It's December. 2020 and its craziness is almost over! Are you ready?
Specifically, are you ready for the holidays? For those of us still committed to pandemic precautions, it's going to be a different, and yes, a bit less jolly, season.
But one thing is the same as in previous Decembers. We still need to make some tax moves before Jan. 1.
Some December tax moves will demand a little homework and financial calculations. Others will require you to dust off your crystal ball and make some political predictions. All these ancillary actions are necessary to determine what affect certain tax moves will have and whether you want to make them at all.
Did you expect anything else this chaotic COVID-19 year?
OK, take a deep breath and let's get to it, starting with some annual tax standbys.
1. Check, and adjust if necessary, your withholding. If you don't pay enough in taxes throughout the year, either via payroll withholding or estimated taxes (more on this in a minute), you could end up facing a surprisingly large tax bill next year. The easiest way to avoid this is to adjust your withholding. Now.
Yes, you probably don't have many pay periods over which to spread these tax payments. But upping the amount at least some can help reduce any tax shortfall come April 15, 2021. The Internal Revenue Service's online withholding calculator can help.
You also should look into tweaking your withholding if you — and your spouse, too, if y'all file a joint return —took on some side gigs to supplement your salary (or salaries). True, estimated tax payments can help make up the shortfall, especially when it's due to untaxed added income. The final 1040-ES payment for the last quarter of 2020 is due Jan. 15, 2021.
But if you forgot to account for estimated taxes and you (or your jointly filing husband or wife) also have a salaried job, withholding is an easy way to cover these additional tax amounts.
2. Assess taxes due on all your income. If your only income this year is from wages, you can skip to #3. But if you have other income and can control its arrival, you might want to accelerate it into 2020. The reason? The current individual tax rates created by the Tax Cuts and Jobs Act (TCJA).
Those seven income brackets have tax rates that are at historic lows compared to those over the past few decades. They are scheduled to be in place through 2025. But if you're a higher-income earner and your buffed-up crystal ball says that President Elect Joe Biden might be successful in hiking your taxes sooner, you might want to pull as much money into this low tax rate year.
True, it's not that easy for most of us to control when we get paid. But if you can, for example, get a bonus payment or collect on stock options or take some other form of deferred compensation this month instead of 2021, your tax bill will be calculated under the existing TCJA rates.
If you're on the other end of the income spectrum, remember that any unemployment benefits you got this year are taxable income. You need to make sure you paid estimated taxes on those earnings. Or, as noted in #2, are able to up your (or your spouse's) regular pay's withholding ASAP to help offset any due tax and possible penalties.
3. Add to your nest egg. It's never too soon or too late to think about how you'll pay for your retirement. So this month, give yourself a gift that can make future Decembers more comfortable: add to your retirement account, be it an IRA, self-employed retirement plan or workplace 401(k).
It might be too late to add to a 401(k) or similar workplace plan, but check with your benefits office just in case.
As for IRAs, yes you do have until next April's filing deadline to put money into these accounts. But the sooner you contribute, the sooner the power of compounding growth starts working for you.
Plus, putting money into your retirement funds could qualify you for the Retirement Savers Credit and it's always good to know about these dollar-for-dollar tax breaks earlier in the tax process. A traditional IRA also might be deductible.
4. Turn your traditional IRA into a Roth. While the traditional IRA deduction is appealing to many, in many cases a Roth IRA is a better retirement move. You fund these retirement accounts with already-taxed money so there's no deduction. But you won't owe any taxes when you take Roth distributions — at your pace; there's no required minimum distribution (aka an RMD) for these accounts — in your golden years.
If that's an appealing retirement prospect, you can convert your taxable traditional IRA to a tax-free Roth. The only downside is that you'll owe taxes on the traditional account's tax-deferred earnings. But with current TCJA tax rates so low, relatively speaking, you'll be paying less on the converted amount.
Of course, don't make financial moves based solely on tax implications. And run the numbers and make sure you can cover the conversion taxes. If you have to use money from your IRA to pay the tax bill, that reduces the conversion benefits.
