2020 can't end soon enough for me; maybe you're feeling the same way. But while we're counting down the socially distanced minutes to Jan. 1, let's use this time to do things now to lower our tax bill. Here are a few ideas that may be right for you.
1. Harvest your investment losses. If you have some stocks or funds in a taxable account with losses, consider selling. You can use an unlimited amount of losses to offset taxable gains. And you can generally deduct up to $3,000 in additional losses and carry forward additional amounts to future years. You'll have to wait at least 31 days to buy it back or the IRS will consider it a tax wash sale.
2. Harvest your investment gains. This is pretty much the opposite of the previous idea. If you've held that security for more than one year, the federal government taxes it as a long-term capital gain. That tax rate happens to be at zero percent for married couples filing jointly with up to $80,000 in taxable income, or a single taxpayer with up to $40,000 in taxable income.
Since the 2020 standard deduction is $24,800 for married filing jointly and half that for singles, this means a married couple filing jointly can earn at least $104,800 and not pay federal income taxes on these long-term capital gains — profits on stocks held more than a year. Those filing single returns can earn half of this amount and not pay federal taxes on long-term capital gains.
3. Donate to your favorite charity. Charitable contributions are normally itemized deductions and won't help you lower taxes unless you itemize. But the CARES Act allows up to $300 (married or single) this year in an above-the-line deduction, meaning that it helps you whether you itemize or not. Plus, you get to support your favorite charitable cause.
4. Contribute to your 401(k), 403(b) or IRA. If you have a little extra cash from that cancelled vacation, consider upping your contributions to your employer plans. You'll enjoy that vacation so much more when you are retired and COVID is just a bad memory. Though you have until Dec. 31 to contribute to a 401(k) or 403(b) and until April 15 to contribute to your IRA, why wait?
5. Consider a Roth conversion. This may increase your taxes this year, but will lower taxes years later. You would take some of your money in a tax-deferred vehicle like an IRA and convert it to a tax-free Roth IRA. The IRS will generally tax you on the amount you convert as ordinary income. This would be especially attractive if your income is lower this year and you have the money in your taxable account to pay the taxes. Here are seven factors to consider for a Roth conversion.
6. Make sure you won't be penalized by the IRS for not paying enough. If you don't pay the required minimum amount in withholding or tax estimate payments, the IRS can charge you both interest and a penalty. This IRS calculator can help you determine if you need to up your withholding amounts.
7. Consider a distribution from your IRA or 401K. Required minimum distributions (RMDs) have been waived this year but, if your marginal tax rate is low enough, you may want to take it anyway. This will lower your taxable RMDs in later years.
8. Check your flexible spending accounts (FSA). If you are contributing to your employer's FSA account, you may have until March 15, 2021, to use it or lose it. Check your balance and what expenses qualify.
9. Max out your Health Savings Account (HSA). If you have a high deductible health plan, you can lower your taxes up to $7,100 (half that amount if single) by contributing to your HSA account. Consider holding on to receipts for medical expenses and waiting to reimburse yourself years later. This gives you the benefit of both a traditional IRA with the tax deduction this year and a Roth with years of tax-free growth.
10. Lower income. If you are self-employed, consider ways to delay income, such as holding off on billing customers. You can also move expenses up, such as paying bills early or stocking up on necessary supplies.
One warning is that there is nothing simple about taxes and some of these moves can backfire. For example, the tax gain harvesting can result in higher Affordable Care Act health care premiums. So seek competent tax advice.
A second warning is that tax law is always subject to change, so pay attention to who wins the presidential election and what those proposed changes will be.