FinEdFriday: Is There Anything I Can Do to Lessen My 2020 Tax Liability? Yes.
You are running the numbers, or reading the email from your CPA, and the words explode out of your mouth: “I owe how much!?”
Don’t crumble yet. Many of us have been there.
Especially when personal, national, or even global events happen in a given calendar year, there are sure to be some differences in how your tax situation unfolds. Maybe you sold taxable investments after you lost your job or after the stock market appeared scarier than it ever had before. Or maybe your business boomed because of the pandemic, and you took home more income than you would normally. Whatever happened, there are several ways you can lessen the tax liability you racked up in 2020.
Note: the following assumes you did not already use any of these strategies in 2020...No double dipping.
Open and Contribute to a Traditional IRA
IRA stands for Individual Retirement Account. It is an account that you contribute to pre-tax for the long term, can hold many different types of investments, but can only be used after certain time frames or for certain purposes. If, before April 15th, 2021, you open and contribute to an IRA as a “2020 contribution,” you can deduct your contribution from last years tax calculation. This is per person, so if you are filing your taxes jointly with someone else, they can open and contribute to their own as well.
4 things you should know when opening and contributing towards an IRA:
1. There are limits on how much you can contribute. For 2020 and 2021, the annual contribution limit is $6,000 per person If you are over the age of 50, you can add an extra $1,000 to that as a “catch-up contribution,” bringing your total to $7,000.
2. You must have earned income from 2020 in order to contribute to an IRA. If your income is lower than the contribution limit above, then that income level becomes your contribution level. In other words, you cannot contribute what you don’t make.
3. There are AGI (adjusted gross income) limits if you are covered by an employer’s retirement plan. In 2020, If you filed individually, your compensation limit “phase-out” begins at $65,001 up to $75,000, when you are then fully phased out If you filed jointly, your compensation limit phase-out begins at $104,001 up to $124,000, when you are then fully phased out. If you are in between amounts, your contribution to an IRA is only partially deductible. If you make more than the limit, your contribution is not deductible, and this would not help your 2020 tax bill. Also, if you are not covered by an employer, but your spouse is, the deductibility limits change.
4. If you had earned income from 2020, but your spouse did not, you can open a “Spousal IRA” for them and contribute up to the annual contribution limit. If neither of you are covered by an employer’s plan, you can deduct this contribution.
Open and contribute to an HSA
HSA stands for Health Savings Account. When, and only when, you are covered by a High Deductible Health Plan (HDHP) that allows HSA contributions, you can contribute into the account before April 15th, 2021 and deduct the contributions from your 2020 taxes.
Again, there are limits on contributions. If you are on an individual health insurance plan, you can contribute up to $3,550. If you are on family coverage, you can contribute up to $7,100.
HSA’s grow tax-free using certain investments in the account, and if you use their funds for qualified medical expenses, you do not have to pay taxes on that profit. That’s right, you can contribute money into them, deduct the amount from your taxes, let them grow tax-free, and then use the funds for qualified medical expenses tax-free.
Contribute to an already opened Solo 401k
If you own a business, have no employees (a spouse is ok), and opened a Solo 401(k) plan before December 31, 2020, you might be able to make deductible contributions. The rules here can get complicated when it comes to the type of business you are operating and how much you contributed last year. If you would like to know more about this strategy you can contact us or your tax professional.
In conclusion, these are just a few ways to possibly keep more of your hard-earned money in your pocket. Remember, a tax professional can help keep track of all deductions, exclusions, credits, and write-offs that your unique tax situation may come across. These professionals, especially Certified Public Accountants, are the wizards of the modern financial world. Having one of these tax professionals and a financial advisor who communicate with one another on your behalf is a superpower. We’ll leave you with this:
You’ve heard it before...
“It’s not what you make, it’s what you keep.”
We like to add: “It is also what you do with what you keep."
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor. Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.