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.
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 $450,000. President Biden has clarified he won’t raise income taxes on married households making less than $450,000 and singles making less than $400,000.
However, in my opinion, the ideal household income is closer to a MAGI of $340,100 based on 2022 income tax rates. Up to $340,100, a married household’s marginal income tax rate is a reasonable 24%.
After about $200,000 per person or $400,000 for a family of up to four, 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 marriage penalty tax has all but disappeared after the Tax Cuts and Jobs Act was passed in 2017. So if you’ve been on the fence about marrying due to a higher tax bill, you really don’t have to worry any more. It’s only married couples making over $500,000 who will likely pay more taxes together than as unmarried individuals.
The majority of actions to reduce your taxes must take place during the calendar 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.
- 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.
Your big stock losses can offset any big gains in the calendar year. Any further losses can be carried over to the tune of $3,000 in capital loss deductions a year. $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) Increasing Expenses During Good Years
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.
If you are an employee, you can 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 Roth IRA 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.
For high-income individuals looking for a workaround for the income limits on Roth IRA contributions, the backdoor Roth conversion is a solution. A nondeductible contribution can be made and then converted tax-free to a Roth IRA. This works because there are no income limits on non-deductible traditional IRA contributions or on Roth IRA conversions. However, be careful of the pro-rata rule.
The deadline to do a backdoor conversion for 2021 is Dec. 31. Congress seems highly motivated to eliminate the backdoor conversion in the future.
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.
Related: 10 Reasons Why Starting An Online Business Is A No-Brainer
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 is $19,500 for 2021 and $20,500 for 2022. 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 401(k) 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) Set Up A Revocable Living Trust
If you haven’t talked to an estate planning lawyer yet, please do so. Setting up a revocable living trust is vital if you have dependents. Not only does a revocable living trust help protect your assets, it also helps with the orderly distribution of assets in case of your untimely demise. Finally, a revocable living trust is usually cheaper than going through probate court, where the public has access to all your finances.
While on the topic of estate planning, please put together a Death File as well. The Death File is like a hyper-detailed will that includes all your accounts, passwords, important people to contact, and your wishes. You can and probably should also include audio and video recordings in your Death File as well, so there is less ambiguity.
I promise you will feel incredible relief once you put your Death File together.
Study Up On The Latest 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.
Every year, there are many new propositions and tax laws that pass that may affect your future tax liabilities. For example, California recently 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.
Perhaps the most interesting tax information we should pay attention to are any changes in the estate tax threshold. If the estate tax threshold drops from an impressive $12,070,000 per person in 2022, then you may want to change your spending and giving habits while living.
Let’s say the estate tax threshold per person declines to just $3 million per person in 2023. At the rate you’re going, you estimate you’ll end up with an. estate worth $7 million by age 60. If you believe at age 60 the estate tax threshold will still be at $3 million, then you probably want to be more aggressive in spending your $4 million overage. Or, you may consider not working as much because paying a 40% death tax is a waste.
To know the right year-end tax moves to make each year, you need to review all the most pertinent rule changes every year.
Start A Business To Save On Taxes
Based on my experience, one of the best ways to save more on taxes is to 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.
For 2022, every business person can start a Self-Employed 401(k) where you can contribute up to $61,000 ($20,500 from you and ~20% of operating profits). In other words, to contribute the maximum to a Solo 401(k), your business needs to make at least $223,000 in operating profits.
Further, all your business-related expenses are tax deductible as well. If you want to go to Hawaii to see a prospective client, you can deduct your travel-related expenses. If your parents so happen to live in Hawaii, it’s like getting a discounted trip to see them.
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 should also be considered good.
It’s understandable that some people want to raise taxes on others without having to pay more themselves. Most working Americans don’t pay income taxes. However, 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. For more nuanced personal finance content, join 50,000 others and sign up for my free weekly newsletter.
Hi Sam,
I have been reading your posts for the past few years. Thank you very much for publishing this useful content!
