- \ Gerard Gruber
- December 6, 2021
While “tax season” is typically the time many folks focus on their income taxes, the best way to minimize your annual taxes is to engage in a year-round tax-wise strategy. As another year comes to a close, there’s still time to make a few smart money moves in 2021 that can ...
While “tax season” is typically the time many folks focus on their income taxes, the best way to minimize your annual taxes is to engage in a year-round tax-wise strategy. As another year comes to a close, there’s still time to make a few smart money moves in 2021 that can also position you to save and build more wealth in the year ahead.
1. Think Long-Term
One huge mistake taxpayers tend to make is in viewing each tax season in isolation, only seeking to “fix” their tax bill once they realize how high it will actually be. But, the more prudent (and less stressful) approach views tax planning as a way to reduce your lifetime tax bill. That is, planning to spend less overall.
Planning Tip: Work with your advisor and tax planning professionals to identify if you have taxable gains or losses that make sense to exercise this year.
2. Utilize Tax Gain Harvesting
Although this year has posted relatively strong year-to-date market performance, and many Americans are also benefiting from historically lower capital gain and income tax rates, it is unclear whether these will last.
Of course, we can’t know what your future taxes will be. But it can sometimes make good, big-picture sense to intentionally generate taxable income with tax-gain harvesting in years when tax rates are more favorable—like now!
Tax-gain harvesting involves selling appreciated holdings to deliberately generate taxable income. Why? To reach the goal of minimizing your lifetime taxes paid, not just your 2021 taxes.
This is especially true once you’re tapping into your portfolio in retirement. Essentially, you “fork up” the taxes on gains in years with lower rates to avoid paying more on those gains when rates increase in the future.
3. Tax-Loss Harvesting
On the other hand, you may have some tax-loss opportunities you can take advantage of this year, as well.
Tax-loss harvesting typically involves (1) selling all or part of a position in your portfolio when it is worth less than you paid for it, (2) reinvesting the proceeds in a similar (not “substantially identical”) position, and (3) optionally returning the proceeds to the original position after at least 31 days have passed to avoid the IRS “wash-sale rule.”
Keep in mind, tax-loss harvesting typically lowers a harvested holding’s cost basis, so you’re actually postponing rather than eliminating taxable gains. There is a benefit, though. The more time you have, the more control you’ll have over when, how, or even if you’ll realize the gains. For example, you can reduce gains through charitable giving, estate planning, and even gifting to lower the burden.
4. Max Out Retirement Contributions
Contributing the maximum amount to your retirement plans not only helps to increase the amount of your retirement savings, but can potentially lower your taxable income. 401k plans with employer matches should be visited first in order to take advantage of the maximum employer contribution in the calendar year.
Unlike 401k contributions which must be made before the close of the year for pre-tax purposes, IRAs have an extended deadline. Individuals have until April 15, 2022 to make IRA contributions that are eligible to count for 2021.
5. Consider a Roth Conversion
A Roth conversion refers to the transfer of an Individual Retirement Account (IRA), either traditional, SIMPLE, or SEP-IRA, into a Roth IRA. Roth IRAs are attractive investment vehicles because they offer tax-free growth and withdrawals. Because taxes are paid on the money upon contribution, it is not taxed when taken out in retirement. This is especially beneficial for individuals who believe they will be in a higher income tax bracket in the future when they begin making withdrawals.
Unlike traditional IRA accounts, Roth IRAs do not require individuals to take Required Minimum Distributions (RMDs) during their lifetime. The account continues to enjoy tax-deferred growth and ultimately, tax-free distributions. This allows for strategic tax planning (and saving) in retirement, but can also be a wonderful legacy gift for heirs to receive if the funds aren’t used during the account owner’s lifetime.
6. Give Charitably
Gifts made to your favorite charity in the form of cash or appreciated stock are another great option, especially for individuals who itemize their deductions.
- Not sure who to donate to?
- Need to bunch deductions into a single year to accommodate your tax strategy?
A popular option in recent years has been to consider contributing multiple years’ worth of gifts into a Donor Advised Fund (DAF). Using a DAF allows investors to take advantage of a larger tax break in the current year while still spreading the gifting out over several. As mentioned above, it may be worthwhile to take advantage of a move like this one while tax rates are more favorable.
7. Make Tax-Free Gifts to Family
The IRS allows individuals to give as many family members as they like up to $15,000 a year tax-free. Not only will these gifts reduce your taxable income amount, but can reduce the overall size of your estate for estate planning purposes.
With the annual exclusion provision, you’re allowed to make multiple $15,000 gifts to as many different people as you want. For example, if you have five children and you want to max out your giving, then you could give a total of $75,000 without any gift tax consequences.
What if you go over $15,000?
If you give somebody more than the annual exclusion amount, you’ll end up having to file a gift tax return with the IRS. For example, if you gave someone $20,000, you’d report that amount, subtract out the $15,000 annual exclusion amount, and then have $5,000 left over.
But, that still doesn’t mean that you’ll actually have to pay any tax. The reason is that on top of the annual exclusion amount, there’s also a lifetime exemption from gift and estate tax that you’re allowed to use. In 2021, that amount is $11.7 million. Unlike the annual exclusion amount, the lifetime exemption applies to all the gifts you make, rather than on a per-person basis.
The only time you actually pay any gift tax out of pocket is if you use up your entire lifetime exemption. This is very rare and is a problem for very few Americans.
The financial professionals at Harbor West appreciate the value in calculated tax planning. We work to ensure our clients are taking advantage of the best strategies available to them and use state of the art tax analysis software for all our clients. If you are looking for ways to reduce your taxable income and keep more money in your pocket, we’d be happy to help you evaluate your options. Schedule a Complimentary Consultation with us today to learn how Harbor West can help you build wealth and secure financial peace for your future.
This information is for general purposes and is not intended to provide specific investment advice or recommendations. Opinions, estimates, forecasts, and statements of financial market trends are based on current market conditions and are subject to change without notice. Individuals should always consult their own financial or tax advisor regarding their specific situation before acting on any information provided. Harbor West and Geneos Wealth Management, Inc. do not provide tax or legal advice.
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