And remember that you don't have to convert your entire traditional IRA. You can do a partial conversion. Determine how much of the associated tax you and afford to pay this year.
5. Bunch your itemized deductions. You choose every tax year whether to itemize or claim the standard deduction. With the standard amounts almost doubled by the Tax Cuts and Jobs Act, the trend definitely is toward the standard amount, which for 2020 returns is $12,400 for single filers this year, $18,650 for heads of households and $24,800 for jointly-filing married couples.
If, however, you find that itemizing will give you a larger deduction, then use that method. And one way to bump up your Schedule A claims is to bunch your tax deductible expenses. Bunching is simply the consolidation of deductible expenses into one tax year. If you're near the $10,000 cap on state and local taxes, there's not much you can do here. If, however, you have room to work, consider paying at least some 2020 property taxes this month in order to get the most out of them.
Medical expenses also face a cap, which remains for this tax year at 7.5 percent of your adjusted gross income (AGI). Any doctor and dental (and more) costs that exceed that amount can be claimed on Schedule A. As the tax law now stands, this could be the final year the 7.5 percent cut-off is in place; it's set to go to 10 percent in 2021. But I suspect Congress will keep it at 7.5 percent when it finally takes up legislation to renew expiring tax breaks.
Your mortgage interest deduction is still allowed. Making your January home loan payment in December can give you some more interest to claim this year.
The same is true for charitable donations, which are still deductible and not limited at all. If you're close to having more in itemized claims than your standard deduction amounts, think about making 2021's charitable contributions now. It could be enough to push you over the limit so you don't lose the value of other itemized claims.
6. Check on your medical spending account. Your deductible medical expenses might not be that large because you take advantage of another medical tax break, a flexible spending account (FSA). This workplace benefit allows you to set aside pre-tax dollars to pay for out-of-pocket medical expenses.
If you've still got a balance in your medical FSA, look at ways to spend that money this month.
Yes, some workplaces allow medical FSA owners a grace period until March 15 of the next year to spend this money. Others let you roll over up to $500. If you get either option, then there's not such a year-end rush.
But if you don't have a carry-over or grace period, then you need to spend your FSA funds by the endo the benefits year, which for most companies is Dec. 31, or you lose the money.
7. Review your portfolio for tax-related moves. If you have stocks, you've probably been holding your breath all year. The market's been up and down and you, like economists, are trying to determine whether it's finally going to take that long-feared, long-anticipated nosedive.
If your patience has paid off with increases in the value of your holdings, you might want to take profits now, known in the tax world as harvesting tax gains. You'll cash out on a high note and not have to worry any more about when the market will drop.
It could be a tax plus, too. As long as you've held the assets for more than a year, you'll pay the usually lower capital gains tax rate. The maximum capital gains rate is 20 percent but it's lower, 15 percent and possible no tax at all, depending on your adjusted gross income.
Also, it's prognostication time again. Biden has proposed hiking capital gains tax rates. For some investors at very high-income levels, it could top out at the maximum ordinary rate of 37 percent (or more). That's almost double the current 20 percent top capital gains tax rate. If you're worried this might happen, it might be a good time to cash out when tax rates are low.
Trimming your holdings also could be worthwhile if you're at the other end of the investing spectrum. Selling assets that, to be brutally honest, stank, will produce tax losses. Use them to offset your gains, easing or possibly erasing your overall investing tax liability.
If your tax loss harvesting leaves you with extra losses after countering your gains, you can use up to $3,000 of that amount to reduce your ordinary income. Excess losses beyond $3,000 can be carried forward.
Two quick notes here.
One, when you sell assets, make sure your gains are long term. If you sell assets you owned for a year of less, known as short-term holdings, you'll owe tax at your regular income tax rate unless you have short-term losses to offset them.
And two, if you have six grand or more in losses, get a new financial adviser!
8. Determine when to make damage claims. Mother Nature took 2020's annus horribilis attitude to heart. Between wildfires, a surprise derecho and a hyperactive hurricane season, people across the country sustained unfathomable property damages (and worse).