Given recent news about inflation, I have been wondering how can I protect my family’s net worth, my portfolio and maybe make some smart moves given this evolving reality. Would you have any inputs or an inflation-to-do list to share with the community?
Thank you!
Inflation is generally great for your investments. Personally, I plan to allocate more dollars to real estate due to rising rents and asset values.
We’ve got negative real interest rates.
One thing to consider is that if your married your standard deduction is 25k. You only get to deduct charitable contributions that are over the 25k mark. So if you give away 30k your deduction is only 5k.
But people who have the ability to donate $30,000 probably have itemized expenses they can deduct. But good to know.
for this year (and last), you can deduct 300/600 (single/married) in cash contributions without itemizing. That was a covid provision and it’s set to expire on the 1st. It does strike me as good policy (though a large portion of chartable contributions are to churches, which could either be used for the community, or for Leer jets).
There is NOTHING prideful or Patriotic about paying taxes. The government is a terrible steward of what is steals. This country was literally founded on not wanting to pay taxes.
This country was *literally* founded on not paying taxes without representation. Slight difference.
The extreme RT wing/libertarians don’t want to pay taxes, so what happens about police, fire, roads etc? I guess we all carry guns and shoot at will, let our houses burn down, hope we have money to pay for medical treatments and use a horse and buggy, no good roads needed.
Sam – the following sentence in the bullet under charitable deductions needs to be updated to reflect the changes for 2021:
“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.”
I think the special provision for 2020 was an above-the-line deduction from your income prior to the calculation of your adjusted gross income (AGI). For 2021, I think cash donations are considered a below-the-line deduction from AGI, and if you are filing jointly, each person can donate and deduct $300 for a total of $600.
Updated! Thanks
Hey Sam,
What are you thoughts on transferring some of my earnings this year i.e. 50k into a new charity that I will start (new entity, hasn’t created)?
Not only for tax purposes, but also I am increasing doing more animal rights activism work, it would also nice to have my own charity focusing on that purpose.
Thanks
I think that would be great!
I just want to add some clarification to your point around the $3k maximum capital loss deduction. That only applies against earned income. If you have capital gains during the year that will add to your tax burden, then any capital losses can reduce those gains dollar for dollar. It is only once you have exhausted your capital gains to apply the capital losses against does the $3K limit come into play.
This year I have had a lot of capital gains (first world problem, I know) that I am desperately looking to harvest some capital losses against. The problem is that I don’t want to loss those stocks I have the loss with, but might need to sell them and buy them back later. The joys of being an investor.
Hi Chucky,
Are you sure about that?
For example, let’s say I sold a stock for a $50,000 capital gain. Are you saying if I sold another stock for a $50,000 capital loss, this loss offsets the $50,000 capital gain? As a result, I pay 0% capital gains tax?
What if I have $50,000 in capital losses and only $20,000 in capital gains on a stock one year. Can I carry over the $30,000 in losses to reduce my capital gains by up to $30,000 the next year?
Thanks,
Jack
@Jack, yes to both your situations. Here is a link to a Motley Fool article that spells that out. One of the points I will highlight is:
“If you have sold other investments at a profit during the year and therefore have capital gains income, then you can use an unlimited amount of capital losses to offset the gains. For instance, if you have capital gains of $12,000 and capital losses of $11,000, then you can use all of the losses to reduce the amount of gains you have to report, leaving you with a net gain of $1,000”.
https://www.fool.com/retirement/2017/02/15/what-is-the-capital-loss-tax-deduction.aspx
Hello Sam, Great article! If you work over 700 hours at your real estate business, can’t you deduct the mortgage interest, not limited to $25,000 plus any loss associated? The 25k is just for personal taxes correct? My husband and I have 2 single family rentals and have been losing out on deductions, only postponing the loss due to salaries. I’ve since left my job and consult and can take on the hours of managing our properties as well, making it a business and not passive. Thx for sharing your knowledge.
“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.”
