Taxes are our largest ongoing liability. As a result, it behooves us to optimize our taxes as much as possible. This post will discuss all the smart money-saving tax moves to make by year-end.
The good thing about having multiple income streams is the financial security it provides. The bad thing about having multiple sources of income is that taxes are a little more cumbersome to file. All those K-1s can become a real PITA.
Before I had a family, my old goal was to shield as much income from taxes as legally possible. I had a goal of keeping my Adjusted Gross Income to no greater than $200,000 a year. After ~$200,000 per person, the Alternative Minimum Tax kicks in and deductions start aggressively phasing out.
Thanks to lifestyle inflation and the need to support a family of four, I’ve decided to shoot for and limit our household income up to $400,000. The marriage penalty tax has all but disappeared after the Tax Cuts and Jobs Act was passed in 2017. But the future of taxes may change once more.
With Joe Biden as president, shooting to earn up to $400,000 is a worthwhile goal. Biden has promised to raise taxes on incomes above that amount.
After $200,000 per person or $400,000 for a family, I’ve noticed there is no incremental increase in happiness. Instead, making more money often creates more misery due to more work and more stress.
The majority of actions to reduce your taxes must take place during the calendar year unless you’re filing as a business entity on a fiscal year. So if you want to pay less taxes, it’s worth setting aside some time during the holidays and wrestle this beast to the ground.
Money-Saving Year-End Tax Moves To Make
Here are all the smart money-saving year-end tax moves to make.
1) Charitable Donations
Being able to give your time and money away to worthy causes is one of the best benefits of being financially independent. No longer will you always feel conflicted about whether you should save and invest your next dollar versus helping someone in need. You just tend to give more because you can.
Just keep in mind there are guidelines you have to meet in order to claim deductions on charitable donations. Here are several things to keep in mind:
- You’ll need to itemize deductions and file Form 1040.
- The charity organization must be qualified with the IRS and be actively tax exempt. This excludes political candidates and organizations, as well as individuals.
- Used items such as housewares and clothing must be in good condition or better for them to be deductible.
- Donated vehicles can be deducted at fair market value if you meet certain requirements. For example, the charity must sell your car well below market price to a person in need, or the organization must make major repairs to increase the car’s value. Alternatively, you could qualify if the charity will use the car for purposes such as delivering meals to needy individuals.
- If the total of your non-cash contributions is greater than $500, you’ll need to file Form 8283.
- You’ll need a written record of all cash donations with the date, amount, and charity name. So keep your cell phone bills for text donations and any relevant bank statements.
- Following special tax law changes made earlier this year, cash donations of up to $300 made before December 31, 2020, are now deductible when people file their taxes in 2021. This is relevant for those who file using the standard deduction as this is an addition. For those who itemize, it’s the same as always.
- And if you receive goods or services for a donation, you can’t deduct your entire contribution. The value of what you received must be less than your donation, and you can only deduct the difference.
- If you are volunteering and performing services for a charity using your car, you can deduct mileage.
- Travel expenses can be deducted if you go on a trip with a qualified charitable organization and you’re “on duty in a genuine and substantial sense throughout the trip” per the IRS.
- Donations of property are generally deducted at fair market value based on what they would sell for on the open market.
- You can avoid capital gains on appreciated stocks held over a year if you donate them to a charitable organization. The amount you can deduct is determined by the stock’s fair market value on the contribution date.
Giving Percentage Rates By Income
Here are some interesting statistics on average charitable contributions based on income for individuals claiming itemized deductions.
It is great to see the sub-$20,000 income group give away such a high percentage of their income. I remember when I was working minimum wage service jobs, those who also worked in minimum wage service jobs tended to tip the best.
At lower income levels, it’s all about giving and helping each other survive.
Here’s another giving by income chart from the National Center For Charitable Statistics. It’s interesting to see the income groups that give the least earns between $200,000 – $1,000,000.
The reason is likely because this income group pays the most in taxes and earns the majority of income through W-2 income. After all, paying taxes is a form of charity since your tax dollars get redistributed to help others.
I’ve written a lot in the past about how households making $300,000 and $500,000 a year in expensive cities are just living regular middle-class lifestyles. Part of the reason why is because a huge percentage of their income is going towards taxes.
Once you get over $1 million a year in income, a greater percentage of income tends to come from investments, which are taxed at a lower rate.
A good idea is to accelerate your charitable contributions to the current year. One way to give is to strategically use your credit card when making a donation because deductions are based on the date your card is charged, not the date you actually pay off your credit card bill. In other words, you can make a donation via credit card on December 30, 2020, and not have to pay it off until January 2021.
2) Capitalize Losses On Bad Investments
If you own securities or property that have been declining and you’re below your cost basis, consider liquidating before year end if you don’t anticipate a recovery.
Losses on property held for personal use can’t be deducted. Only investment property losses can be written off. And you’ll also need to look at the net of your capital losses and gains, because if your gains are higher than your losses, you’ll owe money on the difference.
