With 2020 nearly over, it is time to prepare for filing your taxes and consider several items to prepare for the upcoming filing season. April 15, 2021, is the filing deadline next year. It can be extended through October 15, but extending your filing deadline does not extend your payment deadline.
There is great uncertainty regarding the possibility of changes to the tax laws for 2021 and beyond resulting from the recent election, but it looks right now as though any major changes would not take place until 2022 at the earliest. With that in mind, there are several time-honored tax planning strategies to consider.
First, employees should review their federal and state tax withholdings to ensure they are having the correct amount of tax withheld. While large refunds can be very exciting, improper withholdings can lead to large tax bills and sticker shock at filing time.
Second, consider deferring bonuses and other income into 2021 if possible. The additional income this year may push you into a higher tax bracket and increase your tax bill. Also, the IRS adjusts tax brackets slightly upward each year to account for inflation so you can earn more money next year at lower tax rates. If you’ve had a good year financially, pushing off any bonuses or other income will defer your tax for a year and will also give you the opportunity to keep some of that money in lower tax brackets.
Many taxpayers have experienced furloughs, layoffs or other reductions income resulting from COVID-19. It may be difficult to delay income opportunities in this case, especially if you are considering withdrawing from a retirement account to help shore up your finances. I wrote recently regarding relaxed rules and reduced penalties on early retirement withdrawals through year-end due to COVID-19, so you may need to review the recent changes if they apply to you.
Next, accelerate deductions if you plan to itemize this year. Typical deductions will include medical expenses, mortgage interest, charitable contributions (make sure they are legitimate organizations) and state & local taxes capped at $10,000 (including property taxes and automobile ad valorem taxes). The first $300 of charitable contributions this year are deductible even if you take the standard deduction this year, thanks to the CARES Act. Make sure to obtain receipts and statements for your deductions to help ensure you take advantage of them.
If you cannot itemize, he standard deduction for 2020 is $24,400 for married taxpayers, $18,650 for heads of household and $12,400 for single filers. Those numbers are increasing to $25,100 (married), $12,550 (head of household) and $18,800 (single) for 2021.
Additionally, retirees may wish to contribute any remaining Required Minimum Distributions (RMDs) from their retirement accounts directly to charity. This avoids claiming the income while simultaneously taking advantage of tax benefits for charitable deductions.
You may also increase contributions to your retirement account such as an Individual Retirement Account with a $6,000 limit (plus another $1,000 if you are over 50) or 401(k) or 403(b) through your employer with a $19,500 limit (plus another $6,500 if you are over 50) to boost your savings and reduce your taxable income.
Consider prepaying college tuition if you are eligible to take advantage of benefits such as the American Opportunity Credit or the Lifetime Learning Credit.
You may also wish to sell stock investments that have realized significant losses, especially if you have capital gains that you’d like to shelter from tax. While federal tax law limits capital losses to $3,000 per year for married filers ($1,500 for singles), they can be carried forward to future years or used to offset gains. Alabama does not limit such losses, so that is an added benefit.
Reach out to a tax professional with questions or concerns regarding specific questions, and keep in mind that nearly everyone’s situation is unique, so what works for some taxpayers may not work for others.