Why is Year-End Tax Planning Important?
Sure, you want to save on your income taxes for the foreseeable future, but solid year-end tax planning has other advantages, too. For instance, you could reduce your estate taxes, make the most of retirement funds, reduce the amount you pay for your child’s education and manage cash flow so you can reach your financial objectives.
If you plan it right, you can defer a portion of this year’s tax liability to the future, which frees up cash for business, investment or personal purposes. You can accomplish this goal by timing when particular expenses are paid or controlling when income is reported. Year-end tax planning also enables you to take advantage of more favorable tax rates if you know it’s going to benefit you to do so. Some caution is required, however, because tax laws are fluid, and it may be difficult to predict how the rules will change from one year to the next. When in doubt, it’s always wise to consult with your CPA. There’s also a lot of good information about Texas Taxes from the state Comptroller’s office.
Read on to discover some other year-end tax tips and tricks that professional tax preparers use to maximize refunds or minimize the taxes that are owed.
Your income is taxed for the year it’s earned, and you can’t postpone reporting gross income from wages and salary that your employer reports. However, you may be able to take a year-end bonus and defer it, provided your company’s standard practice is to pay those bonuses the following year. As you do your year-end tax planning, here are a few other ways to defer your income:
- Delayed Billing: Are you freelancing or otherwise self-employed? In this case, you have more wiggle room. You can delay billing clients until late in December, thereby ensuring revenue isn’t received until the following year. The IRS Texas page has additional resources for self-employed and small businesses.
- Capital Gains: Another of the popular year-end strategies is to defer your income by taking capital gains in the following tax year rather than this one.
Keep in mind, you’ll only want to defer income if you think you’ll be in the same tax bracket (or a lower one) next year. There’s no sense pushing the additional revenue into the following year if it’s going to put you in a higher tax bracket. If that’s the case, you may want to go ahead and pay the taxes sooner rather than deferring that income to the following year.
Last-Minute Tax Deductions
Among the helpful year-end tax strategies is creating some last-minute deductions to lower your tax bill for the coming year:
- Charitable Contributions: You have control over the amount of the contribution and the timing. And you’re making a positive difference – a real win-win. For the tax year 2021, the IRS has expanded your tax benefits by increasing the amount of charitable contributions you can deduct to $600 (if you’re married and filing jointly) or $300 for other types of filing. If you’re using a contribution as a tax deduction, just make sure you have a receipt for any charitable donation you make. (The rule that required a receipt only if the contribution was $250 or more no longer applies.)
- Other Forms of Donation: To supercharge your tax benefit, another idea for year-end tax planning involves donating property or appreciated stock instead of cash. Extra bonus: You’ll be entitled to deduct the market value of the donated property on the date of the gift, thus avoiding the need to pay capital gains tax on the appreciation that’s been built up. Again, make sure you have documentation for your donation.
- Hospital or Doctor Bill: If you have bills coming due close to year-end, pay them before December 31st so you can claim them on this year’s taxes.
- Upcoming Taxes: An estimated state income tax bill that’s due January 15th or a property tax bill that’s due early next year can be paid early so you can include them on next year’s tax return. On the other hand, if you find that property tax financing is a problem, or you may owe delinquent property taxes, Tax Ease can help.
End-of-Year Tax Tips Caution: The Alternative Minimum Tax can be an Achilles heel for those who speed up their deductions. Make sure you understand the rules before accelerating your last-minute deductions.
To Itemize or Not to Itemize?
The Internal Revenue Service (IRS) reports that approximately 75% of U.S. taxpayers go with the standard deduction. Many of those people could be losing out by not itemizing. One of your year-end tax strategies should be to figure out your taxes both ways to determine if itemizing is right for you. You can get a general idea ahead of time by estimating your qualifying expenses for the year. Here are the standard deductions for 2021 taxes:
- Single taxpayers: $12,550
- Married, filing jointly: $25,100
As you’re doing your year-end tax planning, if you’re close to the itemization cut-off, that’s when you know you need to engage in “bunching” – timing your expenses to create fat years and lean years. For example, you put as many deductible expenses as you can in one year to surpass the amount of the standard deduction to get a larger write-off. This is your “fat year.” Then the next year, you keep expenses below the standard deduction to get the more favorable deduction. This is your “lean year.” By alternating this way, you can maximize your tax benefit.
Watch Out for The AMT
Here’s another warning to go with your year-end tax tips: If you’re not careful, the AMT (alternative minimum tax) can hit you hard. Created to ensure wealthy taxpayers couldn’t use legal deductions to reduce their tax obligation, the AMT is beginning to affect the middle class, too. Calculated separately from your usual tax liability, the AMT has a whole other set of rules, and you have to pay whichever tax bill comes in at a higher amount. At the end of the tax year, the AMT comes into play when certain expenses that would normally be considered deductible do not qualify under the alternative minimum tax. For instance, certain taxes such as state and local income tax and property tax may not be deducted under the AMT. If you know you’re going to be subjected to the AMT this year, don’t pay the installments in December 2021 that are due January 2022.
