What a year! Even though 2021 has been unusual, to say the least, one thing doesn’t change. With the end of the calendar year, our thoughts (at least here in the accounting world) turn to taxes.
We have held off on posting this while we await a sense of where tax rates will land in 2022. But with a deadlock in the Senate, it appears that rates may be similar in 2022. So our advice below is based upon that premise.
We’ve got tips to help you reduce your taxable income for 2021 or increase your refund. Some advice is similar to previous year’s, while we’ve also got a few new ones that the IRS enacted due to the impact of COVID.
1. Defer your income
Figure out your adjusted gross income for 2022 and 2021. This will help you identify your tax bracket for both years. If it looks like you’ll be in the same or lower tax bracket next year, then consider shifting some of your income to the lower income year. This can be done by asking your employer to defer a year-end bonus to next calendar year.
You can also defer income by taking capital gains in 2022 instead of in 2021. If you’re self-employed, a freelancer or a consultant, consider delaying billing until the very end of the year ensuring that you get paid after you make those New Year’s resolutions.
2. Last-minute tax deductions
Another way to quickly reduce your 2021 taxes is to take advantage of tax deductions.
Business owners can make tax-deductible expenses this year on things like equipment and supplies.
You can also contribute cash or goods to an IRS-approved non-profit organization. Deductions for charitable donations generally cannot exceed 60% of your adjusted gross income, though in some cases limits of 20%, 30% or 50% may apply. In 2021, you can deduct up to $300 of qualified charitable cash contributions per tax return ($600 for married filing joint tax returns) as an adjustment to adjusted gross income without itemizing your deductions.
You will need a receipt, canceled check or bank record for any contribution, no matter what the amount. If you donate an asset that you’ve owned for more than one year, you get a double tax benefit from the donation: You can deduct the property’s market value on the date of the gift and you avoid paying capital gains tax on the built-up appreciation.
Decide if it’s better to itemize your deductions vs. claiming the standard deduction. According to the IRS, about 75% of taxpayers take the standard deduction. But this isn’t necessarily the best strategy. If your qualifying expenses exceed the standard deduction, which in 2021 is $12,550 if you are single or married filing separately, $25,100 if you’re married filing jointly, or $18,800 if you’re head of household, then you likely should maximize your deductions and itemize. Postpone your donation if you think you’ll need the deduction in the 2022 tax year.
You can also consider making a contribution to a 529 Plan, which is a college-savings program. The earnings in a 529 plan grow tax-deferred and withdrawals are free of federal income tax when used for qualified higher education expenses. These funds cannot be used to pay for room and board. Many states offer various tax incentives for contributions to the state’s 529 plan for the residents.
If you live in New York, contributions to a New York 529 plan of up to $5,000 per year by an individual, and up to $10,000 per year by a married couple filing jointly, are deductible in computing New York taxable income. Only contributions made by the account owner, or if filing jointly, by the account owner’s spouse, are deductible.
Finally, this year the federal gift tax exclusion allows you to give away up to $15,000 each in 2021 to as many people as you wish without those gifts counting against your $11.7 million lifetime exemption.
3. Reevaluate your investments
Reviewing your investments with your financial advisor will keep your investment on track for your financial goals. Within the scope of your investments, if you sold stocks this year that resulted in a gain, you may want to consider selling stocks that produce a loss to offset the gain. Taxpayers can deduct up to $3,000 ($1,500 for married filing separately) of their excess losses, which reduces overall income. If you have more than $3,000 in excess loss, it will carry over to offset gains in later years for as long as you live.
4. Up the Ante on Your Retirement Account
One of the best investments is a tax-deferred retirement account since they compound over time free of taxes and often employers match contributions. It also reduces your taxable yearly income.
If you are participating in your employer’s 401(k) plan, make sure that you’re putting in the maximum amount of money allowed ($19,500 for 2021, $26,000 if you are age 50 or over). If that amount isn’t realistic, try to contribute at least the amount that will be matched by employer contributions.
Self-employed individuals or small unincorporated business entity owners might want to consider setting up a Keogh plan or a Simplified Employee Pension (SEP) IRA.
Any contributions to these plans are pre-tax or tax deductible. Maximum contributions to a Keogh plan (if you choose a defined contribution plan) and SEP IRA are 25% of compensation up to $58,000 per person for 2021. The maximum contributions to a Keogh plan (if you choose a defined benefit plan) are up to $230,000 per person for 2021.
5. Make the Most of Pre-Tax Dollars: Medical FSA, HSA and Dependent Care FSA
The pandemic has impacted many parts of our life, including your Flexible Spending Account (F.S.A.). Many companies provide employees with the option to take pre-tax money out of their paychecks and put it into an F.S.A. account to pay for medical or dental expenses that are not covered by insurance.
For many years, the rule was that if you don’t use those funds by the end of the year, that money is lost. Some employers provided a little wiggle room, allowing part of the funds to be carried over or an extension of the deadline. But there was a limit, allowing only $550 to be carried over to the next year.
This year, since many people put off doctor’s visits or weren’t able to take care of medical or dental procedures, employers may opt in workers to carry over the total balance. You may also contribute up to the maximum allowed in payroll deductions of $2,750 for 2021. This may change in 2022, though guidance has not yet been issued by the IRS.
Contributions to a Health Savings Account are made pre-tax. They grow tax-free, plus withdrawals used for qualified health care expenses are not taxed. But beware, some states do not exempt contributions from state taxes. For 2021, the contribution limit is $3,650 for an individual or $7,200 for families. For those 55 years and older, you may contribute an additional $1,000 into your HSA. Any unused funds automatically roll over to the next year. You can change how much you put into your HSA at any time. New this year: Personal protective equipment used to prevent Covid — masks, hand sanitizer, etc. — is now considered an eligible expense.
Dependent Care FSA
The American Rescue Plan has increased dependent care FSA limits to $10,500 from $5,000 for married couples filing jointly and $5,250 up from $2,500 for single filers providing a higher tax break for 2021 if your employer adopts the changes. Similar to medical FSA, any unused funds in dependent care FSA may be rolled over into 2022 if your employer opts in.
6. Reminder to take Required Minimum Distribution (RMD) for 2021
Required minimum distributions (RMDs) are withdrawals you have to make from most retirement plans (excluding Roth IRAs) when you reach the age of 72 (or 70.5 if you were born before July 1, 1949). Withdrawals must be made by December 31. The amount you must withdraw depends on the balance in your account and your life expectancy as defined by the IRS.
In 2021, you must take the Required Minimum Distribution. This was waived last year due to COVID. If you don’t want to have taxable RMD, making a qualified charitable distribution (QCD) from an IRA may be an option to satisfy your required minimum distribution (RMD).
It is one of life’s certainties that we must pay taxes. But we do have control over how much we pay. Now is the time to take action and potentially keep more of your hard-earned cash.
Caveat: In the unlikely scenario that a new tax law is determined by the end of the year, we will inform you as soon as possible.