Sam and co-readers, I saw the note on FSA health spending, but missed mention HSAs. There is a LOT packed into this blogpost, so I can see where my minor tidbits would be accidentally orphaned. Please be aware that HSAs have several advantages when a HDHP is one’s health insurance of choice:
Unlike FSAs, HSA accounts are yours and not a company holding account; therefore those contributed dollars stay with you until you spend them or die and your heirs get the funds (reader, you do have a will, right?) HSA accounts are not forfeit at the end of the year (FSA account are ‘spend it or lose it’).
Only two rules to contribute to a HSA account: (1) be enrolled in a HSA-qualified HDHP, (2) the contributor need not be on Medicare (=65 and still employed, you still qualify.
A HSA-qualified HDHP will have similarly lower premiums as a FSA, and a whole lot cheaper than the vastly more expensive standard options people choose without evaluating cost/benefit.
A HSA-qualified HDHP allows one to open a HSA savings or investment account. Contributions per year are capped (similar to Roth caps).
Funding your HSA can come from pre-tax pay deduction that lowers ones taxable income (like a 401k) or you can fund with post-tax money. After-tax contributions are fully tax-deductible from one’s FEDERAL taxable income using form 8889 and Sch1. This translates to CONTRIBUTIONS are TAX-FREE at the Fed level. Most states also consider this tax-free, but there were a few exceptions when I last read up on tax advantages.
Unlike 401(k)s and some other tax-advantaged accounts, the funding for an HSA doesn’t have to come from earned income — or even YOUR income. You can take savings, investment proceeds, whatever’s under the couch cushions or even gifted money as you panhandle at the traffic light and flow it into an HSA. It is not employment-dependent. Hence this year’s unused contribution rolls over and compounds to next.
HSA earnings are tax-free (like a Roth).
The insured may dip into HSA funds for qualified medical bills at any time (usually include most Dr visits, emergency services and hospitalizations, optical and dental needs, script drugs — look into the coverage before you sign up).
Some financial advocates design interesting investment plans wherein all qualified medical expenses are paid out of pocket, documented, and kept — allowing the HSA funds to grow unmolested to further tax-free gains — as a wealth-building vehicle.
HSA funds can be used to pay medicare premiums.
HSA funds can be used for non-qualified expenses without penalty after age 59-1/2 — but withdrawals of earnings are taxed as ordinary income then. So your HSA account can pay for that “I’ve made it to 60 vacation/porsche”.
Got a real non-medical need for that stash before you are 59-1/2? Well, yes, you can pull out — but there are tax fees involved.
I said earlier that HSAs can go to your heirs. There are some weird rules on how that beneficiary role works for spouses, non-spouses, estates, revocable trusts and such. You can even build a chain of beneficiaries.
There are tons of websites, podcasts, books and perhaps even some older posts here with Sam re HSAs to learn more. So why should you look into this now, before the new year? Because your window to contribute is annually — and like a Roth, you can wait to the Ides of April (or whenever you file) to contribute to the prior year. Read up or find a decent financial advisor (for the love of Darwin, don’t rely on me).
I personally cap off my family’s investment acct early every year just to get it off my plate, dumping it 70/30 into VTI and AGG — but I’m not a sophisticated investor. Seems crazy not to take advantage of as many of these tools as you can.
Can anyone get a HSA? Is this through an employer? Just recently learned about them.
To open and contribute to a HSA, you need to have a HSA-qualified HDHP. Check with your health plan. These can be through an employer or self-insured.
With my employer plans, ALL of them have the same catastrophic cap on annual out-of-pocket. So the minor extra I pay in Dr visits from choosing the low-premium HSA rather than the much higher premium ‘best’ plan is very small for a family of four.
My daughter had an emergency appendectomy last year. Total revealed bills came to $43000. My cap with the HSA is $12000. That’s the same cap for the ‘best’ plan. I would have been out the same cash either way — and having an HSA for 15 years meant I had all the cash to pay the OOP. Unrelated: I asked the hospital if they had any no-interest payment plans. They do, and I have a low monthly payment while my HSA balance continues to grow.
