When is the best time to plan for lowering your income tax bill? Everyday! As we rapidly approach Halloween, it triggers in my mind a few activities that should be addressed by individuals who desire to pay less in income taxes for 2021. Most Americans will not itemize deductions due to the higher standard deduction allowed in the CARES Act of 2020. There remains plenty of other options for lower your bill payable to Uncle Sam.
First, the easiest method of lowering your tax bill is to pay yourself first. Before you get confused from reading the previous sentence, think about areas of tax law that benefit you such as deferring income or contributing to qualified accounts. If you are working with an organization that provides a retirement plan, review the plan documentation and determine if you can make additional contributions to the plan or at least increase your deferral for 2022.
The maximum amount of deferrals you may direct to your employer’s plan depends on the type of plan offered. For example, if your employer offers a 401(k) plan, did you contribute the maximum for your age? If you are under the age of 50, the maximum you could contribute for 2021 is $19,500. You do not have to contribute this amount, but this is the maximum allowed. However, for those of us age 50 or older, an additional $6,500 catch-up provision is allowed in 2021. This is a total of $26,000 of income removed from your taxable income for 2021. This is a valuable reduction in tax burden…for now.
Should you work for any entity that does not provide a retirement plan, consider a contribution to a traditional IRA before April 15, 2022. You may contribute up to $6,000 in a traditional IRA on or before the deadline and escape taxation on this amount income for 2021. If you are 50 years of age or older, you may contribute another $1,000 of catch-up contributions.
If you are self-employed and desire to save taxes in 2021, you may wish to consider a SEP Plan, which is a retirement plan for self-employed individuals. This plan is especially helpful in contributing larger amounts of money to grow your retirement savings. The limit for contributions in this type of plan for 2021 is $58,000 or 25% of your self-employment compensation whichever is lower. If you wish to establish this type of plan, you must form and fund the plan prior to the filing of your 2021 income tax return including extensions of time to file.
Administratively, it is important to initiate the organization of your tax documents for the year. Don’t wait until April 15, 2022, to begin this process. Your taxes are becoming more complicated each year. I know it sounds good, but every time Congress passes a “tax simplification” bill, the Internal Revenue Code gets more confusing. Oh well. There are far worse ramifications that may occur in life.
At the time of writing this article, Congress was mired in conflict as to the amount of a funding bill for improvements to the infrastructure, which is very broadly defined in the bill. Is the amount $6 trillion, $3.5 trillion or $1.5 trillion? No matter how quickly you read the prior sentence, it is a lot of money. What makes it more difficult when planning your taxes for a certain year is that the law continues to change on a rather chaotic basis.
My approach would be for Congress to set a deadline such as October 31 of each year to pass any tax bills. This would allow for ample time to make changes to forms and IRS software to accurately process the upcoming tax returns for the year. In the past two years, primarily due to COVID-19 and the stimulation of the economy with three tax bills, the IRS has been overwhelmed with a task that is insurmountable. Hopefully, we will know the applicable tax laws for 2021 before yearend.
It is wise to visit with your CPA or CERTIFIED FINANCIAL PLANNER™ professional to help you get a handle on your tax burden before it becomes a real challenge. See you on the jogging trail!