The end of the year means the onset of winter, holiday celebrations, and New Year’s Eve parties, but it also means the beginning of tax season. Investing a little time to evaluate your financial picture now will pay off with less stress later. Making a few financial moves now could also result in significant savings when it’s time to pay your taxes next year. The tax laws have changed dramatically over the past couple of years, so even seasoned filers and financial wizards may be confused. All hope is not lost, though. Reading up on the changes and laws in effect for the 2020 tax season is an excellent first step toward minimizing your tax bill.
Max Out Retirement Contributions
One of the first things you should do is maximize your tax-deductible retirement contributions. Contributions made to traditional IRAs, 401(k)s, 403(b)s, and the like are all tax-deductible. Remember, though, that contributions to your Roth IRA are not tax-deductible. How much is the maximum you can contribute? If you are under 50, you may add $19,000 to your employer-sponsored retirement plan and $6,000 to your IRA. Those over 50 can contribute $25,000 and $7,000 respectively. Even if you can’t max out your contributions, you should still put in as much as you possibly can. And while Roth IRA contributions aren’t tax-deductible, if you make less than $64,000 (for a couple filing jointly) or $32,000 (for a single filer), you could qualify for a tax credit designed to encourage retirement savings for those with low or moderate incomes. All retirement plan contributions count, even those to a Roth IRA.
Pay for Next Year’s College Classes Now
If no one in your family was in vocational school, college, or graduate school this year but someone will be next year, see if you can pay the tuition or fees that will be due at the beginning of next year now. Why? It will allow you to qualify for the Lifetime Learning Credit or American Opportunity Tax Credit. What’s the difference? The Lifetime Learning Credit can be claimed by graduate and vocational students and gives you up to a $2,000 credit, while the American Opportunity Tax Credit only applies to college students and awards up to a $2,500 credit. If you’re already finished with school but not finished paying for it, keep in mind that you can also deduct up to $2,500 in student loan interest payments.
Most of us want (and need!) our paychecks as quickly as possible. However, if you’re facing a large tax bill this year, deferring income until next year can lessen your tax blow. Employees typically have minimal leeway with scheduling their regular income, but it might be possible to postpone bonuses until the beginning of next year. Freelancers can delay income by delaying invoices until the very end of the year. And small-business owners can put off taking their pay. But remember only to do this if you expect your income to be the same or less next year, or else it will just come back to hurt you later.
Sell Bad Investments
Have you made some investments that haven’t turned out how you hoped? Now is the time to divest yourself of them. The money you lost on those investments can help offset the gains you made on your successful ventures this year. You can even use the losses to offset up to $3,000 of income if you claim a net capital loss for the year. Don’t sell the investment and repurchase it, though. Legally, if you claim the loss on your taxes, you must wait 30 days after the sale to repurchase the investment.
Evaluate Your Flexible Spending Accounts
Employers offer flexible spending accounts that allow employees to deposit pretax money into accounts for medical or dependent care expenses, but the catch is that they have a use-it-or-lose-it rule. Typically, employees must decide at the beginning of the year how much they will contribute, and all money contributed to the account must be spent by the end of the calendar year or else you’ll lose it. Some employers have worked a grace period into their plans that gives their employees until March 15 to spend their FSA funds. Check with your plan administrator, though, because this does not apply to all plans. Need to spend your FSA balance? Glasses, first aid kits, heating pads, and other health supplies are eligible expenses under most plans.
Gather Documentation for the Child and Dependent Care Credit
Childcare is one of the steepest expenses single-parent households and families with two working parents face. Seventy percent of working parents with young children report spending more than 10% of their income on childcare. The IRS offers the Child and Dependent Care Credit as a form of relief for these expenses. To be eligible, single-parent families or families with two working parents must have a child who is either younger than 13 or disabled. You can also claim adult daycare expenses for a dependent (including your spouse) if your dependent is physically or mentally unable to care for themselves. Up to $3,000 in costs can be claimed for each dependent. A percentage of this amount will then be calculated as you do your taxes because the credit is income-dependent. Gather all child and dependent care receipts so you can claim all relevant expenses.
Check Your Withholding Amounts
It’s OK to owe taxes when you file you tax return, as long as you pay them on time, but if you owe too much, you could also face an underpayment penalty. Freelancers and people who receive 1099 income as well as W2 income will want to be especially careful here. There are three tests you should apply to your financial situation to let you know if you are withholding enough for taxes:
- If you think you’ll owe less than $1,000 beyond your withholding, you’re fine.
- If you paid 100% of the amount you owed on last year’s taxes toward this year’s taxes through estimated quarterly tax payments, you’re fine. However, if your adjusted gross income will be more than $150,000 for the year, you’ll need to pay 110% of last year’s tax payments through quarterly tax payments.
- As long as you pay 90% of this year’s tax liability via withholdings or quarterly tax payments, you’re fine.
If none of these apply to you and you think you’ll owe more than $1,000 beyond your withholdings, add additional withholdings before the end of the year.
Do you itemize your deductions? If so, donating to your favorite nonprofit will help reduce the amount of taxes you owe. Up to 50% of your adjusted gross income can be deducted as charitable donations. Just make sure the IRS has granted the organization you’re donating to nonprofit status: Otherwise, your contributions won’t be tax-deductible. Can’t decide where to give? Check your inbox and you should find appeals from places you’ve volunteered or donated to in the past, or check a list of the best-rated charities for groups that will make great use of your money.
Take Any Required Minimum Distributions
People who have reached the age of 70 1/2 are required by the IRS to receive distributions from their traditional IRAs and almost all company-sponsored retirement plans. You must take the necessary minimum amount each year by Dec. 31. If you’re not sure how much you need to take out, use a calculator to figure out your estimated RMD. The IRS will charge a 50% penalty on the amount you should have withdrawn if you fail to take out your RMD before the year’s end.