The holiday season is fast approaching and that means the much less pleasant tax season is just around the corner. Before long, we’ll have to discuss our 2021 income and expenses with the government and hope not to get slapped with a surprise bill. Fortunately for us, there are some things we can do to reduce the amount we owe the government. Here are three steps that can help you save a lot on your 2021 taxes.
1. Contribute to your retirement accounts
Traditional tax-deferred retirement account contributions to vehicles like traditional IRAs and 401 (k) plans reduce your taxable income for the year. For example, if you earn $ 50,000 in 2021 and contribute $ 5,000 to a tax-deferred account, the government will not tax you on that $ 5,000 at this time. You will only have to pay tax on the remaining $ 45,000.
But this does not apply to Roth accounts. Contributions to the Roth account offer tax-free withdrawals in retirement, so you don’t get tax relief now. Contributing to one of these accounts might be smart if you’re concerned about taxes in retirement, but you’ll have to stick with a tax-deferred account, like a traditional or 401 (k) IRA, if you want to save that. year. .
Retirement savers who qualify for the Savings Tax Credit could reduce their tax bill even further. It’s a tax credit, so it offers a dollar-for-dollar reduction in what you owe. The amount you get depends on your income, your tax filing status, and how much you contribute to a retirement account this year. The maximum credit is $ 1,000 for individuals or $ 2,000 for married couples. This means that if you owed the government $ 3,000 in taxes and you qualify for a $ 1,000 tax credit, you owe the government only $ 2,000. If you’ve already paid more than you owe throughout the year, the rest comes back to you in the form of a tax refund.
2. Make a charitable donation
Charitable donations can also reduce your taxable income for the year, but only if they meet certain criteria.
First, your donation must be made to an eligible tax-exempt organization. If you’re not sure if an organization qualifies, see if you can find it in the IRS’s Tax Exempt Organizations Finder.
Second, you need to document your donations. Make sure you get receipts from the organization you’re donating to or keep your bank or credit card statement showing the donation. You don’t have to submit it when you file your taxes, but if you’re audited and can’t provide proof of your donation, the government can refuse it.
Third, you must make your donations before the end of the year if you want to claim the deduction on your 2021 tax return. A pledge is not enough. You must actually contribute the funds or property before December 31, 2021.
Normally, you need to itemize your deductions in order to claim tax relief for charitable contributions, and you can only deduct up to 60% of your Adjusted Gross Income (AGI). But in 2021, there is a special rule that allows individuals who claim the standard tax deduction to deduct up to $ 300 for charitable contributions. Married couples can claim up to $ 600 in charitable contribution tax deduction without itemizing.
3. Harvesting tax losses
Harvesting tax losses involves selling some of your investments at a loss to offset any capital gains you have made by selling other investments at a profit. For example, if you buy a stock for $ 100 and sell it a year later for $ 200, you have a capital gain of $ 100 that you would normally have to pay tax on. But if in the same year you sold the profitable stocks, you also sold underperforming stocks at a loss of $ 50, the government will only tax you on the difference between your total capital gains and your losses – in this case, $ 50.
It is possible to reduce your tax bill by up to $ 3,000 this way. If your losses exceed $ 3,000, you can no longer deduct your 2021 taxes, but you can carry the excess forward to next year.
This strategy is not for everyone, however. Single filers earning less than $ 40,400 and married couples earning less than $ 80,800 in 2021 will not owe tax on their capital gains anyway, so this strategy may not be as beneficial to them as it is to one. person in a higher tax bracket.
You also don’t want to give up your entire investment strategy to save a little on your tax bill. If the shares of a strong company go down in the short term, that doesn’t mean you have to sell them in order to report them as a loss. You might think that you can just buy it again a little later when it starts to get better, but you can’t.
Buying the same or nearly identical inventory that you recently reported as a loss on your tax return is known as a wash sale, and it can get you in big trouble with the IRS. . So if you think a business is a smart long-term investment for you, you’re probably better off keeping it than selling it for a short-term tax deduction.
The three tips above are some of the most common ways to save on your taxes, but you need to take these steps before the end of the year. Allow an hour or two to review your finances and determine which of the above steps is right for you. Next, be sure to keep track of your pension contributions, donations, and tax losses so you have this information handy when you file your 2021 taxes.