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No one likes to overpay in taxes, but one of the biggest mistakes people make is waiting until April 15th to try to lower their taxes. The window of opportunity to trim that 2020 tax bill is quickly coming to a close. Here are some easy things that you still have time to do to help keep some more money in your pocket before the 2020 tax season is a wrap!
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Contributing to tax-advantaged accounts:
Employer-sponsored retirement plan: The first step is to ensure you take advantage of your employer’s match. That is free money. If you haven’t contributed enough to get it, act quickly and you might still take advantage of it.
If you are looking to save more and reduce your taxes, consider maxing out before the year is up. You can contribute up to $19,500 for 2020 plus an extra $6,500 if you turn age 50 or older this year. As an example, if you are in the 24% marginal tax bracket and you contribute the full $19,500, that can be up to $4,680 in tax savings! You can use a pre-tax savings calculator like this one to help determine your savings based on your marginal tax bracket.
If you’re self-employed, you still have an opportunity to establish a retirement plan and put away a considerable amount of money depending on the type of retirement plan that makes sense for you. Some of these plans must be established by 12/31/2020, and can be funded by the tax filing deadline (04/15/2021) to get the 2020 deduction. A qualified tax professional with the appropriate business experience can help you evaluate the options and select the right one for you.
Deadline 12/31/2020
Traditional IRA: If you are looking to save even more money above and beyond your employer’s retirement plan, want more investment flexibility, or perhaps don’t have access to an employer-provided qualified plan, you have an opportunity to save for retirement in an IRA and deduct up to $6,000 in 2020 (up to $7,000 for those age 50 and older). Note that the deductibility of a traditional IRA is subject to income limits if you are already contributing to an employer-based plan so be sure to check those out here and plan accordingly.
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Deadline 04/15/2021
Roth IRA: If you haven’t contributed to a Roth IRA or haven’t contributed to the limit ($6k before age 50 and $7k at age 50 and older), now is the time to consider it to take advantage of the opportunity to build tax-free income in the future. Keep in mind that you pay taxes at the time of the contribution and then 100% of your contributions can be withdrawn tax-free, and any growth and interest is tax-free once you hit 59 ½ and the account has been open for 5 years. There are also some powerful ways that you can use a Roth IRA outside of just retirement, which you can read more about here.
Deadline 04/15/2021
Roth IRA conversion: You have an opportunity to convert your pre-tax IRAs into a Roth before year-end. You have to pay taxes on any pre-tax money you convert, but if you are in a lower tax bracket this year due to a change of income or perhaps because your accounts are down in value, you can take advantage of converting “cheaply” to generate tax-free income in the future. I can’t speak enough to the importance of preparing for a potentially tax burdensome future. You can see the potential value versus a taxable savings account or traditional IRA by using a calculator like this one or this one. You can read more about when it makes the most sense to convert here.
Deadline 12/31/2020
Health Savings Account (HSA): If you have an HSA-qualified health insurance plan, you can further lower your tax bill by maxing out on contributions for 2020 ($3,550 for individual coverage or $7,100 for family coverage with an additional $1,000 catch-up for those 55 or older). HSAs are typically deducted through payroll, but you can also make contributions directly into your account up until the tax filing deadline to ensure you make the maximum contribution. In addition to providing a tax deduction, HSA dollars carry over indefinitely and are portable.
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You can also typically invest those savings and grow a pot of money that will always be tax-free for qualified medical expenses (unless they change the tax code of course). To go a step further, once you hit age 65, you can withdraw that money like an IRA and pay income taxes for the non-qualified medical expenses. However, if you make the withdrawal for a non-qualified medical expense before age 65, you will have to pay a 20% penalty in addition to income taxes. If you are looking for a great way to save for both short and long term medical costs and save on taxes both today and in the future, look no further!
Deadline 04/15/2021
Other ways to reduce taxable income and avoid a larger tax bill for 2020:
Deferring income and paying home business expenses now: If you are expecting a year-end bonus, ask if you can defer it until the following year, especially if it is already a high income year for you. If you’re having a high income year and have a home business or side gig (which many more people now have due to the pandemic), consider trying to squeeze in any large business expenses on your list before the end of the year, especially if you expect potentially lower income in 2021. Again, this would be a great conversation to have with an experienced tax professional. Here is a guide on finding the best one for you.
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Deadline 12/31/2020
Leveraging losses to reduce your taxable income: Now is the time to review your investments for any “net realized losses” (which means you sold your investments at a loss) or to consider selling some of the investments that are currently trading at a loss. Tax loss harvesting is a great way to buffer the tax impact of any capital gains in addition to giving you the ability to use up to $3,000 of these losses to offset your taxable income. (Remaining capital losses can be carried forward for use in future years.) When practicing this strategy, try to think about your expected income in the future and of the need to sell investments as you might want to save those losses to offset larger capital gains in higher tax years.
Deadline 12/31/2020
Gifting to reduce taxable income and future estate taxes: With the passing of the CARES Act, individual donors can now deduct up to 100% of their AGI (increased from 60 %) for those who are itemizing their deductions. For those individuals not itemizing their deductions, the CARES Act allows for an additional “above-the-line deduction” for charitable gifts made in cash of up to $300.
Secondly, if you are looking for ways to gift your wealth while reducing your taxable estate, you are able to give up $15,000 ($30,000 if you are married) to as many beneficiaries as you want without paying a gift tax or decreasing your lifetime estate tax exclusion amount.
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Deadline 12/31/2020
Increasing withholdings to make up for an estimated tax shortfall: To avoid paying underpayment of estimated tax penalties by not paying enough of your taxes throughout the year, you have a small sliver of time to increase the tax withholdings for your remaining paychecks. Remember to update a new Form W-4 to ensure you have a more accurate withholding for the following year and then make it a habit to check 2-3 times throughout the year to make sure you stay on track. This becomes increasingly important for those of you that have variable incomes or start a new job mid-year. You can use a tax estimate calculator like this one or use this useful W-4 withholding and tax estimate calculator as a guide.
Deadline is by your final 2020 payroll processing date (confirm with your HR department on how much time you have to act on this)
As you can see, there are quite a few things that can be done to lower your tax bill, and they don’t have to be complicated. Just be sure to act quickly. Then take some time to make a plan on how to get ahead of this for 2021 and the years to come so that you can have a happy and prosperous tomorrow.