In the past, we have occasionally interrupted our regularly scheduled programming (read: market commentary) with financial planning thoughts. This year, we’re going to make that a more regular occurrence, committing to using at least one week each month to look at topics we believe are relevant and important for many, if not all, of you to consider. We have built this firm around financial planning, believing that a holistic look at your financial picture empowers more confidence, better decision making, and ultimately stronger growth of your hard-earned capital. It enables you to take better control – to let your money reflect and work towards your goals and values. While we have a plan for what we’ll look at each month, we do welcome your topic ideas. This is going to be a dynamic year. The rules are likely to change. We’ll be working diligently to stay atop these changes and communicate them in ways that are digestible and actionable. Lastly, always remember that your financial picture is unique. What you see and read here will have differing value to each of you – and we encourage you to engage with us to take a deeper dive to evaluate what is best for you!
Hallelujah! A New Year is upon us…though we hesitate to get overly excited (we’ve learned this lesson as Mariners fans). The turning of the calendar didn’t seem to erase all of the issues facing us, but there are green shoots of hope out there – and we hope you are seeing some for yourself. The word that keeps coming back to me as a theme for this year is “delight.” I think that if we can strive to be a delight and to find delight in others and our circumstances, 2021 may prove to be a good trip around the sun.
With that in mind, it’s not lost on me that I am starting this year’s series of financial planning briefings on the topic of taxes. Certainly, we don’t often put “delight” and “taxes” in the same sentence, or even the same paragraph. That said, a big part of effective financial planning involves good timing…and we’re not going to miss our opportunity here to give timely advice on tax planning.
Contrary to much belief, your tax picture for 2020 was not finalized on December 31, 2020. Yes, there were certain things that had to be done by that date to prove worthwhile for 2020 (e.g., charitable giving, 401(k) contributions), but there is still a myriad of things you can do to help:
- Reduce your upcoming tax bill for 2020
- Improve your tax situation throughout 2021
In doing so, you not only keep more dollars in your pocket, but also improve your overall financial picture for the long-term. So enough for the intro, let’s get to the details. We’re going to focus today primarily on what you as an individual can do, while touching just briefly on some ideas for small business owners. As always, we remind you that you should consult with your tax professional before heeding any of this advice.
Health Savings Accounts: Long-time readers may recall we did a deep dive on the ins-and-outs of HSAs back in November 2019 (click here to access). What we want to highlight here is that you can still make 2020 tax-deductible contributions to your HSA up until April 15, 2021, assuming you remain eligible for making such contributions. If you don’t have an HSA opened yet but are eligible, that is fine. You can open it in 2021 to receive the 2020 contributions. Unlike deductions for medical expenses, which require you to exceed certain spending thresholds (7.5% of AGI) and to itemize your deductions, contributions to an HSA are 100% deductible “above-the-line” – meaning you get the deduction regardless of whether you itemize. In addition, above-the-line deductions lower your AGI, which can be beneficial in numerous ways (including helping you qualify for this seemingly unending stream of gov’t stimulus checks).
IRA contributions: IRA contributions, whether Traditional or Roth, can be made through April 15, 2021 for tax year 2020. Traditional contributions are tax-deductible and receive that same “above-the-line” treatment that we looked at above with HSA contributions. Roth contributions are not deductible, but assets in that account will be tax-free forever, making this a very attractive option for many (especially if your income, and thus possibly your tax bracket, was down during this difficult year). The aggregate limit for Traditional and Roth contributions is $6,000 (+$1,000 if 50+). The caveat here is that both Traditional and Roth IRAs contributions are subject to various income and eligibility thresholds, so reach out to us for help determining whether you can make this contribution before you start plowing money into your account only to find you have to later undo it. View the 2020 tax tables to get an idea of what I mean here!
SEP-IRA contributions: For independent contractors and small business owners, the SEP-IRA can be an enhanced means of getting money into a retirement account on a pre-tax basis, as your contribution limit will often be significantly higher than it would be with a Traditional IRA. In addition, you have much longer to get this number sorted out, as the SEP plan can be opened and contributions made until the employer’s actual tax-filing deadline, including any extensions (this often translates to Oct 15th). Generally, you may contribute up to 25% of compensation (~20% if you're self-employed) or $57,000 for tax year 2020 or $58,000 for tax year 2021, whichever is less.
Get organized: I would venture to guess that hundreds of millions of dollars of tax savings are left on the table each year because of:
- Lost records
- Just not knowing the rules
If you can’t prove it, you can’t claim it. If you didn’t even know it was available in the first place, you won’t claim it. Take the next few weeks to get organized. Find records of important expenses that you incurred. Ask questions of us and/or your CPA to learn what’s possible. With this, you’ll be ready come tax time to take advantage of every opportunity to lower your tax bill (legally, of course!). Some things you might want to start searching for that often get overlooked (this is not an exhaustive list):
- Charitable giving history: The CARES Act made it such that charitable giving has enhanced tax perks for 2020, so you can get some benefit even if you don’t itemize!
- College expenses: Even with your favorite student learning from the confines of your basement, you still incurred tuition and other costs, and those may add up to a valuable tax credit, depending on your income.
- Continuing education expenses: Maybe you don’t have a college student, but that doesn’t mean you didn’t have education expenses. With an economy in turmoil, you may have engaged in continuing education opportunities for yourself, and those expenses may get you a valuable tax credit (the Lifetime Learning Credit).
- Private mortgage insurance expenses: With it getting harder and harder to put down 20%, PMI is a more common expense for younger homeowners, and these expenses can be deductible if you itemize.
- Medical expenses: As mentioned earlier, you can claim a deduction here if you itemize and your out-of-pocket medical expenses exceed 7.5% of AGI. We see this come into play most often for retirees, but it can be used by anyone.
- Major expense receipts: If you live in Washington (or any other state with no state income tax), you can instead take a deduction for sales taxes paid if you itemize. While it’s generally advisable to take the suggested number based on your income (the IRS has a handy calculator for this), you can add to this if you had major expenses during the year. Before you start adding things up, be sure to check out the rather short list of qualifying “major” items, as provided by the IRS.
Lastly, if you’re wondering whether all that working from home is going to help you come tax time, the unfortunate answer is “probably not.” If you are a W2 employee, the answer is “definitely not” – whereas if you have self-employment income, you might just qualify, but the rules are strict. Here’s a link to learn more from the IRS, and we invite you to contact us or your CPA to learn more.
That should do it for now. With a tax code that is thousands of pages long, we could probably go on much longer, but we want you to still like us! Please do reach out with questions and/or ideas for future financial planning briefings. Lastly, here’s to a delightful 2021!