Under the tax code, an individual may deduct up to $25,000 of real estate losses per year as long as your adjusted gross income is $100,000 or less and if you “actively participate” in managing the property. The deduction phases out as an individual’s income approaches $150,000. Individuals whose adjusted gross income exceeds $150,000 are not eligible for this deduction. This income threshold hasn’t changed for a while.
Note that you cannot deduct rental losses to your active income (e.g. day job income). Rental losses can only be deducted from passive income. You report your rental income and deductible expenses on IRS Schedule E. The IRS reports that roughly half of the filed Schedule E forms show losses.
Unfortunately for stock investment losses, you’re still only allowed to deduct $3,000 a year in capital loss deductions from income. I’ve had losses of $50,000 or more before that will take over a decade to deduct! At least you can carry over unused losses into the next year and so on. You can also offset capital losses if you have capital gains. $3,000 isn’t a huge tax break for the year if you qualify, but every bit helps when you’re on a mission to pay fewer taxes.
3) Deferring Income And Itemized Deductions
It’s good practice to anticipate and prepare for changes to your income in the upcoming year. If your income is likely to go down next year, you’ll want to take as many deductions in the current year as possible and vice versa.
If you are having a fantastic income year, then it’s best to defer some of your income to the following year. You should also increase your necessary expenses during a great income year. If you are having a bad income year, then defer such expenses until income improves. This is one of the best year-end tax moves to make for business owners.
You can also try asking your employer if they can pay your year-end bonus in the following year if you want to defer income. Back when I was working in finance we had the option to defer our entire year-end bonus until some later date by 1 – 3 years.
4) Contribute To Tax Advantageous Retirement Accounts
You can make additional contributions to your 401k before year-end if you haven’t already maxed it out. The 2020 and 2021 401(k) maximum contribution amount is $19,500. If you are a sole-proprietor, don’t forget to contribute the maximum to your solo-401(k).
In addition, you can make current year IRA and Roth IRA contributions until April 15 the following year. Or, you can wait to see what your modified AGI will be and then contribute accordingly.
For those of you who have experienced a particularly difficult year due to a job loss or other reasons, it may be beneficial for you to covert your traditional IRA into a Roth IRA. The conversion is a taxable event. However, the idea is to convert your traditional IRA when your marginal federal income tax rate is at its lowest point. Once taxes are paid on a Roth IRA, it grows tax-free and can be withdrawn tax-free.
In general, I’m not a fan of paying taxes up front with a Roth IRA, especially if you are in the 24% marginal income tax bracket or higher. If you are struggling financially, it may be even more difficult to bite the bullet and convert, despite being in a lower tax rate.
5) Deduct property tax
Property tax is an expense against rental income. Therefore, don’t forget to deduct it. Your primary mortgage property tax is also a deductible expense on your taxable income.
6) Business Tax Moves
A business which is cash-based, not accrual-based, can defer taxable income to the following year by sending December invoices at the very end of the month. The reason this can work is the business won’t receive payment for those invoices until January or later, and the business’ taxable income isn’t captured until the date the cash comes in.
Companies and sole proprietors can also reduce taxable income in the current year by charging business related expenses in 4Q that they’d normally take in Q1 of the following year. If you expect your business to grow rapidly in the following year, then wait until the following year to load up on capital expenditure.
If you’re having a great business year, simply wait until the new year to cash your November and December checks in January. Although, there’s always a risk the vendor might disappear or go bust before you can cash your check. Make sure you know what the time limit is for cashing in a check as well.
Maximize Business Expense Deductions
One of the best year-end tax moves to make include maximizing your business deductions. If your business needs a vehicle and also is having a great year, consider buying a 6,000+ SUV or truck by 12/31. Let’s say you buy a $70,000 Range Rover Sport and use it 100 percent for business. Tax law allows you to deduct $70,000 (or a lesser amount if you would like – in this case, you use Section 179 expensing).
If the Gross Vehicle Weight is 6,000 pounds or less, your first-year write-off is limited to $10,000 ($18,000 with bonus depreciation as limited by the luxury auto limits). You can learn more about the tax rules for writing off a vehicle here.
Finally, a great private business strategy to hire a close friend or relative who is in a lower tax bracket than your business tax bracket.
For example, you could hire your high school son for $3,000 to redesign your website. His $3,000 in earnings is tax free. Meanwhile, you reduce your taxable income by $3,000 and hopefully get a slick new website while teaching your son about work.
7) Review Your Flex Spending Account (FSA)
Another great year-end tax moves to make is to make sure you don’t lose any money in your flex spending account. Check with your employer if your plan is eligible for a rollover of unused funds until March 15 of the following year.
On the other hand, if you’ve already run out of funds in your flex spending account but have things like medical work or fillings to do at the dentist, try to postpone them until next year if they aren’t urgent. That way you can save on taxes by allocating enough funds in next year’s FSA to cover those expenses.
