As we approach the end of 2021, I am sharing my favorite list of tax-saving ideas that can help you lower your tax bill for 2021. In my practice, In the US tax rules change frequently. 2021 was no exception.
I believe that proactive tax planning is essential for achieving your financial goals. Furthermore, it is key to achieving tax alpha. For you, achieving Tax Alpha is a process that starts on day 1. Making smart tax decisions can help you grow your wealth while you prepared for various outcomes.
Today, you have a great opportunity to review your finances. You can make several smart and easy tax moves that can lower your tax bill and increase your tax refund. Being ahead of the curve will help you make well-informed decisions without the stress of tax deadlines. Start the conversation today.
1. Know your tax bracket
The first step of managing your taxes is knowing your tax bracket. In 2021, federal tax rates fall into the following brackets depending upon your taxable income and filing status. Knowing where you land on the tax scale can help you make informed decisions especially when you plan to earn additional income, exercise stock options, or receive RSUs
Here are the Federal tax bracket and rates for 2021.
|Tax Rate||Taxable Income||Taxable Income|
|(Single)||(Married Filing Jointly)|
|10%||Up to $9,950||Up to $19,900|
|12%||$9,951 to $40,525||$19,901 to $81,050|
|22%||$40,526 to $86,375||$81,051 to $172,750|
|24%||$86,376 to $164,925||$172,751 to $329,850|
|32%||$164,926 to $209,425||$329,851 to $418,850|
|35%||$209,426 to $523,600||$418,851 to $628,300|
|37%||$523,601 or more||$628,301 or more|
2. Decide to itemize or use a standard deduction
The standard deduction is a specific dollar amount that allows you to reduce your taxable income. Nearly 90% of all tax filers use the standard deduction instead of itemizing. It makes the process a lot simpler for many Americans. However, in some circumstances, your itemized deductions may surpass the dollar amount of the standard deduction and allow you to lower your tax bill even further.
Here are the values for 2021:
|Filing status||2021 tax year|
|Married, filing jointly||$25,100|
|Married, filing separately||$12,550|
|Head of household||$18,800|
3. Maximize your retirement contributions
You can save taxes by contributing to a retirement plan. Most contributions to qualified retirement plans are tax-deductible and will lower your tax bill.
- For employees – 401k, 403b, 457, and TSP. The maximum contribution to qualified employee retirement plans for 2021 is $19,500. If you are at the age of 50 or older, you can contribute an additional $6,500.
- For business owners – SEP IRA, Solo 401k, and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefit Plans to maximize your retirement savings and lower your tax bill. The maximum contribution to SEP-IRA and Solo 401k in 2021 is $58,000 or $64,500 if you are 50 and older.
If you own SEP IRA, you can contribute up to 25% of your business wages.
In a solo 401k plan, you can contribute as both an employee and an employer. The employee contribution is subject to a $19,500 limit plus a $6,500 catch-up. The employer match is limited to 25% of your compensation for a maximum of $38,500. In many cases, the solo 401k plan can allow you to save more than SEP IRA.
A defined Benefit Plan is an option for high-income earners who want to save more aggressively for retirement above the SEP-IRA and 401k limits. The DB plan uses actuary rules to calculate your annual contribution limits based on your age and compensation. All contributions to your defined benefit plan are tax-deductible, and the earnings grow tax-free.
4. Convert to Roth IRA
The conversion amount is taxable for income purposes. The good news is that even though you will pay more taxes in the current year, the conversion may save you a lot more money in the long run.
If you believe that your taxes will go up in the future, Roth Conversion could be a very effective way to manage your future taxes.
5. Contribute to a 529 plan
The 529 plan is a tax-advantaged state-sponsored investment plan, allowing parents to save for their children’s future college expenses. 529 plan works similarly to the Roth IRA. You make post-tax contributions. Your investment earnings grow free from federal and state income tax if you use them to pay for qualified educational expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.
Over 30 states offer a full or partial tax deduction or a credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can significantly lower your state tax bill.
6. Make a donation
Donations to charities, churches, and various non-profit organizations are tax-deductible. You can support your favorite cause by giving back and lower your tax bill at the same time. Your contributions can be in cash, household good, appreciated assets, or directly from your IRA distributions.
Charitable donations are tax-deductible only when you itemize your tax return. If you make small contributions throughout the year, you might be better off taking the standard deduction instead.
If itemizing your taxes is crucial for you, you might want to consolidate your donations in one calendar year. So, instead of making multiple charitable contributions over the years, you can give one large donation every few years.