The one slim sliver of light for these folks is that many of them got extra time to file their 2019 tax returns that they extended to Oct. 15.
Even later deadlines: For other disasters later in 2020, taxpayers who got extensions to file 2019 taxes now have deadlines in early 2021. Jan. 15 is the deadline for Oregon wildfire victims, for Hurricane Sally victims in Alabama and those who faced wildfires in September in California. Hurricane Delta victims in Louisiana have until next Feb. 16 to file their extended 2019 tax returns.
Taxpayers who are facing damage repairs due to a natural disaster also must decide whether to make those claims (using Form 4684) on their prior year's tax return, or wait and claim them in the actual year in which the disaster occurred. Here's where some of those calculations come into play. You need to compare to see which tax year gives you the best result and possibly a larger tax refund that arrives sooner to help with rebuilding.
9. Give, give and give some more. The coronavirus pandemic has been devastating for many. If you can afford it on this Giving Tuesday 2020 or any other day this December, consider helping out folks who are less fortunate by donating to a nonprofit.
Your support of charity also could pay off as a tax break on your 2020 return, as long as you make the gift by Dec. 31.
This year, you also have a variety of tax-related philanthropic options. You can give up to $300 and claim those donations directly on your 1040. Or you can give more, including noncash gifts, and itemize those donations on Schedule A. Regardless of which way you choose to claim your charitable tax deduction, make sure you follow the IRS rules.
10. Examine your estate plan. Giving to family can help lower taxes, too, if you have a large estate that might be subject to the federal estate and gift taxes.
We're talking really big here. The TCJA dramatically increased the amount of assets that are protected from Uncle Sam's tax collector when the owner passes away. In 2020, the lifetime gift and estate tax exemption is $11.58 million per individual, meaning an estate of a jointly filing couple is protected from taxes as long as it's worth no more than $23.16 million. In 2021, inflation kicks up the exclusion amounts go to $11.7 million per person or $23.4 million per couple.
But Biden and many of his fellow Democrats have expressed interest in trimming that. Early proposals call for an estate tax exemption of $3.5 million or $7 million for married couples.
Regardless of what the tax threshold is, you can start trimming that taxable amount by giving away assets while you're still around to get the thanks in person. For 2020 (and 2021, too), you can give up to $15,000 to anyone you wish, family, friend or blogger whose work you enjoy reading. This gift limit is per taxpayer, so for married couples that means each spouse gets the $15,000 gift option.
The gifts help reduce your estate's value so that there won't be as much (or any) subject to the possible 40 percent federal estate tax, which Biden has proposed hiking to 45 percent. There's good news for the recipients, too. They don't have to pay a dime on the gifts.
The gifts also are not limited to dollars. You can give assets valued up to the limit, such as real property and family heirlooms as long as they are worth up to or less than the limit without incurring any gift tax responsibilities.
And here's a tip for grandparents with some cash to spare. Instead of giving your $15,000 gift directly to your grandchild, you can pay a student's tuition directly to the school and not count it as a gift under the gift exclusion rule. The school can be any educational institution, not just college. That frees up more to give against your estate.
Even if your gifts use up your entire exemption, that's not necessarily a bad thing. Your loved ones get your gifts and family heirlooms tax-free early, allowing them to enjoy them (along with you) longer. And in the case of financial gifts or assets, they get the benefit of the gifts' potential growth.
But hopefully some of these moves will make a nice tax-saving present for you. Just remember that in most cases, the tax tasks must be completed Dec. 31 in order to provide any benefit on your 2020 tax bill.
You also might want to check out a few more tax-saving ideas (really!) in the December Tax Moves listed in the ol' blog's right column. They're just below the bright red heading of the same name, just under the countdown clock ticking off the time left in tax year 2020.
Give these and those year-end tax moves a look and take advantage of the ones that apply to your financial and tax situations.
They could provide you some nice tax savings, as well as give you another reason to celebrate the ringing out of this extraordinarily trying year.