With the winter holidays looming, the clock is ticking for taxpayers who want to minimize what they will pay next spring. Many money-saving tax strategies need to be implemented by Dec. 31 to have an effect on tax filing in the spring.
“Proper tax planning is taxpayer specific, and one strategy may not work for all,” says Bhakti Shah, vice president and tax planning manager for wealth management firm Beacon Trust in Morristown, New Jersey.
However, get started by using these 10 tax tips to beef up your savings and minimize the amount of federal income tax you’ll pay for 2020:
— Make 401(k), and HSA contributions.
— Cancel your RMD for 2020.
— Convert money from a traditional to a Roth IRA.
— Take a hardship withdrawal, if needed.
— Hold off on mutual fund purchases.
— Harvest your capital losses.
— Pick up capital gains if you’re in a low tax bracket.
— Make purchases for your business.
— Bunch your charitable contributions.
— Meet with your tax advisor.
1. Make 401(k) and HSA Contributions
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. “All of these will, of course, reduce your taxable income,” says Lisa Greene-Lewis, CPA and tax expert with TurboTax.
Taxpayers with a qualified high-deductible family health insurance plan can deduct up to $7,100 in contributions to a health savings account in 2020. Individuals with self-only coverage can deduct $3,550. 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 2020. Workers age 50 and older can make an additional $6,500 in catch-up contributions.
2. Cancel Your RMD for 2020
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.
However, for 2020, the RMD has been waived, thanks to the Coronavirus Aid, Relief, and Economic Security (CARES) Act. If you haven’t already taken your RMD and don’t need the extra money, now is the time to cancel it.
If you took your RMD earlier in the year, the government gave you until Aug. 31 to reverse the distribution. Now that this deadline has passed, talk to a financial advisor to see if you can roll over the distribution or recharacterize it as coronavirus-related, two options that may lower the taxes due next year.
3. Convert Money From a Traditional to a Roth IRA
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.
With RMDs waived this year, “It might be a nice opportunity to convert some of that money to a Roth account,” says Melissa Ridolfi, vice president of retirement and college leadership at Fidelity Investments.
When money is converted from a traditional to a Roth account, taxes must be paid on the converted amount. That means people might want to be careful that the amount they convert doesn’t bump them into the next tax bracket.
4. Take a Hardship Withdrawal, if Needed
This year has been difficult for many workers who have faced unemployment or reduced hours. Anyone planning to dip into their retirement fund to make ends meet should complete the withdrawal prior to Dec. 31.
Normally, distributions from retirement funds made prior to age 59 1/2 incur a 10% penalty in addition to any regular income taxes that may be due. With the passage of the CARES Act, those who have been affected by the COVID-19 pandemic can avoid paying the extra 10%. What’s more, they can pay off the income tax on the withdrawal over a three-year period.
“By the end of the year, you can take $100,000 out of your retirement (fund) and not pay the penalty,” Greene-Lewis says. Eligible individuals include those who have been diagnosed with COVID-19, have a spouse or dependent diagnosed with COVID-19 or are financially impacted by the pandemic because of a quarantine, unemployment, reduced hours or similar circumstances.
5. Hold Off on Mutual Fund Purchases
People should be wary of buying mutual funds at this time of year if they will be held in a taxable account. “You may want to avoid buying a mutual fund right before it makes its year-end distribution or you may have an unexpected tax bill,” Ridolfi 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.
6. Harvest Your Capital Losses
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.
“From an investment standpoint, year-end is a great time for individuals to sell investments that are not performing as expected and reallocate the proceeds from those sales,” Shah says.
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.
7. Pick Up Capital Gains if You’re in a Low Tax Bracket
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. “You tend to drift off your target asset mix (over time),” Ridolfi says.
8. Make Purchases for Your Business
If you used your 2020 quarantine to start a business, you can save money next spring by purchasing business supplies now. Small business owners can also claim a home office deduction if they have a space in their house they use regularly and exclusively for work.
“Your self-employment taxes are based on your net income,” Greene-Lewis says. “You may want to buy some business equipment or a computer for your office.”
The IRS limits these deductions to those who are self-employed so employees who moved to remote work during the pandemic aren’t eligible for a federal tax write-off. However, there are a handful of states, such as California and New York, which allow workers to include unreimbursed work expenses on their state itemized deductions.
[See: 15 Best Remote Working Jobs.]
9. Bunch Your Charitable Contributions
In 2020, married couples filing jointly have a standard deduction of $24,800. For single taxpayers, the standard deduction is $12,400. The Tax Cuts and Jobs Act of 2017, which nearly doubled the standard deduction, also eliminated miscellaneous deductions, capped state and local tax deductions at $10,000 and limited mortgage interest deductions to loans of up to $750,000.
These changes can make it difficult to itemize deductions unless someone has significant charitable donations. One option is to bunch two years of contributions into a single year, which would allow someone to claim an itemized deduction every other year. For those with the financial means, setting up a donor-advised fund is another strategy. It allows people to deposit a large amount into a fund, deduct that amount from their taxes and then make charitable gifts over time.
If you think you’re close to being able to itemize deductions, make a few extra charitable gifts before the end of the year. “Even if you clean out your household goods and clothing and donate them, you could bump yourself up over the standardized deduction (threshold),” Greene-Lewis says.
10. Meet With Your Tax Advisor
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.
“With 2020 being an election year, there could be changes in tax laws that may need to be considered when you make your year-end plans,” Shah says.
An advisor can help pinpoint 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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Update 11/23/20: This story was published at an earlier date and has been updated with new information.