7. Tax-loss harvesting
The stock market can be volatile. If you are holding stocks and other investments that dropped significantly in 2021, you can consider selling them. The process of selling losing investments to reduce your tax liability is known as tax-loss harvesting. It works for capital assets held outside retirement accounts (401k, Traditional IRA, and Roth IRA). Capital assets may include real estate, cryptocurrency, cars, gold, stocks, bonds, and any investment property, not for personal use.
The IRS allows you to use capital losses to offset capital gains. If your capital losses are higher than your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year or $1,500 if married and filing a separate return. Furthermore, you can carry forward your capital losses for future years and offset future gains.
8. Prioritize long-term over short-term capital gains
Another way to lower your tax bill when selling assets is to prioritize long-term over short-term capital gains. The current tax code benefits investors who keep their assets for more than one calendar year. Long-term investors receive a preferential tax rate on their gains. While investors with short-term capital gains will pay taxes at their ordinary income tax level
Here are the long-term capital gain tax brackets for 2021:
|Long-term capital gains tax rate||Single||Married Filing Jointly|
|0%||$0 to $40,400||$0 to $80,800|
|15%||$40,401 – $445,850||$80,801 to $501,600|
|20%||Over $445,850||Over $501,601|
Furthermore, high-income earners will also pay an additional 3.8% net investment income tax.
9. Contribute to FSA
With healthcare costs always on the rise, you can use a Flexible Spending Account (FSA) to cover your medical bills and lower your tax bill.
Flexible Spending Account (FSA)
A Flexible Spending Account (FSA) is tax-advantaged savings account offered through your employer. The FSA allows you to save pre-tax dollars to cover medical and dental expenses for yourself and your dependents.
The maximum contribution for 2021 is $2,750 per person. If you are married, your spouse can save another $2,750 for a total of $5,500 per family. Some employers offer a matching FSA contribution for up to $500. Typically, you must use your FSA savings by the end of the calendar year. However, for 2021, The American Rescue Plan Act (ARPA) allowed you to carry over your entire balance into the new year.
Dependent Care FSA (DC-FSA)
A Dependent Care FSA is a pre-tax benefit account that you can use to pay for eligible dependent care services, such as preschool, summer day camp, before or after school programs, and child or adult daycare. It’s an easy way to reduce your tax bill while taking care of your children and loved ones while you continue to work.
The American Rescue Plan Act (ARPA) raised pretax contribution limits for dependent care flexible spending accounts (DC-FSAs) for the calendar year 2021. For married couples filing jointly or single parents filing as head of household, the maximum contribution limit is $10,500.
10. Child and dependent care tax credit
The enhanced credit for 2021 allows eligible parents to claim up to 50% of $8,000 per child in dependent care expenses for a maximum of two children. The maximum credit will be 50% of $16,000. Keep in mind that you cannot use your DC-FSA funds to claim this credit
The credit percentage gradually phases down to 20 percent for individuals with incomes between $125,000 and $400,000, and further phases down by 1 percentage point for each $2,000 (or fraction thereof) by which an individual’s adjusted gross income exceeds $400,000,
11.. Contribute to Health Savings Account (HSA)
A Health Savings Account (HSA) is an investment account for individuals under a High Deductible Health Plan (HDHP) that allows you to save money on a pre-tax basis to pay for eligible medical expenses.
Keep in mind that the HSA has three distinct tax advantages.
- All HSA contributions are tax-deductible and will lower your tax bill.
- Your investments grow tax-free. You will not pay taxes on dividends, interest, and capital gains.
- If you use the account for eligible medical expenses, you don’t pay taxes on those withdrawals.
The qualified High Deductible Plan typically covers only preventive services before the deductible. To qualify for the HSA, the HDHP should have a minimum deductible of $1,400 for an individual and $2,800 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $7,000 for one-person coverage or $14,000 for family.
The maximum contributions in HSA for 2021 are $3,600 for individual coverage and $7,200 for a family. HSA participants who are 55 or older can contribute an additional $1,000 as a catch-up contribution. Unlike the FSA, the HSA doesn’t have a spending limit, and you can carry over the savings in the next calendar year.
12. Defer or accelerate income
Is 2021 shaping to be a high income for you? Perhaps, you can defer some of your income from this calendar year into 2021 and beyond. This move will allow you to delay some of the income taxes coming with it. Even though it’s not always possible to defer wages, you might be able to postpone a large bonus, royalty, or one-time payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.
On the other hand, if you expect to be in a higher tax bracket tax year next year, you may consider taking as much income as possible in 2021.