Some goggling will bring a plethora of information. Work out how much you paid on average for medical costs for the last five years with your current insurance, plus your premiums. Then calc out what you would have paid if you had a HSA-HDHP vs what it would have saved in premiums, in taxes for maxing out HSA contributions, and what those contributions would have earned since 2015 as a savings Acct or an investment account say with VTI as the sole component.
> HSA earnings are tax-free (like a Roth).
California taxes you on your annual gains. Like with the use tax, they rely on you to report it, but since annual contributions are reported on your W2, you won’t be able to ignore it for long.
That doesn’t detract from its usefulness. While to date I treat it as an extra retirement account, it does have 45k now in it for a really bad day at the hospital. Provided I can avoid that, it will pay for coverage between retirement and turning 65.
What’s your opinion on using donor-advised fund for charitable contributions?
I think they are great. I should write a more detailed post about it.
Donor advised funds are the most popular giving vehicle today next to people writing a check or using a credit card for donations. However, keep in mind that not all donor advised funds are created equal and many are under pressure to not give to selected organizations. make sure you select a donor advised fund that reflects your value system.
Hi Sam, if I maxed out my 401k from my regular corporate job, and I opened my own side biz (hopefully in 2021), could I still qualify to open a Self-Employed 401k?
Yes you can! Check out this post:
How To Save Over $100,000 In Your Pre-Tax Retirement Accounts
Thank you, Sam!! Will definitely look into this.
I think the best thing you could do is print out this article and every comment and go through each one with your CPA, to make sure they are evaluating each item for your tax return.
Corrections
#6 Even with a cash basis accounting you cannot exclude taxable income when all restrictions to your claim on that income have been removed. Even if you have not physically received the check before the end of the year its still taxable income.
for what its worth that’s my 2C
Hi Sam,
Lot of good stuff detailed all in one place here. However (got be a however), it seems to me that there are two distinctly different categories of retirees, those with sufficient means and those with insufficient means (to maintain their chosen lifestyle until death).
Of these two, the first category can be split again into two additional categories, those whose total income (passive income plus investment growth and income) is greater than while working (typically, this would mean their net worth was growing) and those whose income is less than while working (which would typically mean their net worth was decreasing). The difference between the two can be a very sharp line and should have some sort of a name if it does not already, something like “the takeoff point,” or the “retirement Rubicon,” or something like that.
These latter two categories are likely to see things very differently when it comes to 401k plans and Roth IRAs and it seems that sometimes you are advising one group and sometimes the other.
1) “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.”
Who is this advice targeted for? If we do as you have suggested many times, and secure a suitably large passive income, along with a big enough portfolio to continue getting serious returns, then we should cross the takeoff point and a Roth IRA is the best thing going.
2) “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.”
Again, passive retirement income for the win (in accordance with your own advice elsewhere). Given that every projection I’ve made shows our own retirement income is already going to increase when we retire, and then keep on increasing up to age 72, when RMDs kick in and jump us into a higher bracket (or two) if I can’t manage enough partial Roth conversions in the meantime. Then it rises drastically into our nineties. Even so, we have no plans to run out and buy a 7 bedroom McMansion in Sun City or southern Florida.
Roths comes first, if for no other reason than to reduce the burn of paying higher taxes later due to high RMDs.
This makes the main reason for 401k contributions become the fact that they can be converted to our Roth plans in big chunks, in between retirement (and moving away from high state income taxes) and age 72, a limited window, unless we are willing to go up a tax bracket to convert even larger sums (unlikely).
A secondary reason would be a minor one, but potentially still worth doing, which is that the deduction for 401k contributions could reduce taxable income to a point where an annual contribution (max of 7k) to the Roth account(s) could be made where it otherwise could not.
For some reason, I love reading into taxes, particularly how to minimise the amount you pay each year. This post is no exception and has some great ideas, so thanks very much!
Great list thanks! I’m trying to figure out if I should do anything in regards to Prop 19 in CA. Technically we have until Feb 15th of next year, but I need to think things through sooner rather than later. It’s so annoying when there are complicated tax changes like this, but it’s important we understand them because there can be significant ramifications.
