8 Tips to Reduce Taxable Income at the End of the Year

Act before December 31 to increase your tax breaks.

Whether you are having a good year, rebounding from recent losses, or still struggling to get off the ground, you may be able to save a bundle on your taxes if you make the right moves before the end of the year. Below are the 8 year-end tax tips which can help you to save your taxes.

1. Defer your income

Income is taxed in the year it is received—but why pay tax today if you can pay it tomorrow instead?

It's tough for employees to postpone wage and salary income, but you may be able to defer a year-end bonus into next year—as long as it is standard practice in your company to pay year-end bonuses the following year.

If you are self-employed or do freelance or consulting work, you have more leeway. Delaying billings until late December, for example, can ensure that you won't receive payment until the next year.

Whether you are employed or self-employed, you can also defer income by taking?capital gains?in 2022 instead of in 2021.

Of course, it only makes sense to defer income if you think you will be in the same or a lower tax bracket next year. You don't want to be hit with a bigger tax bill next year if additional income could push you into a higher tax bracket. If that's likely, you may want to accelerate income into 2021 so you can pay tax on it in a lower bracket sooner, rather than in a higher bracket later.

2.?????Take some last-minute tax deductions

Just as you may want to defer income into next year, you may want to lower your tax bill by accelerating deductions this year.

For example, contributing to charity is a great way to get a deduction. And you control the timing.

Individuals, including married individuals filing separate returns, can claim a deduction of up to $300 for cash contributions made to qualifying charities during 2021. The maximum deduction is increased to $600 for married individuals filing joint returns.

• You can supercharge the tax benefits of your generosity by donating appreciated stock or property rather than cash.
• Better yet, as long as you've owned the asset for more than one year, you get a double tax benefit from the donation: You can deduct the property’s market value on the date of the gift and you avoid paying capital gains tax on the built-up appreciation.

You must have a receipt to back up any contribution, regardless of the amount. (The old rule that you only had to have a receipt to back up contributions of $250 or more is long gone.) Other expenses you can accelerate include:

• an estimated state income tax bill due January 15
• a property tax bill due early next year
• Or a doctor or hospital bill

But speeding up deductions could be a blunder if you're subject to the alternative minimum tax, as discussed below.

Don’t miss out on valuable tax deductions if you can?itemize rather than claiming the standard deduction. According to the IRS, about 75% of taxpayers take the standard deduction but could be missing out on valuable tax deductions if they can itemize.

• If your qualifying expenses exceed the standard deduction, which in 2021 is $12,550 if you are single, or $25,100 if you’re married filing jointly, and $18,000 for the head of household then you likely should maximize your deductions and itemize.
• Don’t worry about figuring out if you can itemize or should take the standard deduction. TurboTax will figure it out for you based on your answers to simple questions about your deductible expenses.

3.?????Beware of the Alternative Minimum Tax

Sometimes accelerating?tax deductions?can cost you money… if you're already in the?alternative minimum tax (AMT)?or if you inadvertently trigger it.

Originally designed to make sure wealthy people could not use legal deductions to drive down their tax bills, the AMT is now increasingly affecting the middle class.

The AMT is figured separately from your regular tax liability and with different rules. You have to pay whichever tax bill is higher.

This is a year-end issue because certain expenses that are deductible under the regular rules—and therefore candidates for accelerated payments—are not deductible under the AMT.

• State and local income taxes and property taxes, for example, are not deductible under the AMT. So, if you expect to be subject to the AMT in 2021, which is due in January 2022, don’t pay in December 2021.

4.?????Sell loser investments to offset gains

A key year-end strategy is called “loss harvesting”—selling investments such as stocks and mutual funds to realize losses. You can then use those losses to offset any taxable gains you have realized during the year. Losses offset gains dollar for dollar.

And if your losses are more than your gains, you can use up to $3,000 of excess loss to wipe out other income.

If you have more than $3,000 in excess loss, it can be carried over to the next year. You can use it then to offset any 2021 gains, plus up to $3,000 of other income. You can carry over losses year after year for as long as you live.

5.?????Contribute the maximum to retirement accounts

There may be no better investment than tax-deferred retirement accounts. They can grow to a substantial sum because they compound over time free of taxes.

Company-sponsored 401(k) plans may be the best deal because employers often match contributions.

Try to?increase your 401(k) contribution?so that you are putting in the maximum amount of money allowed ($19,500 for 2021, $26,000 if you are age 50 or over). If you can’t afford that much, try to contribute at least the amount that will be matched by employer contributions.

Also, consider contributing to an IRA.

• You usually have until the April 15, 2022 filing deadline to make IRA contributions, but the sooner you get your money into the account, the sooner it has the potential to start to grow tax-deferred.
• Making deductible contributions also reduces your taxable income for the year.
• You can contribute a maximum of $6,000 to an IRA for 2021 plus an extra $1,000 if you are 50 or older.

If you are self-employed,?a good retirement plan might be a Keogh plan. These plans must be established by December 31 but contributions may still be made until the tax filing deadline (including extensions) for your 2021 return. The amount you can contribute depends on the type of Keogh plan you choose.

6.?????Avoid the kiddie tax

Congress created the?"kiddie tax" rules?to prevent families from shifting the tax bill on investment income from Mom and Dad's high tax bracket to junior's low bracket.

• For 2021 the kiddie tax taxes a child's investment income above $2,200 and less than $11,000 at the same rates as the parents.
• If the child is a full-time student who provides less than half of his or her support, the tax usually applies until the year the child turns age 24.

So be careful if you plan to give a child stock to sell to pay college expenses. If the gain is too large and the child’s unearned income exceeds $2,200, you could end up paying taxes at the same as you do.

7.?????Check IRA distributions

You must start making regular minimum distributions from your traditional IRA by April 1 following the year in which you reach age 72 (prior to January 1, 2021, it was 70 years and 6 months). Failing to take out enough triggers one of the most draconian of all IRS penalties:

• A 50% excise tax on the amount you should have withdrawn based on your age, your life expectancy, and the amount in the account at the beginning of the year.
• After that, annual withdrawals must be made by December 31 to avoid the penalty.

When you make withdrawals, consider asking your IRA custodian to withhold tax from the payment. Withholding is voluntary, and you set the amount, but opting for withholding lets you avoid the hassle of making quarterly estimated tax payments.

Important note: One of the advantages of Roth IRAs is that the original owner is never required to withdraw money from the accounts. The required minimum distributions apply to traditional IRAs.

8.?????Watch your flexible spending accounts

Flexible spending accounts also called flex plans, are fringe benefits which many companies offer that let employees steer part of their pay into a special account which can then be tapped to pay child care or medical bills.

The advantage is that money that goes into the account avoids both income and Social Security taxes. The catch is the notorious "use it or lose it" rule. You have to decide at the beginning of the year how much to contribute to the plan and, if you don't use it all by the end of the year, you forfeit the excess.

Health and dependent care FSAs can choose to allow either an unlimited (in amount) carryover for unused amounts from 2021 to 2022, or may add or extend a grace period that relates to the 2021 plan years. The carryover or grace period may be for up to 12 months.

For example, if your FSA’s plan year runs from January 1, 2021, through December 31, 2021, then the maximum allowed grace period would let participants incur FSA eligible expenses through March 15, 2022, for their 2021 plan year.

The Consolidated Appropriations Act (CAA) was signed into law on December 27, 2020, as a stimulus measure to provide relief to those affected by the pandemic. The CAA allows employers to extend healthcare FSA and dependent care FSA grace periods for up to 12 months into the following plan year for plan years ending in 2020 and 2021.