Tax Planning

Financial decisions shouldn’t be based on taxes alone.  However, it helps to consider tax implications of your choices.  Everyone’s tax situation is different, and it’s important to consider your situation before selecting any options.  Each option has qualifications that must be met so it’s important to follow the rules.  This is a brief overview of federal tax planning that doesn’t include all of the rules and qualifications.  People who have state income tax can look into their options.

Bunching deductions – If you don’t have enough deductions to itemize, you might be able to bunch them and itemize every other year.  That’s what I do, but it became more difficult when the standard deduction temporarily doubled since my mortgage interest is so low.  For example, my property taxes are due January 31, and I get the bills in October.  I paid my 2020 property taxes in January 2021, and I’ll pay my 2021 property taxes in November 2021 so I’ll be able to claim two years of property taxes on my 2021 tax return in an attempt to get over the standard deduction.  Of course, the itemized deduction for taxes is temporarily capped at $10,000.

Charity – Giving is great, regardless of taxes.  Donations to qualified charities must be given, mailed, or charged by December 31.  If you itemize, you might be able to use the bunching method.  If you don’t itemize in 2020 and 2021, you can deduct up to $300 in qualified cash donations.  This temporary deduction increases to $600 if married filing joint.

People over 70 ½ can make qualified charitable distributions from their retirement accounts without needing to itemize.  That portion of the distribution is not taxable income, but it does count towards the required minimum distribution.

Retirement – Planning for retirement is always a good thing.  For IRAs, you generally have until April 15 to contribute for the previous year.  For example, if you contribute in February of 2021, let the investment company know if it’s a 2020 or 2021 contribution.  For contributions that are withheld from your paycheck, such as a 401k, the deadline is December 31.

If you think your taxes will be higher in the future (because of tax law, income, or both), a Roth IRA or Roth 401k might be in your best interest if you qualify.  You don’t get a tax deduction now, but your future distributions (including earnings) will be tax free, assuming the rules are followed.  Plus, there are no required minimum distributions (RMDs).

If you think your taxes will be lower in the future, a traditional IRA, SEP IRA, 401k, and other types might be in your best interest.  You generally get a current tax deduction.  If you contribute to a traditional IRA or SEP IRA, the deduction (if allowed) will appear as a separate line on your tax return.  If you have withholding from your paycheck, such as a 401k, your taxable wages are reduced.  It might not be obvious on your tax return, but it can be reconciled on your W-2.

Inheritance – If you have children, you might consider their taxes when deciding on traditional versus Roth retirement accounts.  Due to a recent law, children must deplete inherited retirement accounts within ten years.  If they inherit a Roth account, it’s no problem since the income is not taxable to them.  If they inherit a non-Roth account, they could jump into a much higher tax bracket depending on their other income and the size of the inherited taxable account.  So, your hard-earned money gets wasted on tax.  If you contributed to a pre-tax account (i.e. traditional IRA), you can slowly convert to a Roth IRA (and pay the tax) once your income tax bracket decreases.  This might happen after you retire (or get a lower paying job) but before you start taking RMDs.  You can still convert after you start taking RMDs, but it doesn’t count towards your RMD amount.

Tax refunds – It’s better to get a small refund or owe a small amount.  A large refund means you gave the government a large interest-free loan.  It’s your money, and you could have been using it to make more money.  If you adjust your withholding to owe, try not to owe more than $1,000 to avoid penalties.

Happy tax planning!

Linda 🙂

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