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2020 is already a distant memory for many Americans. Almost halfway through January, it might feel that there is no planning that can be done on your 2020 taxes. In fact taxpayers do still have some tax planning opportunities.
“Most tax planning should be done before the end of the year,” says Nicole Davis, CPA at Butler-Davis Tax & Accounting in Conyers, Georgia. “However, there is on opportunity that taxpayers can still take advantage of to save tax dollars.”
Effective tax planning is proactive planning. While not all planning opportunities are still available for the 2020 tax year, the remaining few can really make a difference to the taxpayer’s bottom line.
Being Paid In
One of the basic elements of tax planning is for taxpayers to confirm that they have paid in enough withholding. While this might seem obvious, many taxpayers are surprised when they file in April and discover they owe additional taxes. But taxpayers have until January 15, 2021 to make a 4th quarter estimated tax payment for the 2020 tax year.
“Failure to pay at least 90% of the current year’s tax liability or 100% of the prior year’s tax liability can lead to substantial penalties for underpayment of taxes,” Says Colin Horsford, CPA and Managing Partner of Horsford Accounting & Advisory. “It’s best for taxpayers to make those payments ahead of time so they’re not hit with a large tax bill with added penalties for underpayment.”
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This may also be a good exercise for the new year.
“Taxpayers should check their withholdings for 2020 to determine if any changes need to be made for 2021,” explains Davis. “To avoid having to owe each year, withholdings need to be reviewed and adjusted at least annually.”
Retirement Planning Can Still Help
One of the biggest opportunities for taxpayers on their 2020 tax planning comes from retirement accounts. By choosing the right account, taxpayers can lower their tax bill and meet their retirement goals.
“Taxpayers can still contribute to eligible retirement accounts. Depending on the retirement vehicle, the contributions can count as a deduction,” says Davis.
IRAs are often the vehicle of choice as funding them is very straightforward. Individuals can contribute $6,000 for 2020 with an additional $1,000 for those over age 50.
But a traditional IRA might not be the best answer for those who have their own businesses.
“Business owners can also take advantage of retirement deductions through SEP IRA plans,” says Davis. “Simplified Employee Pension (SEP) IRAs are especially beneficial in employee/shareholder only or husband/wife entities. SEPs are fully funded by the employer. The employee does not have to contribute a dime.”
The SEP IRA is a perfect tool for 2020 tax planning in January especially since this contribution does not need to be made until the taxpayer files. For the 2020 tax year, the maximum is the lesser of 25% of compensation or $57,000. This amount is much higher than the traditional IRA and can provide real tax savings.
Don’t Forget The HSA
There is another opportunity that taxpayers can take advantage of: funding a Health Savings Account or HSA by April 15 for the 2020 tax year. To take advantage of this, the taxpayer must have had a HAS-compatible High Deductible Health Care Plan for 2020, in which case they can fund $3,550 for individual plans and $7,100 for family plans. Plus, if the taxpayer is over 55, they can also make the $1,000 catch up.
“The contributions grow tax-free and never expire and can be withdrawn tax-free as long as they are used for qualified medical expenses,” explains Hosford.
But taxpayers need to be strategic with these accounts as well. If they only have a limited amount of liquidity to fund a retirement account or HSA, there is a clear answer on which account to prioritize.
“HSA contributions can be invested much like an IRA and can be used for non-medical expenses after the age of 65, though taxpayers will have to pay taxes on those withdrawals,” says Hosford.
Thus, the account can double as both a savings account for medical costs and a retirement vehicle.
Proactive Planning Is the Best Planning
Ultimately there is still some tax planning that can be done for 2020. But if taxpayers want to really take control of their tax returns, 2021 is still a blank canvas to do real planning.
Davis agrees. “There are a number of strategies at your disposal throughout the year. This also ensures that the taxpayer optimizes their tax savings.”
But the key is to do the planning year-round. Often the best way to do this is to work with a tax professional.