Year-end tax planning is an important part of managing your taxes. In general, you want to do everything you can in 2021 to increase your deductions, lower your income, and maximize your credits.
1. Increase Your Itemized Deductions
For 2021 you can take up to a $300 ($600 if filing a joint return) deduction for charitable cash contributions when taking the standard deduction. If your itemized deductions fall just short of the Standard Deduction, you may benefit from these ways to maximize your Itemized Deductions in 2021:
Increase your charitable contributions in 2021. Make donations in 2021 that you were originally planning to make in 2022.
Even if you don't itemize, donating to charities using retirement plan money donated directly from your retirement account to the charity can decrease your taxable income.
Since job expenses incurred by W-2 employees are not deductible (except for certain types of employees), you should ask to be reimbursed by your employer if you had any job expenses.
Make January's mortgage payment in December.
Make payments up to, but not over, the $10,000 ($5,000 if Married Filing Separately) limit on state and local taxes, real estate taxes, and personal property taxes. Here are some ideas to consider:
Make your 4th quarter state estimated tax payment in December instead of January.
Prepay next year's real estate taxes if the property tax is assessed before 2022.
If you are already over the limit you may be able to capitalize certain real estate taxes.
Pay for as many medical expenses as possible in 2021. (Medical expenses can't be deducted unless they exceed 7.5% of income. You could consider getting a health plan with a health savings account (HSA) since you can deduct HSA contributions.)
2. Adjust Your Withholding
When you're new to a job, you fill out a Form W-4. The W-4 determines how much federal and state taxes are withheld from your paycheck. You may want to give your employer a new Form W-4 if the taxes being withheld are too much or too little. You can get the most accurate withholding estimate by using the IRS's estimator tool . If you owe taxes each year, you could fill out a new Form W-4 and choose an extra withholding amount so your employer withholds more taxes from your paycheck. This will reduce the amount of taxes you owe with your tax return because you'll be paying those taxes throughout the year instead. If you're getting a big refund every year, you could increase your estimated deductions amount so your employer withholds less tax from your paycheck. This will lower your tax refund, but it gives you extra money in your paycheck each month rather than having to wait over a year to get that money back as part of your tax refund. When you have a life change such as getting married or divorced, buying a home, having a baby, or having a child leave home, you should probably file a new W-4 with your employer to reflect your current situation.
3. Lower or Increase Your Income to Maximize Credits and Deductions
Many credits and deductions are affected by your income. If your income is too low, you might not qualify for the full amount of a credit or deduction. On the other hand, if your income is too high, a credit or deduction might be reduced. The Earned Income Credit and Child Tax Credit are examples of credits that can be affected in this way. How to Lower Your Income:
Ask your boss if your year-end bonus can be paid to you in January instead of December.
Increase your 401(k) contributions.
Make a traditional IRA contribution.
Sell incentive stock options in January instead of December.
If you own a business, delay collecting revenue from late December to early January or purchase equipment and supplies in December.
If you have gains from selling successful stocks during the year, sell some stocks that have gone down in value to offset the stock gains.
Wait to sell profitable investments until January.
If you have self-employment income or own a rental property, gather your receipts and search your checkbook to find every deduction you can take.
How to Increase Your Income:
Do the opposite of the tips above.
Work overtime.
Make sure you are reporting all cash earned from side jobs such as babysitting, house cleaning, and lawn cutting.
4. Increase Your American Opportunity Credit
If you paid less than $4,000 of tuition for your college student, you can pay for the first semester or quarter of next year's college tuition in December and use that tuition for this year's American Opportunity Credit. However, you want to do the exact opposite if you've already paid more than $4,000 for your college student who qualifies for the American Opportunity Credit. You get no additional benefit from the American Opportunity Credit if you pay more than $4,000 in tuition each year. In this case, you'd want to wait until January to pay tuition. That way you might increase your American Opportunity Credit next year since you've already maxed out the allowed credit this year. Be sure to watch for a Form 1098-T from your college or university.
5. Claim Your College Student Child
A college student's parents almost always get more tax benefit from claiming their child as a dependent than the college student gets from claiming themselves. This is because the parents' tax bracket is usually higher, so they usually benefit more from the education credits than the student does. See exception for high income earners. You can only claim the education credits if you're claiming the student as a dependent. If you can claim your child as a dependent, make sure you coordinate with each other so your child doesn't try to claim themselves on his or her own return.
6. Spend Your Flex Plan
Some flexible spending accounts let you carry over up to $500 from one year to the next. Other flex plans require you to spend all of it by the end of the year (the use-it-or-lose-it rule). If you have too much money in your flex plan, spend it in December on any medical expenses you can such as doctor visits, orthodontists, prescription medications, etc.
7. Qualifying for the Qualified Business Income (QBI) Deduction
You may qualify for the QBI deduction if you had business income (Schedule C, F, or E). The QBI deduction is generally 20% of your net qualified business income. However, if your taxable income is over $164,900 ($329,800 if Married Filing Jointly or $164,925 if Married Filing Separately) then your deduction will start to be limited by wages paid to employees. Once fully phased in, the deduction is limited to no more than 50% of wages paid. If you are self-employed, have high taxable income, and will be limited by the wage limitation you could consider hiring an employee and paying them wages to increase your QBI deduction.
References
FreeTaxUSA.com (2021). Tax tips. Retrieved from
https://www.freetaxusa.com/help/display_faq.jsp?faq_id=7568&utm_source=email-
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