Keep More Dollars in Your Pocket: Tax Planning

Post Written by: Thomas K. Williams, CFP®, CPA

It’s that time of year – thinking about income taxes and capital gains taxes and deductions – tax planning.

With a savvy financial planning tax strategy, you may be able to reduce your income tax contribution to the U.S. Department of Treasury.

  1. Go to a Pro 

If your tax return is prepared by a tax professional, set up a meeting with him or her to review your current tax situation. Everyone’s tax situation is a little different. Your tax return preparer not only should have an excellent knowledge of tax planning opportunities but will be in a great position to marry that knowledge with your specific tax situation, thereby potentially identifying tax-saving opportunities for you. The meeting may only last an hour but it can be an hour well spent.

  1. Build Your Nest Egg

Take advantage of making contributions to whatever retirement plans that are available to you. These commonly include 401(k) plans, IRA’s, and Simplified Employee Pension Plans (SEP). For 2021, up to $19,500 from your pay can be contributed to a 401(k) plan, which increases to $26,000 if you are age 50 or older. Assuming you have sufficient earned income (wages, salary, self-employment income, etc.), you can also contribute to an IRA in 2021 up to $6,000, or, if you are age 50 or older, $7,000.

The deductibility of these contributions is subject to various rules that should be reviewed. Contributions to IRAs can be made up to April 15th of the year for the preceding year, if desired.

Additionally, if you are a self-employed individual, especially if you have no employees, consider establishing an SEP as part of tax planning. Contributions to a SEP can be made for as much as 25 percent of your adjusted net earnings from self-employment with a cap of $58,000 for 2021. SEP contributions can be made up until the due date of your tax return (which this year has been moved to May 17) plus extensions for the preceding year. This means you could defer contributions to an SEP for 2020 up until November 15, 2021, the extended due date of your 2020 return assuming you file for an extension.

  1. Let The IRS Help Pay Your Medical Bills

 If you have a high-deductible health care plan, you may be able to lighten your tax load by contributing to a Health Savings Account (HSA). Your employer may offer an HSA, but if not, you can set one up yourself at a bank or other financial institution that offers this service.

A high-deductible health care plan is a plan with a minimum annual deductible of $1,400 for individuals and $2,800 for families. It also has to have a maximum out-of-pocket expense of $6,900 for individuals and $13,800 for families. An out-of-pocket maximum means the most you will pay on deductibles, copayments, and coinsurance.

Contributions to an HSA are tax-deductible and withdraws are tax-free if they are used for qualifying medical expenses. The individual limit on contributions to an HSA is $3,600 for 2021, but if you have a family high deductible plan, the limit is $7,200 for 2021. Note: If you are age 55 or older, each of these limits is increased by $1,000. Contributions to an HSA can be made up to April 15th of the current year and still be deducted in the prior year for tax purposes.

  1. Don’t Overlook This Gift

Because of the significant increase in the standard deduction in recent years, many more taxpayers use it rather than itemizing deductions. Itemized deductions typically include mortgage interest, state, local, and real estate taxes capped at $10,000 and charitable contributions. However, under a special rule for 2021, even those taxpayers who do not itemize can deduct $300 of cash donations ($600 for married couples filing a joint return) to qualified charities.

  1. Consider Bunching to Help with Tax Crunching

 Many taxpayers use the standard deduction because of its simplicity, as well as providing a tax benefit, which exceeds the benefit from itemizing deductions.

However, for those taxpayers who are charitable with little or no mortgage interest, their charitable contributions may produce no tax benefit year after year. For example, a married couple with $5,000 of mortgage interest, $10,000 of charitable contributions, and the cap of $10,000 for state, local, and real estate taxes receive no tax benefit from the $10,000 they gave to charity but for the $600 benefit mentioned in No. 4 (which expires in 2021). The couple’s standard deduction in 2021 is $25,100.

Accordingly, it could be prudent, if affordable, to bunch their charitable contributions for 3 or 4 years into one tax year, thereby allowing them to receive a tax benefit through itemizing their deductions in that year while using the standard deduction in following years.

  1. Stay in Control While Giving Money To Charity

Bunching charitable contributions can save taxes, but if individuals contribute three or four years of donations to charities within one year, it may be difficult for them to take a hiatus in giving.

The creation of a Donor Advised Fund (DAF) may be a solution. A DAF is easy to create through Schwab, Fidelity, or other major financial custodians. In essence, it’s a charitable fund that must pay its assets to charity over time. A  tax contribution deduction is provided to the donor in the year the DAF is funded.

You and your family can remain in control as to what charities receive the donations from the fund. There is no tax environment within the DAF, making it an excellent vehicle to consider funding with appreciated securities, since if desired, the appreciated securities could be sold after they are in the DAF with no tax consequences. Furthermore, any income earned within the DAF is not taxable.

  1. Farm for Losses to Save Taxes 

Financial market volatility or company-specific issues can cause a security in your portfolio to drop below what you paid for it, thereby creating an unrealized loss.

The IRS only allows losses to be deducted when realized, i.e. when the asset is sold. Harvesting these losses in your portfolio can help reduce your taxes on any realized capital gains you may have. To the extent capital losses offset all capital gains, they are permitted to offset up to $3,000 of non-capital gain income in the same year. If realized, losses that exceed the capital gains for the year, plus $3,000, are allowed to be carried over to future years.

Many taxpayers consider tax-loss harvesting at year-end but this should be considered throughout the year to maximize the tax planning strategy. Wash sale rules prohibit the deducting of a loss if the same or identical security is purchased 30 days before or after the loss security is sold, requiring care to be taken when harvesting losses.

  1. Do You Have the Energy To Reduce Your Taxes?

 Do not forget about the tax credit available for homeowners who install alternative energy equipment such as solar electric systems, solar hot water heaters, geothermal systems, etc.

The recently passed Consolidated Appropriations Act of 2021 extended this credit ,which is 26 percent of the cost for qualifying systems placed in service before January 1, 2023. There is no cap on the amount of the credit and because it is a credit, it is a dollar-for-dollar reduction of your tax liability.

 

The above ideas relate to the federal income tax law we have currently in 2021. These laws may change with new legislation under a different administration in the future. As with any new tax legislation, some planning ideas may be modified or eliminated, but that also creates opportunity for more creative solutions!

If you would like guidance on financial planning with the knowledge to keep taxes minimized, Domani Wealth’s team of CPAs, CERTIFIED FINANCIAL PLANNER® Professionals, and Certified Financial Analysts can come alongside you. Working with us, may help you feel confident and comfortable with their financial picture. Give us a call anytime at 855-555-5455, email info@domaniwealth.com, or book a quick, no-obligation consult today!

 

 

This material has been prepared for informational purposes only and is not intended to provide specific tax, legal, or accounting advice. Please consult with your own tax, legal, and accounting services for guidance.

 

 Important Disclosure

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from Domani. A copy of Domani’s current written disclosure brochure discussing our advisory services and fees continues to remain available upon request.

PLEASE SEE ADDITIONAL IMPORTANT DISCLOSURE INFORMATION

 

 

 

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