Rather than raising taxes on incomes above $400,000 deductions should be completely phased out. If one wants to give to charity, that is a good thing but a tax deduction is simply the equivalent of a government subsidy to the charity. I still remember in 2016 seeing Hillary Clinton’s tax return where it showed she donated $1,000,000 to the Clinton Foundation, which resulted in a loss to the taxpayer of over $350,000.
Could purchase a vehicle weighing over 6K lbs for business by 12/31 to get a huge write-off. For example:
Say you buy a $47,000 crossover vehicle that tax law classifies as a truck. Say further that you use the crossover truck 100 percent for business. If the GVWR is 6,001 pounds or more, tax law allows you to deduct $47,000 (or a lesser amount if you would like—in this case, you use Section 179 expensing).
Spreading the tax deduction. If the GVWR 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).
In this example, the combination of (1) truck status and (2) GVWR of 6,001 pounds or more produces a potential $47,000 first-year tax deduction, whereas failing either truck status or GVWR threshold limits the first-year regular depreciation write off to $18,000 with bonus depreciation.
Great tip and reminder!
Let’s hope folks mainly buy the truck because they need to though.
Sam – Have you ever looked into buying into a partnership that specializes in buying and converting the land into a conservation easement?
This was recently brought on my radar this year when I finally found the CPA I’ve been looking for for years.
I actually bought a couple of units into a deal myself spent $68,600 and that bought me a deduction worth $343,000. This particular deal has a 5:1 ratio of donation (of the purchased land) to deduction (based on the highest and best use appraisal).
My CPA helped calculate how much I should invest to maximize the maximum the IRS allows in terms of deductibility against your AGI. In this case, we calculated that the largest deduction I could utilize in 2019 based on my projected AGI of $350,000, which translated into two units at $34,300/unit. This will save me about $140,000 in taxes and net of the donation is an actual savings of $71,400 (greater than a 100% return).
It’s a great option for high earners in high marginal tax rates. It doesn’t make sense at every income level.
Dom
I’ve heard of it! But haven’t done so. Will look into it. Sounds like a great tax shield. Maybe you want to do a guest post about how to do something like this.
Those conservation easements are subject to IRS scrutiny in recent years. Expect the partnership to get an audit.
Careful with conservation easements. These are a huge red flag to the IRS and will almost guarantee an audit. In my experience most of these audits are not resolved at the IRS audit team level but instead get elevated to IRS Appeals. Even if the taxpayer prevails after the audit, the taxpayer will incur thousands in legal/CPA fees and an inordinate amount of stress.
-Tax lawyer who charges clients $400 to defend IRS audits
If one is doing the easement with a group or LLC, won’t that bear the expenses for the audit, rather than an individual?
Regarding your statement: “If you’re not subject to AMT, you can also consider paying property tax installments and state taxes in the current year that aren’t due until next year. Accelerating these payments may help you benefit every other year and lower your tax burden for the current taxable year.”
Doesn’t the IRS now limit people to $10,000 in SALT … State and Local Taxes – that’s all taxes including property taxes, etc.
Sam, I would also recommend to look into the Opportunity Zones investment program. On one hand it helps you save on taxes and on the other hand helps to revitalize parts of the city whicg would otherwise not have seen investment opportunities.
Of course, one needs to run the numbers to make sure the deal makes sense and not let the tax tail wag the dog.
Good reminder on Opportunity Zones! I had written about the topic in the past. Haven’t taken the plunge yet because I haven’t found the perfect vehicle to do so yet.
Not only are they good investments, IRS lets you roll over cap gains into the Opp Zone. Similar to a 1031 exchange.
There are also other tax advantages if you keep the money in there for 5-7 years.
Got 3 more less-known tax saving strategies:
1. If you got family/friends you are supporting financially (who’s likely in a lower tax bracket), consider gifting them long-term appreciated (capital gains) stocks. The transfer is direct – with no changes in cost basis. When they sell, they likely will pay 0% capital gains tax rate where you might have paid 23% federal + x% state rate.
