Tax planning is the art of cutting your tax bill before you start working on the actual tax return, and it’s a lot easier than you’d think. By taking a few simple steps while it’s still 2021, you can trim your income tax bill down to size.
Max out your SALT
The state and local taxes (SALT) deduction on your federal tax return is limited to $10,000 per year. If you live in a high-income-tax state, you may very well end up maxing that particular deduction out just by claiming your state income taxes. However, if you are still under the $10,000 limit, now is the time to pay off a few extra state and local taxes so that you can maximize your federal deduction.
Note that the SALT deduction is an itemized deduction, so if you’re planning to take the standard deduction you needn’t bother working on this one.
The SALT deduction includes the following:
- your state and local income tax OR your sales tax for the year
- real estate taxes
- personal property taxes
Let’s say that you add up these three categories of taxes for 2021 and find that you’re well under the $10,000 cap, but you definitely have enough itemized deductions to make claiming them worthwhile. In that case, consider prepaying your real estate taxes for next year. You’ll increase your deductions this year, and if it turns out that you don’t have sufficient itemized deductions for 2022, you’ll still have been able to deduct the real estate taxes for that year.
Cancel out capital gains
Did you sell stocks, bonds, or other investments at a profit? You’ll probably owe capital gains taxes for 2021 in that case. However, a little trick called “tax loss harvesting” can reduce or even eliminate your capital gains taxes.
You see, any capital losses you take during the tax year will be subtracted from your capital gains for that year in order to figure out how much taxes you owe on those gains. If you sold stock and made a $5,000 profit on the transaction, but lost $5,000 on another stock sale that year, you’d end up owing nothing in capital gains taxes.
Tax loss harvesting is surprisingly easy: all you need to do is add up your capital gains for 2021, then look for an investment in your portfolio that’s suffered losses and sell that investment before the year is up. The more losses you can harvest (up to the amount of your gains), the lower your tax bill will be.
Grab points on your refi
Own your own home? You’re no doubt aware that interest rates are extremely low right now, so just about everybody with a mortgage can reduce their monthly house payments by refinancing. As an extra bonus, if you pay points on your refinance, you can deduct said points as part of your mortgage interest deduction for the year.
Like the SALT deduction, the mortgage interest deduction is an itemized one. If you don’t have enough itemized deductions to beat out the standard action, then skip this strategy.
Calculate your charitable giving
Charitable donations can be an extremely powerful deduction. Both cash gifts and donated items can be included as part of your itemized deductions for the year. However, the charitable gifts deduction is limited to a certain percentage of your adjusted gross income (AGI) for the year. For tax year 2020, the basic limits were 50% of AGI for non-cash contributions and 60% of AGI for cash contributions to qualified charitable organizations, and the same limits will likely apply for 2021. “Qualified charitable organizations” means official charities, including churches, publicly supported charities, regular educational organizations, and the like. No, you can’t count money or gifts you gave to individuals, no matter how deserving.
If you’ve already approached or exceeded those income limits for charitable giving, consider holding off on any further giving until 2022 rolls around. That way, you’ll be able to keep those funds in your bank account (and earn a bit of interest on them) in the meantime while getting the maximum possible tax benefit for your generosity. On the other hand, if you are well under those limits for the year and plan on itemizing your deductions, consider cleaning out your garage or attic and donating those items to Goodwill or the Salvation Army. Just make sure you get a receipt for the donation!
Take care of medical expenses
The medical expense deduction is yet another itemized deduction, with a further limit based on your adjusted gross income. Briefly, any medical expenses up to 7.5% of your AGI for the year are not deductible. You can start deducting medical expenses once you’ve exceeded that 7.5% floor amount.
If you’ve already had substantial medical expenses this year, now might be a good time to take care of any additional medical procedures or expenditures that you’ve been waiting on. By cramming all those medical expenses into one year, you can get the biggest possible tax break from them. On the other hand, if you wait until 2022 to get that dental work done, it’s possible you won’t hit the 7.5% minimum on your medical expenses for the year and therefore won’t be able to deduct it at all.
Timing is everything, even for income taxes
For tax planning, when you spend the money is just as important (if not more so) then what you spent it on. Take a look at your deductible 2021 expenses, and see if you can save a little extra by either making further expenditures before the year is out or putting off those expenditures until 2022. If you have to spend the money anyway, you might as well use it to qualify for a bigger tax break.