Before Year-End, Consider These 10 Tax-Saving Strategies

Article Highlights:

Taking a Closer Look at Tax Strategies
Tax Credits for Education
Converting a Traditional IRA to a Roth IRA is a simple process
Minimum Distributions Requirements
Donations to Charities
Qualified Charitable Distributions (QCDs) are charitable distributions that meet certain criteria
Individual Health Savings Accounts (HSAs)
State Taxes Paid In Advance
Payment of Medical/Dental Bills
Gifting
Avoiding Underpayment Penalties

It's hard to realize, but the holiday season is almost here, which means the 2021 tax season is only around the corner. With the end of the tax year approaching, tax-savvy individuals should take some time out of their busy schedules to assess the actions they've already taken to maximize their tax benefits and see what else they need to do. Now is the moment to make sure you've utilized all of the tax-saving options accessible to you.

There are several clever tax-advantaged changes you can make. Even if you aren't eligible for all of them, it's a good idea to take a break from holiday shopping to make sure you've done everything you can to reduce your tax burden and maximize your write-offs and deductions. Here are ten of the most popular and effective tactics, along with some helpful reminders that may help you avoid paying penalties:

Make the Most of Education Tax Credits: Qualified taxpayers can use the Lifetime Learning education credit and the American Opportunity Tax Credit to prepay 2022 tuition bills for an academic period that begins by the end of March 2022, and the tuition payments are included in the 2021 credit calculation. If you are eligible for the credit and have not yet met the 2021 maximum for qualified tuition and related expenditures paid, you can increase your credits by paying for early 2022 tuition before the New Year. If you've been paying tuition expenditures for the entire 2021 tax year, this may not apply to you, but if your student just started school this fall, it will almost certainly provide you with some additional assistance.

Convert a Traditional IRA to a Roth IRA: When you convert a traditional IRA to a Roth IRA, the amount you convert is normally taxed in the conversion year. Taxpayers with very low incomes in 2021 may be able to convert the assets in their conventional IRA to a Roth IRA at a considerably lower tax rate than if they waited until a higher-income year to do so.

Penalties for Non-Compliance with the Required Minimum Distribution (RMD) Rules: Every year, after a taxpayer reaches the age of 72, he or she must take a "required minimum distribution" from their qualified retirement plan or IRA. If this is the first year that this rule applies to you and you haven't yet withdrawn the required amount, don't worry; you won't have to until the first quarter of the next year. Of course, if you wait until 2022 to collect your 2021 distribution, you'll have to take two in one year — one for 2021 and one for 2022. If you fell into this group before 2021, you only have until December 31st to take the required distribution and avoid penalties.

Charitable Deductions: Many people who itemize their taxes take advantage of the possibility to deduct their contributions to a preferred charity or place of worship. Did you know that you can pay all or part of your planned giving for 2022 in 2021 and raise your deduction for 2021? Though this may not appeal to people who itemize every year, alternating between taking the standard deduction one year and itemizing the next can provide a significant tax benefit.

Even if you take the standard deduction and don't itemize your deductions, you can deduct up to $300 ($600 if you file jointly with your spouse) for financial contributions to qualified charities in 2021. Checks and credit cards are examples of cash payments. This non-itemizer deduction does not apply to donations to donor advised funds or private foundations.

Contributions to charities are tax deductible in the year they are made. If you make a credit card donation before the end of the year, it will be counted for 2021. This is true even if the credit card bill isn't paid until 2022. Furthermore, if you mail a check in 2021, it will count for 2021.

Qualified Charitable Distributions: Those who are 70½ years old or older can transfer funds (up to $100,000) from their IRA to qualified charities without the funds being taxed, as long as the transfer is made directly by the IRA trustee to a qualified charitable organization that is not a private foundation or a donor-advised fund. If you are obligated to make an IRA distribution (you must be 72 years old or older), you can have it sent directly to an eligible charity, and the amount will count toward your RMD for the year.

Although you will not receive a tax deduction for the transferred amount, this qualified charitable donation (QCD) will be excluded from your income, potentially reducing the amount of your Social Security benefits that are taxed. Additionally, because your adjusted gross income will be lower, tax credits and some deductions that have phase-outs or limitations depending on AGI may benefit you.

If you intend to make a QCD, notify your IRA trustee or custodian well before December 31 so that they have enough time to complete the transfer to the charity. If you've made conventional IRA contributions since turning 70½, new laws may limit the amount of the QCD that isn't taxable, so it's a good idea to confirm how your tax might be affected.

Make the Most of Your Health Savings Account Contributions: This year, did you become eligible to contribute to a Health Savings Account? If that's the case, you can contribute up to the annual maximum amount to that account, regardless of when you became eligible during the year.

Prepay State Income and 2022 Property Taxes: You undoubtedly know that if you itemize your deductions and are not subject to the alternative minimum tax, you can deduct both your property taxes and state income (or sales) tax up to $10,000. But did you know that in some situations, you can boost the amount you deduct on your 2021 return by paying some of your taxes ahead of time by December 31, 2021? You can ask your employer to increase your state withholding by a fair amount, or you can pay your 4th-quarter state estimated tax installment in December (due in January) and increase your deduction if you are self-employed. The same is true for real estate taxes: if you make your first installment for 2022 in 2021, you can deduct it from your 2021 income. However, keep in mind the so-called SALT limit: the total amount of state and local taxes that can be deducted is $10,000. So, if you already pay $10,000 or more, don't choose to prepay state taxes.

Pay Unpaid Medical or Dental Bills: If you itemize your deductions, you can deduct eligible medical and dental expenditures that exceed 7.5 percent of your adjusted gross income. If you've reached or are approaching that point, it can be more cost-effective to pay off any outstanding obligations rather than spreading them out over time. If you're close to or above the limit, it can make sense to estimate your medical and dental expenses for the coming year and defer those that you can until 2021 to boost your deduction. Dental work or eyeglasses could be among these costs. Another crucial consideration: if you're thinking about doing this with a credit card and won't be paying the debt off right away, be sure you're not paying more in interest than you're saving with the increased deduction.

Remember the Annual Gift Tax Exclusion: While gifts to individuals are not tax deductible, you are allowed to make gifts to individuals up to a certain amount each year without paying any gift tax or having to file a gift tax return. You can give $15,000 to as many individuals as you like in tax year 2021 without having to pay a gift tax. If you want to do this, make sure you do it before the end of the year because you won't be able to carry the $15,000 over into 2022. Such gifts do not have to be in cash, and the recipient does not have to be a family member. If you're married, you and your spouse can both contribute up to $15,000 to the same individual (for a total of $30,000) without having to file a gift tax return or pay any gift tax.

Examine the Payments You've Submitted Thus Far: If you believe the income taxes you've paid so far for 2021 are insufficient, you should increase your withholding in the time you have left to make up for it. If you owe taxes but don't pay them on time, you'll be subject to a quarterly penalty. Even if you underpaid for any or all of the first three quarters of the year and will owe taxes when you file your 2021 return, you can make up for it by increasing your year-end withholding, because federal withholding is regarded as though it was paid ratably throughout the year. Increased withholding and the possibility of paying estimated taxes can also help to lower the penalty for not paying taxes in the fourth quarter.

Every taxpayer's circumstance is different, thus the advice given here may or may not apply to you. Seek counsel from an experienced, competent tax professional to ensure that you are putting yourself in a tax-advantaged position. If you require assistance, please contact our office.