2. Similar strategy as above but for charities – gift appreciated stocks to a Donor Advised Fund (that you control). You can also time it so that you gift it all in one year when extra deductions help and not donate in other years. You can then control when the fund actually distribute money out to charities – so to charities you donate money to yearly anyways, it’ll remain the same for them.
3. If you’ve got 1 property you’re renting out and has no mortgage and you’re living in another primary residence with a large mortgage (and interest deduction), but you’re still pretty close to the $24k total standard deduction limit, consider swapping (move into the no-mortgage place and rent out the with-mortgage place). This way, you still take the $24k deduction, but now your mortgage interest can be used to be deducted from rent. For example, you’re in California – maxed out your State Tax deduction of $10k. Your primary residence has a mortgage where you’re paying $14k interest a year. But your other rental has no mortgage. You’d have itemized deduction of ~$24k – which is useless. But if you swap the 2 residence, you’ll still have standard deduction of $24k. But now you can deduct the extra $14k from rent income.
Great tips! If I buy this new property close by, I will pay cash and rent out my existing property with a mortgage that I just refinanced.
James – Did you mean to address Property Tax? The SALT limit is $10k, but mortgage interest is maxed on a $750k mortgage.
I was indeed talking about Federal Income tax. In my example, the $10k SALT deduction already included property tax. But yes, it could make a difference if the 2 properties have vastly different property tax. For example, assuming property A (currently your rental) still had $0 mortgage interest deduction and property 2 (your primary residence) had $14k mortgage interest deduction.
Example #1. Property A Property Tax = Property B = $5k. Then Property Tax makes no difference. You’ll still have an extra $14k deduction if you swap.
Example #2: A Tax = $3k. B Tax = $8k. Your State income tax is $10k (reaching the SALT limit – which renders itemizing deduction of property tax useless). If you swap, you get an extra $5k in deduction – making it $19k total.
Example #3: A Tax = $8k. B Tax = $3k. State income tax is $10k. If you swap, you lose $5k in deduction from property tax – making it only $9k in total deductions benefit.
Example #4: A Tax = $8k. B Tax = $3k. State income tax is $7k. Without swapping, your itemized deduction will be $24k total and rental deduction will be $8k for a total of $32k. With swapping, your itemized deduction will be $24k still (due to $10k SALT limit) total and rental deduction will be $17k for a total of $41k. So looks like still just $9k in total deductions benefit.
Thanks James.
In your original comment, it read to me like you were confusing SALT and mortgage interest, so I was just clarifying.
The idea of swapping properties to deduct the higher property taxes is a cool point though.
Cheers,
Ben
“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.”
Paying your taxes is not like giving to charity. These things generally benefit you *at least defense, healthcare, infrastructure. Even public schools and safety net programs (e.g. food and shelter programs) benefit you like insurance does. You may need them someday. You don’t get to choose what you contribute to directly but they are still there for you. Paying taxes is essentially giving to yourself and not like giving to charity. But I agree it is being a good person to pay your taxes but no one deserves a congratulations or anything. It is pulling your weight for a shared benefit.
Do you think we should broaden the tax base so that everybody pays some income tax who generate income? As of now, a large percentage of the income earning population does not pay any income tax. It might be good if we all pay something to pitch in for our great country.
Amen
Everyone should be on the hook for some taxes, even if it’s a token amount, so that no one is completely invested in raising them.
Frankly, since the most important thing a government can do is provide a stable currency (as this requires them to do everything that makes it stable) a government could just charge usage fees for its currency (recognizing that even the barter system is based on perceived financial value as measured in currency, and therefore subject to a fee), and eliminate taxes altogether.
It might seem like a subtle change at first, but it could have some seriously positive impacts on how budgets are set.
I’ve paid a fair amount of taxes all my life mostly using the standard deduction and am fully vested in raising them as they are far too low. We don’t have a national healthcare system and a large segment of the population can’t even feed themselves a few weeks after losing a job. Fairtax.org is the best tax system out there basically making a flat tax system progressive. No deductions or loopholes.
