Q4 2021 Financial Wellness: Year-End Tax Planning Strategies

Strategy 1: Defer Income and Accelerate Expense

What are some helpful tax savings strategies we should consider before the end of the year?

• The typical tax planning strategy is to defer your current year income and accelerate expenses before the year end. In other words, people want to pay less taxes…always, you can do so by lowering your income by deferring it to next year, and accelerating your expenses i.e. paying them before year end so you can take deductions this year. But this may not be applicable to everyone. Consider whether deductions or credits may be worth more to you this year or next year and you can control the timing of them.

For example: If you are in a higher tax bracket this year, you may want to accelerate expenses and deductions to offset your immediate taxes. Alternatively, if this year you received less income than in years past but expect to earn more in the future, then you may want to accelerate your income and defer the expenses to future years when you may be in a higher tax bracket.

What are some of the ways people can shift income and expenses from one year to another?

• One way to shift income is to contribute pre-tax dollars vs. after-tax dollars to your retirement plans. The difference between these two types of contributions is pre-tax is deductible against your current income vs after-tax offers no deduction.
• If you want to lower your income, you may want to consider contributing pre-tax dollars. Conversely, if you are in a lower tax bracket this year and expect it to be higher in the future, you may want to contribute after-tax dollars instead. This would be a contribution to a Roth IRA or Roth 401(k), we will cover a bit more of this in a little bit.
• Lastly, with your expenses, you can pay your real estate tax bill and medical bills before year end, or bunching multiple years of charitable donations to this year so you can get a deduction for them sooner rather than later.

Strategy 2: Charitable Gifting

What are some charitable donation tax planning ideas to consider?

• The COVID relief package extended some of the tax benefits for charitable gifting to tax year 2021:
  • For individuals who take the standard deduction, you are now eligible to deduct up to $300 for the cash donations you gift to charities and the deduction is up to $600 for married couples.
  • For those who take itemized deductions on the other hand, cash contributions you make to public charities are now eligible to offset 100% of your adjusted gross income this year. Traditionally, the deduction for most charitable cash contribution is limited to 60% of your adjusted gross income. This limit was temporary suspended for tax years 2020 and 2021, so you can potentially make and deduct eligible contributions to offset up to 100% of your income. This is extremely beneficial for anyone who is earning an unusually high income this year.

Strategy 3: Retirement Plan Savings

When it comes to my retirement savings, what are some last minute planning tips I should consider before year end? Is there anything I can still put into motion for the tax year 2021?

• Saving for retirement is one of the most important financial goals that we should all take into consideration when we manage our financial plans. Deferring income to retirement plans is an easy way for individuals to lower taxable income, while saving for future years. An important consideration in your tax planning strategy is to decide whether you should maximize your 2021 retirement plan contribution.
• A 401(k) plan is an employer-sponsored retirement account that employees contribute a percentage of their income to, and employers may offer a match percentage to those contributions.
  • The 2021 contribution limit to this type of plan is $19,500 with catch-up of $6,500 for those who are 50 years old or older. Contributions to 401(k)’s apply to the calendar year in which they are withheld from the participant’s paycheck. In other words, you have until December 31^st to maximize your current year’s contribution limit for this type of plan and get a deduction on it against your wages if you are doing a pre-tax contribution.
• The traditional and Roth IRAs on the other hand are retirement accounts that you can opt to open with a financial institution and save on your own.
• For these types of IRA accounts, employer contribution matches do not apply and they have specific income and contribution limits.
  • The current year’s contribution limit for this type of retirement saving account is $6,000 and with a catch-up of $1,000 available for those who are 50 or older. The deadline to make your IRA contribution is the tax filing deadline so for 2021, it will be April 15, 2022.
  • Your traditional IRA contributions may be tax-deductible depending on your income level. The deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels.
  • Contributions to a Roth IRA are funded with after-tax dollars, meaning there's no tax deduction against your income at the time you make the contribution. However, when the money is withdrawn from the account (presumably after you retire), no income tax is due on the earnings that have been accrued as long as you made your first Roth IRA deposit/contribution 5 years before your first withdrawal.

Are you able to have more than one retirement savings account at the same time, say both a 401(k) and an IRA?

• Absolutely! There is no restriction to having both types of retirement saving plan/account at the same time. They are independent from one another, but just keep in mind the deduction for your traditional IRA contribution will depend on whether you have a 401(k) at work.

Strategy 4: Savings for Families with Children

During the pandemic there were child tax credits offered, which the IRS has been distributing since earlier this summer. Will those affect our 2021 taxes? And if so, how?

• In continued response to the Covid-19 pandemic, in 2021 the IRS has been sending advanced child tax credit payments to families with qualified children. For those who did not opt-out of the payments, the amount you received in advance will be subtracted from the total child tax credit that you will be claiming on your 2021 tax return.
• The full credit for children under the age of 6 is $3,600 and for children between the age of 6 and 17 is $3,000, this credit is for each child that you may have. The credit gets reduced to $2,000 per child for married couples’ income that is greater than $150,000, and single filers with income of greater than $75,000. The credit is then further reduced below $2,000 for married joint filers with income above $400,000, and $200,000 for single filers.
• The child tax credit is fully refundable for the 2021 tax year, meaning even if you don’t owe any federal income tax, you can still get a tax refund for the full credit.

Are there any additional tax savings for those who paid for childcare during the year?

• Yes, you may also qualify for a tax credit that will reduce the cost of childcare. The childcare tax credit is calculated based on your income and a percentage of expenses that you incur for the care of qualifying children to allow you to go to work, look for work, or attend school.
• For the 2021 tax year, if your children are younger than 13, you're eligible for a 20% to 50% credit for up to $8,000 in child-care expenses for one child or $16,000 for two or more. Parents whose combined adjusted gross income does not exceed $125,000 is eligible for the full credit. The credit amount gradually reduces from there based on your income level - the tax credit is completely eliminated for those with income above $438,000. This is also another refundable tax credit so you can claim it and your money back even though you don’t owe any taxes.
• Another way to reduce your child care expense is to consider participating in the flexible savings account for dependent care expenses that’s offered through Rockland Trust as our employer. The money that you contribute to this type of account is deducted from your gross salary and will not be subject to federal, state, Social Security and Medicare taxes.

Strategy 5: Major Life Changing Events (Birth, Marriage, Death, Etc.)

How about for those who have experienced any life changing events such as getting married or having a baby, what should they should pay attention when it comes to filing their taxes?

• When it comes to filing your taxes, for those who got married or will be married before the end of this year, your status is treated as “married” for the entire year regardless of when it happened. Once you are married, you can no longer claim the individual filing status. Similarly, for a spouse who died during the year, assuming there is no remarriage in the same year, the filing status still remains the same for the year of death.
• For anyone who has a life changing event during the year, it’s always a good idea to review your tax withholdings from your paychecks to see if it still makes sense based on your current situation and whether you may need to make adjustments.
• The goal is not to withhold too much money so you are giving Uncle Sam an interest-free loan, but also not to withhold not enough that you will have an unexpected large tax bill in April.

NOTE: Tax preparation and any actions taken whether those we have been discussing here today or otherwise are recommended to be done with a licensed tax professional. Your local IMG team members are here to help if you have any questions.