- Look at expenses to see if you can itemize.
- Analyze your income bracket to determine if you can defer or accelerate income or deductions.
- Take opportunities to bump up deductible expenses.
The last month of the year means a lot of things — holidays, parties, bowl games and more. It’s also an opportunity to do year-end tax planning.
By now, you have a good idea of where you will end 2021 in terms of income earned and deductions available.
One key late-year decision is to analyze your expenses to see if you might be able to itemize. Otherwise, you would take the standard deduction, which has become much more widespread since the tax law changes in 2017, with about 90% of taxpayers going in this direction. Common itemized deductions include real estate taxes, mortgage interest, state income taxes, charitable donations and medical expenses.
Here are some year-end tax tips as they apply on federal returns:
Figure your deduction situation
For 2021, the standard deduction is worth $12,550 for singles and $25,100 for married couples filing jointly. Those figures are up $150 and $300, respectively, from 2020. It’s $18,800 for heads of household, also up $150. If your qualifying expenses exceed those thresholds, you likely would want to itemize.
Determine your tax bracket
Another aspect that can help guide year-end planning is figuring out your income bracket. Think of brackets as buckets holding water. As your income rises, you fill up the first bucket, where the lowest tax rate applies, then move on to brackets with successively higher tax rates.
The lowest rate is 10% for singles earning $9,950 or less, or $19,900 or less for married couples. Rates top out at 37% for singles with income above $523,600 and married couples above $628,300. In between are rates of 12%, 22%, 24%, 32% and 35%.
Rate analysis can help determine whether you might want to defer or accelerate income or deductions. For example, if accepting a higher-paying job in December might bump you from the 12% bracket into the 22% bracket, it might be worth waiting until January.
However, “If your income is relatively low, you maybe can increase it to fill up the 10%, 12% or even 22% brackets,” said Kelli Peterson, a certified public accountant and certified financial planner at Savant Wealth Management. With tax rates possibly rising in future years, it could be smart to “max out lower brackets now,” she said.
Consider optional expenses
Many people don’t have much late-year wiggle room when it comes to income. Most likely, you aren’t taking a new job in December, for example, although you might have some opportunity to delay a bonus or other income into January.
There’s often more opportunity to bump up deductible expenses. You probably can’t do much to significantly alter your mortgage interest, for example, but there are other options such as charitable donations.
The basic rule is that you can deduct donations to qualified charities. The amounts you give, plus other deductible expenses, might be enough to push you into the itemizing range. If you give a lot of money or want to donate non-cash assets, the tax rules can get complicated. Publication 526 from the Internal Revenue Service provides details.
Special donation rules might apply
One special note for nearly all taxpayers is that a special deduction for cash donations of up to $300 per person is available ($600 for married couples), with no itemizing required. Cash donations include those made by checks, credit cards and so on.
For seniors who don’t need to live off all of their retirement money, making a qualified charitable distribution or QCD can come in handy. If you’re at least 70½, you may elect to take advantage of this provision, which enables you to directly transfer up to $100,000 from an Individual Retirement Account to one or more charities.
You wouldn’t get the deduction that would normally apply, but the money isn’t recognized as taxable income, which can help meet required minimum distributions and avoid taxes on some Social Security payments and possibly higher Medicare charges. Congress changed RMDs to start at age 72, but QCD eligibility still begins at 70½, Peterson noted. Seniors can use this provision to meet a portion or all of their RMD, she added.
You also might want to open a donor advised fund, especially if your income jumped and you need a late-year write-off. These vehicles allow you to donate cash or other assets like appreciated stock, claim the deduction now, then take some time in deciding which charities to recommend supporting. Meanwhile, account balances grow tax-free.
Many investment companies, brokerages and charitable foundations will open one on your behalf. Some, like Fidelity Investments, require no minimum contribution amount.
Medical deductions are a possibility
Medical deductions remain favorable. Tax reform was supposed to boost the medical-deduction floor to 10% from 7.5%, meaning people who itemized could write off only those health expenses that exceeded 10% of their income. But Congress lowered the threshold back to 7.5% on a temporary basis, then made it permanent at that level, making it easier to deduct medical and dental costs.
To get above that threshold, you might be able to time surgeries or other procedures, taking them this year or next. Many health expenses are deductible including unreimbursed doctor fees, hospital costs, prescription medications, some transportation costs, some insurance premiums and more. IRS Publication 502 goes into detail.
“Bunching” is the idea of skipping certain deductible expenses in one year (and taking the standard deduction), then doubling down the next to get into the itemizing range. It can be done easiest with flexible, optional expenses like charitable donations, but medical expenses also might get you over the hump.
Capital gains might be worth taking
Plenty of investors are sitting on paper profits in taxable accounts from the stock market or gains in other assets. Often it’s wise to delay selling to defer paying taxes on a gain. But if your taxable income is modest, it can pay to realize gains and pay them this year, especially if you qualify for the 15% long-term capital-gain rate or even the 0% rate.
Long-term rates apply to assets held more than one year; otherwise, gains are taxed as ordinary income at rates that typically are higher. That 0% rate could apply if your taxable income for the year is below $80,800 for married couples or $40,400 for singles.
Conversely, it could be smart to realize losses. As a general rule, if your losses exceed your gains for the year, you can deduct up to $3,000 of the excess against regular income, carrying unused amounts to future years. Such “loss harvesting” is best done late in the year, when you have a more complete picture of your tax situation.