Actually, everyone who generates income pays taxes. (Unless they are paid in cash and live in a no sales tax state.) Up until somewhere around $200,000 in annual income, households pay more in payroll taxes than they do in income tax.
Ugh, I hate seeing this misleading argument about poor people not paying income taxes. No, we should not shift the burden of income taxes to the poor because they pay taxes in other ways outside of income taxes. They pay sales, state, local, property, etc at a much higher burden than you or I do. It’s convenient to narrow the argument down to income taxes, and make it seem like poor people aren’t contributing to society. Way to further a rich person narrative, bro.
How did you go from what I said to “the poor people aren’t contributing to society”? That’s a pretty arrogant statement.
See: Spoiled Or Clueless? Work A Minimum Wage Job As An Adult
Some argue there is a very big benefit if 100% of income-earning Americans pay some amount of income tax because there would be more skin in the game, more fiscal prudence, less waste, more revenue to benefit everyone, and more patriotism.
Feel free to elaborate what you think is the right income tax paying percentage should be for Americans who earn income and why. Further, what are you doing to help society and the poor? Thanks
**********
The Tax Policy Center has updated its estimate of the percentage of Americans who pay no federal individual income taxes. And the number is: 44 percent in 2018—about 2 percentage points above last year. The share of non-payers will drop steadily until the individual income tax provisions of the Tax Cuts and Jobs Act (TCJA) expire after 2025, causing a 2-percentage point drop.
While the share of households paying no federal income tax will increase, nearly all those households will continue to pay some taxes— whether federal payroll taxes, federal excise taxes, or state taxes.
The large percentage of people who don’t owe federal income tax is a feature, not a bug, of the revenue code. By design, the federal income tax always has excluded a significant fraction of households through a combination of personal exemptions, the standard deduction, zero bracket amounts, and more recently, tax credits.
Passage of the TCJA was the main cause of the 2 percentage point jump in non-payers of the federal income tax. The law’s increase in the standard deduction and its expansion of the Child Tax Credit (CTC) were the main drivers of this result. However, the effects of those changes were dampened somewhat by the elimination of personal exemptions.
The fraction of non-income-tax-payers grew for those in all but the top quintile, and by the largest amount (3 percentage points) among middle-income households.
Due to real income growth over time, the share of those who don’t pay federal income tax will steadily decline by roughly half a percentage point-a-year until the TCJA’s individual provisions expire in 2025. In 2026, the share of those paying no income tax will drop by 2 percentage points.
Anyway, my point…and I concede that it does come across as arrogant…is that by limiting the tax argument to only federal income taxes like you did in your reply to me, and ignoring the full tax burden that people pay, it only serves to feed the narrative that divides us. It makes people think that poor people don’t pay taxes aka contribute like everyone else does. I think the progressive tax system we have now is the right one. However, the top tax rates should be much higher than they are now. And yes, that would mean I pay more in taxes, and a large percent still would not. (if we continue to limit the argument to only federal taxes)
I hope you find the extra money you are looking for, and that it satisfies you in life.
Brian it’s attitudes like yours that are causing California’s economic implosion. You think taxes are too low and want to raise them. In CA, high earners already pay 37% Fed plus 2.4% Medicare plus 13.3% state. Total marginal tax rate of 52.7%. If Biden gets his way and the current CA bill increasing taxes is passed, that would go to 39.6+2.4+7.4 FICA + 16.8 for a total of 66.2%. So two thirds of marginal income. That’s why high earners are fleeing CA. Welcome to Venezuela.
But they still have money for expensive homes, cars, and toys after paying taxes so I think they are not too high yet. Anyone is free to move out of CA but they still have a better economy than most States.
@Brian – I always love when people say “yes, that would mean I (would) pay more in taxes”, the inference being that they are happy to pay more in taxes. How much have you added to your income tax return each year because you are so happy to pay more in taxes? Oh, none? Then you are no better than the rest of us that seek to minimize our tax burden; you just like to sound more pious.
