Just a few days remain to take advantage of 2020 tax-saving opportunities. Now is also a good time to look ahead and make income tax adjustments that will affect your taxes in 2021.
Below are 12 tips to reduce your tax bite for 2020 and start planning for next year:
Donate to Charity
As a result of the CARES Act, cash donations of up to $300 to qualifying charitable organizations are deductible if they are made before December 31, 2020. The $300 tax deduction is available to the almost 90 percent of U.S. taxpayers who elect to take the standard deduction instead of itemizing deductions.
The CARES Act also raised the limit for itemized charitable deductions on a taxpayer’s Schedule A from 60 percent of a donor’s contribution base (typically the donor’s adjusted gross income) to 100 percent for 2020 only. This limit applies only to cash contributions to qualifying organizations.
Make a Qualified Charitable Distribution
Taxpayers age 70½ and older can make a Qualified Charitable Distribution to a qualified charity that counts toward their required minimum distribution (RMD) for a traditional IRA. While mandatory RMDs were suspended for 2020, withdrawals can still be taken if taxpayers choose to do so.
This means paying two- or three-years’ worth of deductible expenses by the end of 2020 so you can itemize on your 2020 tax return. Since state and local taxes have a $10,000 cap and 2020 standard deductions are $12,400 (single) and $24,800 (married couples), plus $1,300 extra if taxpayers are age 65+, this often involves making large charitable donations.
Create a Donor Advised Fund (DAF)
A DAF is set up with a custodian such as Schwab, Vanguard, and Fidelity for future charitable giving. Donors deposit funds (typically in excess of their standard deduction amount so they can itemize) and receive a deduction for the tax year in which a DAF deposit is made.
Consider a Roth IRA Conversion
With a Roth conversion, taxpayers move all or part of their money held in a tax-deferred traditional IRA to a tax-fee Roth IRA. Taxes are due in the year of the conversion. If 2020 was a year with reduced income, a conversion may make sense for someone in a lower tax bracket.
Try Tax Loss Harvesting
This term refers to the practice of proactively selling investments that have lost value during the past year by December 31 and using the capital loss to offset investment gains and up to $3,000 of ordinary income on federal income taxes.
Review Income Tax Withholding
Estimates can be done for both 2020 and 2021 whether you have tax withheld from your pay and/or make estimated quarterly payments. The fourth quarter 2020 estimate is due on January 15, 2021. Use the IRS Tax Withholding Estimator tool to help determine how much to set aside.
Use Up Flexible Spending Account (FSA) Funds
Money set aside pre-tax in an FSA must generally be used by the end of the calendar year or be forfeited.
Some employer plans allow a short grace period (up to 2.5 months) to spend FSA funds or the ability to roll over up to $500 to 2021.
Check on the specifics of your plan to see if you qualify.
Review Voluntary Retirement Savings Plan Contributions
Now is the time to make changes for savings plan deposits from 2021 paychecks.
If your income is stable or increased in 2020 and you have at least six months’ of expenses stashed away for emergencies, consider making a larger retirement savings deposit. Even 1 percent more of pay in savings can translate to thousands of extra dollars saved at retirement.
Try New Tax-Savings Techniques
Many people experienced a drop in income in 2020 related to the pandemic. As a result, they may qualify for tax breaks that they always had “too much income” for before. Examples include the earned income tax credit and the retirement saver’s credit.
Be Realistic About 2021 Tax Refunds
This has not received much attention amidst stories about COVID-19 deaths, vaccines, stimulus payments, and food banks, but it is another looming issue.
Low-wage taxpayers who count on tax refunds the most may be less likely to receive them.
Refunds occur only when people earn an income and over-withhold for taxes. Unemployed workers who did not do either in 2020 may get less money back than before (depending on personal income tax variables such as tax credits and unearned income).