A Fool and His Money Are Soon Parted…

…the rest of us wait until income tax time. Ba dum chhh. Seriously though, the IRS says that the average taxpayer spends about 13 hours preparing their tax return each year. It’s also been estimated that Americans spend around $27.7 billion every year on tax preparation. No doubt, tax season is a big part of our financial lives. One that most of us would rather do without. That’s part of the reason why we, here at Beacon, work so hard to make your tax season as simple and easy on your wallet as possible. That means everything from having a tax smart investment philosophy, posting your tax documents to your portal, communicating well with you and/or your CPA and working to identify strategies that might improve your overall tax situation, now and in the future. With that in mind, here are a few potential ways you can still reduce your 2020 tax bill, proactively impact your 2021 bill, and hopefully be smart as you file on or before the tax filing deadline. In addition, I’ve included some important notes regarding the recently passed, American Rescue Plan Act of 2021.

The American Rescue Plan Act of 2021

On Thursday, President Biden signed a $1.9 trillion Covid relief bill. You can read about it here. There’s a lot to the bill but for the purposes of today’s Friday Brief there a few things of note. Pay close attention to your adjusted gross income if you file as an individual and your adjusted gross income (AGI) is close to $75,000 or if you file as a couple and your AGI is around $150,000. Many of the provisions in the bill have steep phase-out limitations that kick in around these income levels. Making smart decisions about your income in 2021 and implementing some of the ideas in this Brief for 2020 and 2021 could mean the difference between receiving a reasonable amount of cash and getting nothing.

Is there anything you can do to reduce your 2020 tax bill?

Many of the things you can do to reduce your tax bill needed to be done prior to the end of last year, however there are a few things you might consider that could improve your 2020 tax situation.

Make a contribution to a traditional, Roth or SEP IRA: This can be a great and easy way to save for the future and improve your tax situation. Knowing which one is best for you, how much to contribute, and how it might impact your tax bill is complex but definitely worth checking into if you or your spouse had earned income (W-2 or 1099) in 2020.  It sometimes makes sense to contribute to one even if you feel like you don’t have the cash flow.  How? By using money invested in a savings account or taxable brokerage account assuming, of course, that money is invested for the long haul.  A Roth IRA contribution won’t save you any money of your 2020 taxes but it still could be a good thing to do.  You have until April 15, 2021 to make an IRA contribution for the 2020 tax year.   SEP IRA contributions are allowed up until the end of your extension period if you file for one.

Contribute to your Health Savings Account (HSA): If you are enrolled in a high-deductible health insurance plan (HDHP), you may qualify for an HSA. HSA stands for Health Savings Account, and it’s a handy way to save for medical expenses and reduce your taxable income. That’s because the accounts get a triple tax benefit: The money you contribute reduces your taxable income, it grows tax-free, and withdrawals are tax-free, if used for qualified health expenses. Each year, you decide how much to contribute to your HSA account, though you cannot exceed government-mandated maximums. In 2020, these limits are $3,550 for an individual and $7,100 for a family; adults over 55 can add up to $1,000 more.  Because of their tax advantages and because any unused dollars roll over to the next year, HSA’s can also be a great place to save for medical expenses that might occur during your retirement.  Click here to read more about the many benefits HSAs offer.  You can make a 2020 contribution to an HSA up until April 15, 2021.

What can you do to proactively improve your 2021 tax return?

If you’re a regular reader you’ve seen some of these before, but the following strategies can have a big impact on your tax liability.

Increase your pretax 401(k) or 403(b) contributions:  Anyone with access to a 401(k) or 403(b) can contribute up to $19,500 in pretax dollars this year.   If you’re over age 50 and participate in one of the above retirement plans you can take advantage of the $6,500 catch-up provision that raises your annual contribution limit to $26,000.

Review your charitable giving strategy: It’s too late to do any giving that would impact your 2020 return but now is a good time to consider your giving plan for 2021.  Does your current giving strategy have a positive impact on your tax situation?  Should you donate shares of appreciated stock, use a “Lumping and Clumping” strategy or, if you’re taking Required Minimum Distributions (RMDs) from your retirement accounts, should you give via a Qualified Charitable Distribution (QCD)?

Review your 1099 tax forms: At Beacon, we believe that a good investment process should focus on the things you can control – like taxes.  That means that we do most of our portfolio rebalancing in qualified accounts, use tax efficient ETFs and place each of the investments we select for our clients in the most tax efficient type of account.  Ignore any of these important tactics and you could end up with a multi-page 1099 that causes you to pay more in taxes than necessary. If your 1099 from your brokerage account is more than a couple pages long or is having a negative impact on your tax bill it might be time to review your investment process.

Pay for childcare or healthcare expenses via a Flexible Spending Account (FSA): An FSA is a type of savings account offered through an employer that allows you to pay for qualified childcare and healthcare expenses with pretax dollars.  There are limits on how much you can contribute and any money in your FSA must be used prior to the end of the year but they can still be a good deal if you have predictable childcare or healthcare expenses.

Adjust your withholding: If you end up owing a chunk of change on your 2020 taxes it’s probably a good idea to consider adjusting your tax withholding from your paycheck or IRA distribution. Alternatively, you could consider making quarterly payments.

Is there anything else to think about as you file this year’s tax return?

File electronically: The IRS processes electronic returns faster than paper ones.  If you’re due a refund it could come 3 to 6 weeks earlier if you file electronically and the IRS checks electronic returns to make sure they are complete.  This may shock you, but less than 1% of electronic returns have an error compared with 20% of paper returns.  In addition, the IRS acknowledges the receipt of electronic returns which should give you peace of mind knowing your return has been received.  Owing taxes doesn’t get in the way of filing electronically, either.  Just send your payment in along with Form 1040-V or pay with direct debit.  You can pay with a credit card and get the points but expect to pay a 2.5% service charge to do so which wipes out any potential benefit.

At Beacon, we don’t prepare tax returns but we love to review them.  Doing so helps us identify ways to save you money, now and in the future. If you’re a client, we’ll reach out to you after tax season to see if you’d like us to review your return.  If you’re not a client and you’d like to hear more about our tax planning process click here. Please let us know if there’s anything we can do to improve your tax situation.

Geoff Hall, CFP®
[email protected]

My wife, Crystal, and I have been married for nine years and have two kids, Cooper (7) and Rhodes (5.) When I’m not spending time with them you might find me downtown serving at our church, pushing my limits during a mountain bike ride or having coffee with a friend in the Five Points area. I've been practicing wealth management for 25 years and I'm thankful for the privilege of shepherding my family of clients through the ups and down of the markets and of life for that matter.