It may have seemed like forever, but 2020 is finally coming to an end. With that comes your chance to get ready for Tax Season, even though it isn't as wonderful as the December holidays.
We have put together 14 tips to get ready for tax time and get into shape for 2021.
1. Perform a Financial Checkup
It's been a wild ride. Now is the time to look back to see how much your income fluctuated in 2020. If you lost a job, had your hours reduced or increased, or experienced a shift in your bonus, your withholdings from FICA to your 401(k) may not match reality anymore.
Take your most recent pay stub, and look into all your taxes, Social Security, and other withholdings and make sure everything still makes sense for you.
2. Cancel Your Required Minimum Distribution
Usually, the IRS makes you start taking your RMD at age 72, but not this year. This year, the RMD has been waived through the Coronavirus Aid, Relief, and Economic Security (CARES) Act. If you don't need the extra money and haven't taken it yet this year, cancel it.
3. Convert from a Traditional to a Roth IRA
Withdrawals from a traditional IRA are taxed when withdrawn since the earnings were not taxed while in the account. Distributions from a Roth IRA, on the other hand, are tax-free. Also, Roths don't have RMDs, which helps with reducing taxes in retirement.
With the waiver of this year's required minimum distribution, it's an excellent time to convert a traditional IRA into a Roth. Be careful, though. You are taxed on the amount converted.
4. Adjust Your Paycheck Withholding
Many people don't think about adjusting their paycheck withholding, and changes in income occur over the year. Obtain a Form W-4 and ask your tax professional to help you modify your withholdings to better reflect your situation.
Besides, who wants Uncle Sam to have their money any sooner than required?
5. Defer Bonuses
Expecting a bonus at the end of the year? It might put you into another tax bracket and increase your taxes for 2020. However, if you can delay the bonus until after the first of the year, you can preserve your old tax bracket spot.
Also, you won't have to pay taxes on the bonus when you do your 2020 taxes.
6. Accelerate Deductions and Defer Income
Some deductions count the year you pay them. When you own a home and get a mortgage interest deduction, then make an extra mortgage payment on December 31. You might be able to claim additional interest paid as a tax deduction for 2020.
You can take the deduction immediately instead of waiting another year to get it. That's one example. Talk to your tax professional about others.
7. Donate to Charity
If you traditionally clear out your closets, attic, and basement at this time of year, enjoy the tax benefits of giving to charity while helping a worthwhile cause. Monetary donations count as well. If you tithe to your church or give to other charities throughout the year, keep track so you can deduct that amount as you itemize your tax deductions.
8. Maximize Retirement
Reduce taxable income and save for retirement at the same time. Make additional contributions to your 401(k) or traditional IRA. For the self-employed who put savings in a SEP IRA, you can contribute up to the lesser of 25% of your net self-employment income or $57,000 for 2020.
9. Spend Your FSA
Don't forget about your flexible spending account. If there is money left, get your doctor visits out of the way. The use it or lose it problem may not apply, but you can only carry over $500 of unused money in your 2020 FSA. You may also face a time limitation for using the leftover funds.
10. Make 401(k) and HSA Contributions
While you can continue to contribute to traditional IRAs and health savings accounts through April 15 of next year and have it count for this year, the same isn't true for your 401(k).
Make additional contributions to your 401(k) before December 31st, then add to your HSA and IRA accounts before Tax Day to reduce your taxable income.
11. Make Business Purchases
Did you start a business while in quarantine? Save money next year by purchasing your business supplied before December 31st. Small business owners can claim a home office deduction, too, if they have space in the house used exclusively for work.
Need a new computer or a comfy desk chair? Now is the time to buy, then take the purchase off your taxable income.
*Warning, you must be self-employed to use this tactic.
12. Gather Receipts for Property Taxes and Large Purchases
If you pay property taxes, state taxes, or make a large purchase with the attendant sales tax, keep those receipts handy. You can deduct state and local property tax and sales tax up to $10,000. These taxes are typically fully deductible.
13. Harvest Capital Losses
Do you have realized capital gains on your taxable accounts this year? Look into tax-loss harvesting. Harvesting is selling positions at a loss to offset the capital gains. Then reinvest the proceeds in a similar security to maintain your strategy. Compliance with IRS "wash sale" rules is crucial.
This year, the stock market took a dip but then recovered like crazy, so this step may not have the oomph it did in years past. Consider your options carefully before pulling the trigger.
14. Review All Tax Deductions and Credits for 2020
Go back before the end of the year and see if you took advantage of all the tax deductions and credits available to you for this tax year. There's nothing wrong with looking. Found money is the best kind. Taking advantage of all deductions and credits helps you find money you didn't know you had until now.
We know it's already a busy time of year, but taking care of your tax situation as soon as possible so you can relax after the holidays.