End of Year Tax Planning: How to Strategize and Save

You have less than a quarter of the year left to strategize and save on your income taxes. Around all the upcoming holiday buzz, what can you do to trim your taxes for 2021?

Itemize or Take the Standard Deduction?

Which will lower your taxes the most — itemizing or taking the standard deduction? The difference could mean significant dollars in savings. 

Would itemizing help you? Let's take a look:

The Difference Between Itemizing and Standard Deduction

As a taxpayer, you have a choice between itemizing and taking the standard deduction. You get to select the option that saves you the most money. 

Be aware that each year the standard deduction fluctuates and can vary by filing status. For example, taxpayers who are older than 65 or blind, can receive a higher standard deduction. People who can be claimed as a dependent by another taxpayer receive a lower standard deduction. 

What is the Standard Deduction?

If you have no other qualifying deductions, you can take the standard deduction.

The standard deduction is the dollar amount set by the U.S. government that reduces your taxable income. In 2021, the standard deduction stands at $12,550 for single taxpayers and those married filing separately. For taxpayers married filing jointly, it is $25,100, and for those who file as heads of household, the standard deduction is $18,800.

Choosing the standard deduction means you cannot claim home mortgage interest, charitable contributions, or other income tax deductions. To enjoy the benefits of these, you have to itemize.  

When Should you Itemize your Income Taxes?

You should itemize your income taxes when the sum total of all your deductions is greater than the standard deduction. 

Itemizable deductions include state and local income taxes (limited to a maximum of $10,000), mortgage interest, mortgage insurance premiums, losses from a federally declared disaster, donations to a qualifying charity, and unreimbursed dental and medical expenses if they exceed 7.5% of your adjusted gross income. 

Often the best approach to deciding between the standard deduction and itemizing is simply doing the math. Ask your tax professional to run the numbers both ways, and file the one that saves you the most money.

Consider Bundling

One often overlooked strategy is called bundling. In this approach, you use a donor advised fund to make charitable contributions over more than a single year. Then, you bundle the total contributions for the current and future years together into one year, combine that deduction with others, and file your taxes. In this way you often will be able to exceed the standard deduction and get a bigger tax break.

The next year, you make charitable donations from you donor advised fund but forego itemizing your deductions. In the third year, you bundle your tax-deductible charitable gifts together and start the process over again. 

Is bundling right for you? Consult with a wealth management professional or tax preparer to find out.

Income Deferral: What Is It? Can It Work for You?

Income deferral is another cost-saving strategy that's new to many taxpayers.

What is Income Deferral?

What is income deferral? You defer a part of your current income for a number of years to be received in future years. You don't pay taxes on that income until you receive it in the future, hopefully at a lower tax bracket. Income deferral can either be qualified or non-qualified. An example of qualified deferred compensation is a 401(k) plan.

Nonqualified deferred compensation is an arrangement you make with your employer. Imagine you are 60 years old and plan to retire in five years. You earn $500,000 a year. Your company lets you defer 20% of your compensation over 10 years. If you take the income now, you pay a 37% tax rate on $100,000 of your income, putting your total tax payment at $185,000. If you defer that $100,000 of income until you retire, your tax rate could plunge to 24%, saving you about $65,000.

Is it a Good Idea to Defer Income?

Conventional wisdom says it's almost always a good idea to defer income. But conventional wisdom failed to reckon with the Tax Cuts and Jobs Act (TCJA). This legislation dramatically cut income tax rates for most taxpayers. 

When it was passed, the TCJA's low rates were set to expire in 2025. They could disappear sooner than that, however, if President Biden's proposed tax policies pass congress. It's not clear if deferred compensation is as beneficial as it once was. Check with your wealth manager or tax preparer to see if some form of deferred comp is right for you. 

How Much of My Income Can I Defer?

Before the age of 50, you can defer $19,500 per year into your 401(k). After age 50, you can defer $26,000 a year. If you defer more than the allowable amount, you could get double taxed. 

All About Charitable Donations and Deductions

The Christian principles of financial planning always include giving generously. Under current tax law, the U.S. government also rewards generosity. Taxpayers can deduct contributions to qualifying charities from their taxable income.

What Are the Rules of Charitable Deductions?

As with everything else involving the IRS, the rules around charitable deductions can get complicated. In general, however, cash gifts to qualifying charities that equal 60% of your income or less can be deducted from your taxable income. 

In 2020, the federal government temporarily increased that amount to 100% of your adjusted gross income for cash gifts. This increase remains for 2021 as well.

To qualify for the deduction, you must make the gift to a tax-exempt organization approved by the IRS, and you must do so within the calendar year.

Can you Take Charitable Deductions Without Itemizing?

No, you can only deduct charitable contributions if you itemize. Taxpayers using the standard deduction will not receive a tax benefit from making gifts to charities. But don’t forget, there are more than just tax reasons to give to charities.

How Can Charitable Deductions Fit Into your End-of-year Tax Planning?

In addition to cash contributions, you can donate stocks, mutual funds, a car, or other non-cash assets to your charity of choice. You may claim the full market value of asset you've owned for more than one year before you gifted it. The best part about this is that any long-term capital gain is not taxed. So while you may have only paid a portion of the current value, you pay no tax on the gain and you get to deduct the full current value.

You may also want to consider setting up a donor advised fund, which offers several benefits for charitable donors. Let us know if you would like help determining if a donor advised fund is right for you.

Most importantly, make a contribution to your favorite 501(c)3 organization before December 31 to receive tax benefits this year. 

The fourth quarter of the year is the time to get your tax strategy in order and execute it. Contact Cooke Wealth Management for assistance determining how to save the most on your income taxes.