If you’re planning on leaving Corporate America next year, get your physical done this year (usually free under preventative care). Also consider going to specialists to treat specific injuries. Maybe you need an MRI for a bum knee. Maybe you should finally see a pulmonologist for your asthma or COPD.
Try and get your money’s worth when it comes to healthcare. Don’t neglect physical ailments that are bothering you, for they might get worse and more difficult to fix in the future.
8) Consider Revising Your Withholding
Even though you probably submitted your W-4 form to your employer ages ago, you can still file a revised form to make adjustments to the remaining pay periods left in the year. If you anticipate you haven’t withheld enough taxes so far this year, you can increase your withholding to help reduce penalties and fees when you file your taxes.
Check if you’ve already paid 100% of your current tax liability this year. If so and your AGI is less than ~$150,000, you should be able to avoid being charged a penalty. But you’ll need to have paid 110% of your current tax liability in the year to avoid getting dinged if your AGI is above ~$150,000.
This safe harbor method is generally the easier option to avoid paying a penalty because the alternative is to have withheld 90% of your tax liability, which can be difficult for freelancers and independent contracts to calculate.
If you are earning both W-2 wages and 1099 income, bumping up your January 15th estimated tax payment to compensate for having underpaid in previous quarters doesn’t work. Each quarter is treated separately with estimated taxes. However, withheld taxes on paychecks are treated as if they were paid throughout the whole year.
9) Review Your Retirement Contributions To Date
The maximum 401k contribution limit remains at $19,500 for 2021. You should max out your 401(k) if you are in the 24% marginal federal income tax bracket or higher to save on taxes. Maxing out your 401k every year is one of the best year-end tax moves to make.
Even though this is the season of giving, don’t forget to pay yourself first. Take a look at how much you’ve contributed to your retirement accounts so far to date, and make additional contributions to the maximum.
If you only have one retirement account and it is already maxed out, check if you’re eligible to take additional deductions by opening additional accounts. You may not qualify if you have a high AGI, but it’s always good to know what your options are, especially if your income is likely to decrease in the future.
10) Know All The New Tax Rules
We all need to spend several hours each year reviewing and understanding the latest tax rules. Given the tax code is tens of thousands of pages long, spending several hours a year is the least we can do.
There are many new propositions and tax laws that passed in 2020 that may affect your future tax liabilities. For example, California abolished Proposition 58 in place of Proposition 19. The new proposition reassesses the value of a rental property to market rate when it is passed to a child. This way, California can charge higher property taxes. For a primary residence, the value is also reassessed to market rate with a $1 million buffer.
To know the right year-end tax moves to make each year, you need to review all the most pertinent rule changes every year.
The Ideal Income Based On Taxes And Happiness
As a reminder, below are the 2020 federal income tax rates for individual taxpayers and married individuals filing joint returns. They may go up in 2021 or 2022 under Joe Biden. Therefore, if you make over $400,000 it’s good to make some adjustments.
Based on the latest federal income tax rates, the optimal gross adjusted income for an individual is about $163,300 and about $326,600 for married couples with up to three children. At these income levels, you’re paying at most a 24% marginal federal income tax rate. Every dollar above requires you to pay a 32% marginal income tax rate.
Due to deductions, I’ve simply rounded up the ideal income to $200,000 per individual and $400,000 per household. You are getting the most bang for your buck making $200,000 and $400,000, respectively.
If you’re making more, but your lifestyle is terrible, consider cutting back on your work hours or change jobs or professions. At the very least, stop stressing about having to be the best employee possible to get that raise and promotion.
We don’t know exactly how much more or less we’ll make the next year, but we can all make an educated guess and plan accordingly.
Starting A Business Is Smart To Save On Taxes
If you want to save more on taxes, start a business or a side business. You can either incorporate as an LLC or S-Corp or simply be a Sole Proprietor (no incorporating necessary, just be a consultant and file a Schedule C and 1040.
Every business person can start a Self-Employed 401k where you can contribute up to $57,000 ($19,500 from you and ~20% of operating profits) for 2020. All your business-related expenses are tax deductible as well.
The first step is to launch your own website to legitimize your business. The next step is to obviously go try and make some income! Most expenses related to the pursuit of such income should be considered a business expense. Below is an income statement example from a sole proprietor.
Pay Your Taxes With Pride
For those of you who are paying more in taxes than the median household makes a year (~$68,000), feel proud that you are contributing a lot to society. Paying taxes could even be considered a form of charity after a certain amount.
Taxes are used to pay for defense, healthcare, infrastructure, food and shelter assistance programs, public schools, and more. If these things are considered good, then paying taxes is absolutely a form of giving.
It’s understandable that some people want to raise taxes on others without having to pay more themselves. If you are one of them, I encourage you to start contributing more yourself before going after other people who already are.
Hopefully these great year-end tax moves will help you save money!
Readers, what other smart money-saving year-end tax moves do you recommend making before year-end? Disclaimer: I’m not a tax professional, so please consult one before making any tax moves.