6 Tax Tips to Reduce Next Year’s Bill
Maybe you’re anticipating a big tax bill on April 15, or maybe your accountant already gave you the bad news: You owe money to Uncle Sam. Either way, you would like to avoid a repeat next year.
Fortunately, you can take steps to reduce your tax burden and even benefit other financial areas of your life, such as retirement. Here are six tax tips for lowering your bill come tax time next year.
1. Adjust Your W-4
If you had a sizable tax bill (or even a sizable tax refund) for 2020, then one of the first items to check is your W-4. You can adjust it for tax status (did you recently get married or divorced?) and dependents (did you recently have a baby?).
Your W-4 helps determine how much is withheld for taxes on your paycheck, so updating it whenever your life changes could have an impact on your tax return.
2. Focus on Your 401(k)
One of the simplest ways to reduce your taxable income is to fund a tax-deferred account such as a 401(k). You make contributions pre-tax, reducing the amount of income that is taxed. The bonus is that you also build toward your retirement savings.
For 2021, you can contribute up to $19,500 to a 401(k). If you’re 50 or older, you can “catch up” by contributing up to $6,500 more.
Be aware that you will pay taxes when you withdraw funds in retirement. You may want to balance any tax-deferred plans with a Roth 401(k) or Roth IRA.
With a Roth, you pay taxes on your contributions now, but you can make tax-free withdrawals in retirement.
Consider talking with a fiduciary financial advisor about the right mix of retirement income buckets for you.
3. Contribute to an IRA
You may also be able to get a tax deduction for contributions to a traditional IRA. You’ll need to know the rules for claiming deductions. They vary based on tax filing status, income, and participation in an employer-sponsored retirement account.
For 2021, you can contribute up to $6,000 to an IRA, or $7,000 if you’re 50 or older. If you earned less than $6,000 (or $7,000 for 50-and-older), then you can only contribute up to your earned income.
4. Sell Your Losing Stocks
Selling losing stocks via a strategy known as tax-loss harvesting can help your tax bill in two ways:
You can use the loss against any capital gains tax you owe for “winning” stocks.
You can also use the net loss to offset up to $3,000 in ordinary income.
You can also carry forward your losses to reduce taxes on future capital gains and ordinary income, making tax-loss harvesting a potentially powerful strategy for your financial planning toolkit.
5. Open an FSA or HSA
If your employer offers a flexible spending account (FSA), you can make pre-tax contributions to it. Just as with a 401(k), your contributions reduce your taxable income.
FSAs are commonly used for costs such as medical expenses or dependent care—but they come with a caveat: You need to use the money by the end of the year or lose it. Check with your human resources department to see if they offer a carryover provision or a grace period for unused funds.
You can open a health savings account (HSA) without having to worry about the “use it or lose it” rules of an FSA. But you’ll need to have a high-deductible health plan to contribute to it.
If you contribute through your employer, your contributions will be pre-tax. If you make contributions on your own, you can write off your contributions.
Your contributions will grow tax-free and can be withdrawn tax-free if you use the funds for qualified medical expenses.
The benefits of HSAs make them an ideal way to reduce income taxes while paying for health care expenses now or in retirement.
For 2021, you can contribute:
FSA: Up to $2,750
HSA: Up to $3,600 for individual coverage and $7,200 for family coverage
6. Give to Charity
If you have a big heart and a big tax bill, you might try increasing your donations to charity.
The Tax Cuts and Jobs Act increased the standard deduction, so fewer taxpayers are itemizing. However, you might consider whether “bunching” your contributions would help.
With this strategy, you combine two or more years of contributions into a single year. Ideally, doing so will give you the ability to itemize deductions.
You can combine this strategy with a donor-advised fund, which will allow you to donate to charity even in the years you don’t fund the account.
Think of Tax Planning as a Year-Round Activity
A lot of people only think of taxes when they fill out their state or federal tax returns. But the best planning is year-round.
By starting now, you set yourself up to take advantage of a range of strategies, such as contributing to tax-advantaged accounts, harvesting stock losses, and getting strategic about charitable donations.
A financial advisor can help you determine which strategies are right for you in light of your long-term goals. Our fee-only, fiduciary financial planning firm in Roseville and Folsom, California, can provide tax planning as part of our comprehensive wealth management service.
By making tax planning a year-round activity, you may find opportunities that you didn’t even know existed—and avoid writing another painfully large check to Uncle Sam.
Schedule a complimentary, 15-minute call with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor serving the greater Sacramento area with an office in Roseville, CA. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country's leading professional association of fee-only financial advisors.