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"What's been on top of mind for my clients is the Biden proposal," says Andy Subkoviak, senior investment strategist with investment advisory firm Parametric in Seattle. Although its provisions seem to be a moving target, the proposed Build Back Better Act could have some significant tax implications.
That means now may be the time to consider tax-saving tips such as Roth conversions and harvesting cryptocurrency losses. Plus, there are perennial year-end tax planning tasks that should be completed regardless of if and how the law changes next year.
Here are 10 tax tips for 2021 to beef up your savings and minimize the amount of income tax you'll pay:
People can make tax-deductible contributions to traditional IRAs and health savings accounts up to April 15 of next year. However, the door closes on Dec. 31 for 401(k) contributions. "There's no way to make additional contributions (after the new year)," says Eric Bronnenkant, head of tax for Betterment, a financial advisory company.
Taxpayers with a qualified high-deductible family health insurance plan can deduct up to $7,200 in contributions to a health savings account in 2021. Individuals with self-only coverage can deduct $3,600. Those age 55 or older are eligible for an additional $1,000 catch-up contribution.
Tax-deductible contributions to a traditional 401(k) are capped at $19,500 for 2021. Workers age 50 and older can make an additional $6,500 in catch-up contributions.
Normally, retirees who have a traditional 401(k) or IRA must take a required minimum distribution each year once they reach age 72. Depending on the size of a person's retirement account, this distribution can be sizable and result in a significant tax bill.
Last year, the Coronavirus Aid, Relief, and Economic Security (CARES) Act waived RMDs, but they are required again this year. If you haven't already taken your RMD, make sure you do that before the end of the year.
"If you don't take it, you'll get a 50% penalty," says Craig Ferrantino, president of Craig James Financial in Long Island, New York. "That's … painful."
Withdrawals from traditional IRAs are taxed in retirement, but distributions from Roth IRAs are tax-free. Plus, Roth IRAs don't have required minimum distributions, which can also be beneficial for those looking to reduce taxes in retirement.
Fortunately, the government allows you to convert money from traditional accounts to Roth accounts to get these benefits. When money is converted from a traditional to a Roth account, taxes must be paid on the converted amount.
With some concerned about rising tax rates, it may best to not delay making any planned conversions. "If we're going to do a Roth conversion, this is the year to do it," Ferrantino says.
Families with children can use 529 plans to prepare for college expenses and save on their state income taxes next spring. Most states offer a state income tax deduction for contributions made by residents to a state-sponsored plan. However, a handful of states may allow a deduction for contributions to any 529 plan.
While there is no federal tax deduction for 529 contributions, money in these plans grows tax-free and can be withdrawn tax-free when used for qualified education expenses.
People should be wary of buying mutual funds at this time of year if they will be held in a taxable account. "It being November, it's an active time of the year for capital gains distributions," Subkoviak says.
You could get hit with a bill for year-end dividends even if you just purchased shares, and, essentially, you'll be paying taxes on a profit you didn't actually see. To avoid paying additional taxes, consult with a broker before making a purchase to find out when distributions are made.
If you own stocks that have lost money, you can sell them and deduct up to $3,000 on your federal taxes. That money can offset gains on other stocks or be applied to regular income taxes.
Just be careful not to violate the wash-sale rule, which would disallow the deduction. This rule states you cannot purchase the same or a substantially similar stock within 30 days before or after the sale.
The end of the year is also a good time for some people to sell stocks that have appreciated significantly in value. This can be a particularly good strategy for those in the 10% and 12% tax brackets since their capital gains tax may be zero. The stocks can then be repurchased, which resets the basis and minimizes the amount of tax to be paid on future gains.
Even if you're not in the lowest tax brackets, you may want to sell winning stocks to reset the basis if you're also harvesting losses. Another reason to sell investments at this time of year is to rebalance your portfolio.
A loophole in the law means people who own cryptocurrency should consider harvesting those losses in 2021. "Right now, the wash sale rule does not apply to cryptocurrencies," Subkoviak says.
That means investors can sell cryptocurrency for a loss and then immediately buy the same currency without it affecting their ability to deduct the loss. As with other investments, cryptocurrency losses can be used to offset capital gains or regular income taxes.
However, the Build Back Better proposal is poised to close this loophole so it's in your best interest claim losses now if you can. "Don't wait until 2022," Subkoviak says.
Deducting charitable donations has traditionally been a popular way to reduce tax liability, but not everyone can do so. "Normally, you need to itemize to deduct any charitable contributions," Bronnenkant explains. That can be hard to do with the 2021 standard deduction set at $12,550 for single taxpayers and $25,100 for married couples filing jointly.
However, the CARES Act included a provision to allow taxpayers to write off up to $300 in charitable contributions on their 2020 return even if they weren't able to itemize. That deduction is back for 2021, Bronnenkant says, and has been increased to $300 per person so a married couple, filing jointly, is eligible for an up to $600 deduction.
To claim the deduction, your gift must be a cash donation, but gifts to donor-advised funds do not qualify.
November is a good month to meet with a tax advisor. They have finished their October tax filings and may have time in their schedule before the busy tax season starts after the first of the year.
An advisor can help pinpoint end-of-tax-year strategies to reduce taxable income through retirement contributions or itemized deductions. That, in turn, may be key to ensuring households remain eligible for some income-based tax incentives such as student loan interest deductions. If you don't regularly use a tax professional, running numbers through tax software can be just as beneficial.
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