Loss harvesting is one of the year-end strategies that taxpayers use to reduce their tax obligation. They sell investments like stocks and mutual funds at a loss, then use the loss to offset taxable gains they acquired throughout the year. Dollar for dollar, losses will offset gains. In addition, if the losses you incur outpace your gains, you’re permitted to use up to $3,000 of the excess loss to reduce other income. Or you can carry this loss to the following year to offset any gains you have that year and negate up to $3,000 of other income. You can carry over your losses year after year during the course of your lifetime.
Retirement Account Contributions
One of the best tax planning tips is to defer taxes through retirement accounts. Because they compound over time without incurring taxes, retirement accounts can grow to a substantial amount. There are three great retirement options:
- Employer-Sponsored 401(k): Tax planning tips would be incomplete unless we included this retirement option. It is undoubtedly the best vehicle because 401(k) plans typically feature employer-matched contributions. If at all possible, increase your contribution to the maximum allowable amount. In 2021, this is $19,500. If you’re aged 50 or older, the amount is $26,000. In any event, it’s wise to review your contribution amount periodically to ensure you’re contributing as much as your circumstances will allow in order to reduce your taxable income.
- Individual Retirement Account (IRA): You have until April 18, 2022 to make a contribution to your IRA account. Of course, the sooner you invest the money, the faster it will grow tax-deferred. In 2021, you can contribute a maximum of $6,000 to an IRA (and another $1,000 if you’re aged 50 and above).
- Keogh Plan: This is a good retirement plan option for those who are self-employed. Your Keogh plan needs to be established by the end of the year, but you can continue to make contributions until the tax filing deadline (and include deadline extensions). How much you’re able to contribute is based on the type of plan you choose. This is one year-end tax planning tip that will benefit you well into the future.
What Are Kiddie Tax Rules?
To prevent parents from moving the tax bill for investment income from their high tax bracket to their offspring’s low tax bracket, Kiddie Tax Rules state that any child’s investment income that’s above $2,200 is taxed at the same rate as their parents. So if Junior is a full-time student who contributes to less than half of their support, the tax typically applies until they turn 24. These are year-end tax tips and words of caution for any parent looking to give their child stock to sell in order to finance college expenses. If the gain is too big and the child has unearned income in excess of $2,200, they will likely end up paying the same tax rate as the parents.
Over 70? Listen Up!
This is one of those tax planning tips to be aware of before the year closes. Minimum traditional IRA distribution requirements are back! If you’re going to be 72 by April 1st of next year (or you reached 70 ½ prior to January 1, 2020), you need to start taking regular minimum distributions from your IRA account. If you don’t, you’ll be slapped with a 50% excise tax on the amount that should have been taken out. This is based on your age and life expectancy, as well as the amount of money that was in your account at the start of the year. Following that, you need to make annual withdrawals by December 31st to avoid the penalty. It’s a good idea to ask your IRA custodian to withhold tax from any distribution you receive. Although this is voluntary, doing so means you can avoid the inconvenience of paying the tax in quarterly installments.
Keep An Eye On Your Flexible Spending Account
An FSA (Flexible Spending Account) is a program set up through your employer, who will deposit a portion of your paycheck into a special account. The amount deposited is tax-deferred, which can save you a bundle on income taxes and Social Security taxes. The money in your FSA account can be used to pay medical bills or child care (depending on the type of account). Certain FSAs require you to deplete the account by a certain date or risk losing the money that remains. Know what the rules are for your plan, and make sure you use every bit of the money you can. This may entail an end-of-the-year visit to the doctor or dentist or a trip to the drug store for things like non-prescription pain relievers. By doing so, you’ll be all caught up by year-end – strategies like this one will save you money with little effort!
Budget For Holiday Expenses
Along with end-of-year tax tips, there are other things to keep in mind this time of year. It’s easy to get caught up in the spirit of the holidays. Don’t fall into the trap of overspending and then experiencing sticker shock when the bills come due in January. Create a budget and stick to it, and that will be one less headache you’ll have to worry about in the coming year.
Include Property Tax Financing in Your Plan
While the end-of-year tax planning often relates to income taxes, many people lose sight of the coming due date for property taxes in Texas, which is January 31st – much sooner than Federal tax returns are due. As of February 1st, you’ll be considered delinquent if you haven’t paid, and the property tax penalties will begin to accrue. Make sure you understand your obligations and do a little real estate tax planning before it’s too late. Otherwise, the late fees and penalties could be debilitating. Luckily, property tax financing and other forms of assistance are there to help.