With less than 20 days until the new year, there’s not much time to make changes to your tax situation. But if you are expecting this year to be an unusually high- or low-income year, there may be a few adjustments you’ll want to make before December 31st.
For some taxpayers, this year and next year will be about the same. Their income will be about the same and, their deductions and tax filing will look a lot alike from year to year.
However, if your income and tax returns are often significantly different each year, you will want to do a little estimating this time of year. If you are working, log in to your payroll system (or, look up your year-to-date earnings) to determine approximately how much money you have earned so far this year. Add in your last paychecks and bonuses to come up with an estimate of your total income for the year. Then, review dividends, interest and other income items from last years’ tax return. What went up? What went down? Then, compare these amounts to prior years.
You’ll need to go through a similar exercise with tax deductions you have taken. If you had solar panels installed or bought an electric vehicle in 2019, you likely won’t have that same deduction for your 2020 tax return. Did one of your children graduate from college in May 2019? Unless you’re still providing more than 50% of their financial support, you’ll likely be unable to claim them as a dependent on your return for 2020.
Here are some things to consider before the end of the year once you’ve determined if this is a high or low tax year:
Higher tax year
- Increase retirement plan contributions - 401(k), 403(b), SEP-IRA* or IRA*
- Make more charitable contributions
- Sell securities with losses
- Avoid selling securities with gains
- Defer distributions from retirement plans, e.g., RMDs were suspended for 2020
- Defer income into next year
* Contributions for this tax year can be made after December 31st.
Lower tax years
- Instead of waiting, realize income this year, e.g., stock options
- Defer charitable gifts until a high tax year
- Delay pass-through business expenses
- Sell securities to realize capital gains
- Consider converting an IRA/401(k) to a Roth
Don’t forget that your tax situation can change when you have a major life or career event such as job change, marriage, divorce, birth of a child, death or becoming self-employed.
Getting your payroll tax withholdings right
This is also a great time of year to review your tax withholdings. If your income and deductions are similar from year to year but you always have to pay extra to the IRS or state at tax time, consider increasing your paycheck tax withholding. This is easy to do. Obtain IRS Form W-4 and follow the instructions. It will help you to determine how many exemptions to claim to make sure enough is withheld throughout the year to avoid a surprise tax bill.
Each of these strategies has rules in order to realize the full benefit of tax reduction. Be sure to consult a tax professional to make sure you do it right.
Have more questions about year-end planning? Give your tax advisor or us a call. We’re here to help.
Lyman H. Jackson
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.