Maybe that sounds harsh but I am getting tired as more and more people say they are happy to pay more in taxes, on up to and including Buffett, who has shielded every penny of his fortune from the clutches of the US Treasury.
I agree completely. Buffet alludes to his secretary paying a higher percent in taxes than he does, yet nothing stops him from simply paying more. He would much rather donate his fortune thereby choosing where it goes and let the rest of us fund the military industrial complex, ect for which we have zero choice.
Everyone who lives within their means and uses the standard deduction IS paying more in taxes than anyone who itemizes. Perhaps overly simplistic but itemized deductions are essentially a legal tax avoidance scheme. Let’s get rid of ALL deductions, IRAs, 401k’s and enact a Progressive tax system where there is no advantage for anyone. No need for high priced, tax lawyers, audits, etc. The savings for simplicity goes in everyone’s pockets. Now THATS individual responsibility!
I agree that everyone that generates income should pay an income tax, but I also think the use of the 44% statistic is misleading when paired with comments about people not paying taxes due to exemptions, deductions, tax credits, etc.
According to the tax policy link, 24.7% of people had zero or a negative sum of payroll and income taxes in 2018, so the largest reason for people not paying income taxes is simply that they didn’t have income.
I think a better interpretation of the data is ~20% (44% – 24%) of people had positive income AND didn’t pay taxes, and this group of people benefitted from exemptions, deductions, tax credits, etc.
Sure, that makes sense. Just proposing that everybody who earns income pay some income tax. Yes, there are other taxes, which other people pay as well.
Per the IRS, for both traditional and Roth IRAs. . . you can make 2019 IRA contributions until April 15, 2020.
So you don’t have to do it this month. Since they changed the rules on rollbacks, it might be a good idea to wait so you can see where your modified AGI is going to land, if there is any question you might land on the high side, and have to reduce it, or forego it altogether.
Also, people over 50 have a higher maximum contribution limit for 401(k) plans, as well as for traditional and Roth IRAs, due to catch up provisions.
Good to point out. Thanks
There is also an over 50 catch-up on HSAs as previously mentioned in the comments.
Very useful information. As I have less than a year since starting my small LLC and this would be my first tax ‘season’, it’s a good idea to learn how to save money off these taxes, as the income is still very low and there’s not a lot of money to be squandered. I’ll need to look into all these options and see which I can put to good use.
I’ve been busy gathering things to donate before the month is up for the year. It’s a win win in my book to be able to find things someone else could use, clear up space and get a tax deduction on top of it all.
Fascinating stats on the percentage of giving by income. I can see how taxes paid are a part of that equation. Now if only we could feel confident that the local, state and fed government maximized the use of each of our tax dollars to help those who need it. But at least some of the money should be put to good use!
I’ll reiterate to donate gently used items. Many including myself have a lot of things we buy that we later regret and don’t really need. We take them for granted, therefore we should give them away, get a tax benefit and feel better for helping someone else.
On pace to make 6x the median income in usa for my age this year. I doubt i work much harder…. strategic planning is where it’s at. In 4 years that multiple is projected to grow to 8x. In 8 years the multiple is projected to grow to 13x…. jeez. Just a small bit of planning in the beginning. As a result, I’ll pay a ridiculous amount in taxes…. which is tough for me to think about…. but thanks to your article I’ll be able to navigate the tax landscape a bit more clearly. Thanks!
One tax trick I am employing this year (not really a tax savings though) is how I am dealing with a large capital gains tax I anticipate from selling the medical building I practice in for quite a large profit.
I think my capital gains tax is estimated at $250k from this sale. There were 3 options available, 1) do a quarterly payment plan (I only had 2 quarters to make payments due to timing of sale), 2) increase my withholdings from my income to cover it or 3) take advantage of an irs rule that allowed me to witthold 110% of my previous years tax owed and then settled the difference penalty free in April.
I did #3 which essentially gave me a $250k “float” for over 6 months where I could earn interest on it as well.