Here are some things to consider as you weigh potential tax moves before the end of the year.
Consider opportunities to defer income to 2022, particularly if you think you may be in a lower tax bracket then. For example, you may be able to defer a year-end bonus or delay the collection of business debts, rents, and payments for services in order to postpone payment of tax on the income until next year.
Look for opportunities to accelerate deductions into the current tax year. If you itemize deductions, making payments for deductible expenses such as medical expenses, qualifying interest, and state taxes before the end of the year (instead of paying them in early 2022) could make a difference on your 2021 return.
If you itemize deductions on your federal income tax return, you can generally deduct charitable contributions, but the deduction is limited to 60%, 30%, or 20% of your adjusted gross income (AGI), depending on the type of property you give and the type of organization to which you contribute. (Excess amounts can be carried over for up to five years.) For 2021 charitable gifts, the normal rules have been enhanced: The limit is increased to 100% of AGI for direct cash gifts to public charities. And even if you don’t itemize deductions, you can receive a $300 charitable deduction ($600 for joint returns) for direct cash gifts to public charities (in addition to the standard deduction).
If it looks as though you’re going to owe federal income tax for the year, consider increasing your withholding on Form W-4 for the remainder of the year to cover the shortfall. The biggest advantage in doing so is that withholding is considered as having been paid evenly throughout the year instead of when the dollars are actually taken from your paycheck.
Here are some other things to consider as part of your year-end tax review.
Deductible contributions to a traditional IRA and pre-tax contributions to an employer-sponsored retirement plan such as a 401(k) can help reduce your 2021 taxable income. If you haven’t already contributed up to the maximum amount allowed, consider doing so. For 2021, you can contribute up to $19,500 to a 401(k) plan ($26,000 if you’re age 50 or older) and up to $6,000 to traditional and Roth IRAs combined ($7,000 if you’re age 50 or older). The window to make 2021 contributions to an employer plan generally closes at the end of the year, while you have until April 15, 2022, to make 2021 IRA contributions. (Roth contributions are not deductible, but qualified Roth distributions are not taxable.)
While required minimum distributions (RMDs) were waived for 2020, they are back for 2021. If you are age 72 or older, you generally must take RMDs from traditional IRAs and employer-sponsored retirement plans (an exception may apply if you’re still working for the employer sponsoring the plan). Take any distributions by the date required — the end of the year for most individuals. The penalty for failing to do so is substantial: 50% of any amount that you failed to distribute as required. After the death of the IRA owner or plan participant, distributions are also generally required by beneficiaries (either annually or under the 10-year rule; there are special rules for spouses).
Though you shouldn’t let tax considerations drive your investment decisions, it’s worth considering the tax implications of any year-end investment moves. For example, if you have realized net capital gains from selling securities at a profit, you might avoid being taxed on some or all of those gains by selling losing positions. Any losses above the amount of your gains can be used to offset up to $3,000 of ordinary income ($1,500 if your filing status is married filing separately) or carried forward to reduce your taxes in future years.