electric vehicle or installed solar panels on your home in 2021 please read this carefully, as the salesmen of both items RARELY cover what I am about to go into.
The tax credits they were so excited to tell you about are real, they are awesome, and they are helpful, BUT they are NOT refundable. What that means is these credits only kick in IF and ONLY IF you OWE taxes at the end of the year. I’ll give an example to help illustrate this concept.
If you buy an electric vehicle, you earn a tax credit of $7,500. If you file your taxes next April and discover that you owe the IRS $8,000 great news! Your vehicle tax credit will kick in and reduce your bill to $500. BUT, if you file your taxes and discover that the IRS owes you $450, then you will get absolutely NONE of that $7,500 tax credit.
So, somebody just read that and felt like they got punched in the stomach. If that is, you I have great news. Both the Solar, and the vehicle tax credit can be carried forward. That means you can potentially use the credits next year, and the year after that etc.
So, what you want to do now, is review your tax withholdings on your paycheck. Essentially you want to underpay the IRS by the amount of your credit, to make sure you actually get it back. If you do not currently work with a tax pro, and this situation applies to you, now is the time to find a pro.
Stack deductions
With the standard deduction being as high as it is, it has become increasingly unlikely that you will be consistently itemizing from year to year, so you want to take full advantage.
If you will be itemizing your deductions in 2021, now is the time to look for anything else you can be front loading and stacking on to the year to get as much as you can. That can be a litany of things from getting any needed medical procedures done, to paying an extra mortgage payment on Dec 31 so you can claim an additional month of interest.
A quick call to your advisor, or your tax pro, or a simple google search can give you a long list of potential items you can frontload to really increase your itemized deductions in the current year.
Harvest capital losses
Full disclosure, everything from here on is going to go more in depth, and I highly recommend those who pursue these strategies do not do so on their own. This is where it is wise to consider hiring a tax pro.
If you are someone who has an investment account that is not in a retirement type of account, you have the opportunity to claim capital losses on any investments that have gone down in value. If this is done properly, those losses can be used to offset up to $3,000 in ordinary income, or any capital gains that accumulated throughout the year from profitable investments.
To take this strategy even further you can work with your financial advisor to institute a strategy of what is called tax loss harvesting. Someday I will do a full post on that concept, but it is too detailed to include here.
Take advantage of zero capital gains
In general, capital gains rates are much more forgiving than income tax rates. Where this can be most evident is for individuals with incomes below $40,000 and couples below $80,000. If your income sits underneath those bands, you actually qualify for a zero percent capital gains rate. What that means is you should be looking every year with your financial advisor and tax pro to identify profitable investments that can be sold, and the gains claimed without having to pay any tax.
Personally, I am a fan of zero percent tax rates. This area can actually get pretty large too, if you have been actively tax planning with your advisor to reduce your taxable income, you can have some pretty large amounts of wiggle room under this bar.
Hopefully some of these ideas are able to help you out when you prepare to file this year. Everything on this list is 100% legal, and 100% by the book. I would never recommend trying anything questionable when it comes to taxes. First off, it’s simply not the right thing to do. Secondly, you will get caught. Be honest. Be upfront. But do your best not to leave the IRS a tip.