Take a Second Look at Your 2020 Return

Since your 2020 taxes are fresh on your mind, what could you be doing now to minimize 2021’s bill? May is a good time to check on 4 areas:

– whether you got proper credit for your IRA contributions;

– whether you can save money by looking closely at your Schedule B dividends;

– scrutinizing business expenses if you file Schedule E; and

– using your tax return to make a rough guesstimate of your total annual spending needs.

Are your IRAs correct at the IRS?

If you have an IRA or HSA (Health Savings Account), May is the month when you will likely receive a Form 5498. What’s a Form 5498? In short, a statement from your financial institution showing what they told the IRS about your contributions this year. (See last week’s blog post on Form 5498 for more information.) Make sure that what they told the IRS is correct, especially the contribution year. You might have made a contribution in March of 2021 intended to be a contribution for 2020. Make sure the 5498 got that right.

Are your dividends ordinary or qualified?

Take a look at your Schedule B. Dividends, whether from individual stocks, preferred stocks, or mutual funds, can be either “qualified” or “ordinary.” Qualified dividends qualify for generally lower tax rates – 0%, 15%, or 20%, depending upon how much other income you have. Ordinary dividends do not qualify for lower rates – they are taxed just like your earnings, which enters the 22% bracket at $40,525 in income for singles/$81,050 for married filing jointly.

If you find that a lot of your dividends are ordinary, it might be worthwhile to examine replacing the underlying investment(s) with a similar one that generates qualified dividends.

Have you taken all your business deductions?

One example of an expense that’s often missed is a consultation fee with a personal financial planner where your business is discussed. Talk to your accountant about the deductibility of a portion of that fee. Are there other expenses you incurred on a personal basis which also helped your business? Keep an eye out for those throughout 2021.

Take a shortcut to figuring spending

Many people do not like to track their spending – that’s not unusual. However, when it comes time to figure out how much you need to maintain your lifestyle in retirement, it’s helpful to have a spending figure in mind.

One shortcut is SI – Savings + Borrowing.

First, take your “Adjusted Gross Income” (AGI) from your tax return.

Then, subtract the amount you paid in tax. (Note – it’s not the amount you owed, but the “Total Tax” you paid for the whole year.)

This gives a rough amount of SI = Spendable Income.

Next, look at your non-retirement savings and investment balances for December 31 of each year and calculate the difference. (Your retirement account contributions are already accounted for in your AGI.) This is your Savings.

If your balances went up, subtract that from your spendable income (i.e., you did not need all your income for spending). If they went down, add to it.

Finally, look at your debt balances for December 31 of each year and calculate the difference. This difference is your Borrowing.

If the balances went up, add that to your SI (i.e., you needed more than you made for your spending). If they went down, then subtract.

We’re happy to help

Some people prefer to delegate tax planning to someone else. We are glad to help. Ask us for an encrypted link where your tax return can be sent as a password-protected PDF. The next time we get together, we will take a look at these and other ways to reduce your 2021 tax bill.

For a short online course teaching what’s necessary and what’s not for retirement readiness, see our Simple Finance Retirement Readiness Course page: https://bit.ly/3p3BkXE

Holly Donaldson

Holly Donaldson, CFP® runs an hourly and fee-for-service financial planning practice virtually from her Tampa Bay, Florida office. She also works with clients throughout the U.S. (except Texas) interested in retirement and tax planning advice without product sales or investment management. Holly is the author of The Mindful Money Mentality: How to Find Balance in Your Financial Future (Porchview Publishing, 2013) and publisher of the award-winning monthly e-letter, "The View From the Porch."

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