#taxes

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

Fourth quarter tax topics. If you hold any mutual funds in non-retirement accounts, now is the time to begin checking on “projected capital gain distributions.”

What are projected capital gains distributions?

When mutual funds sell securities for capital gains, they don’t pay taxes on them. Their shareholders do. The funds pass the gains through to shareholders each year through reporting them on Form 1099. For many shareholders, the 1099 gains come as a surprise tax bite. The value of the fund may not have increased at all in the past year, but yet, they still have to pay tax on capital gains.

Why are these important for 2020?

Because of 2020’s roller coaster market ride, many funds are going to show larger-than-normal capital gains, regardless of what happens to their value between October and December. For the funds’ shareholders, that could mean lots of extra taxes. Even if you bought the fund mid-year, you will still get a capital gain distribution.

What To Do About Large Distributions

You can look up your fund’s projected distributions at the fund’s website.

More helpful information is provided by these articles:

https://www.advisorperspectives.com/commentaries/2020/09/11/open-season-capital-gains

https://humbledollar.com/2019/11/the-unwanted-payday/

If you would like help in the fourth quarter – figuring out your 2020 taxable income while you still have time to make adjustments before year-end, schedule a tax planning appointment with your CPA (but after October 15, the final extension deadline for this year) or schedule a 30-minute call to talk with us here: https://go.oncehub.com/HollyPThomas.

Autumn is not the time we normally think about taxes. Taxes are generally considered an annual drudgery that begins around February 1 and ends on April 15 (or in 2020, July). Yet actually, there are tax-savings tasks to think about year round.

But I get it – no one wants to think about taxes year round. And why is that? Here are a few reasons, as stated by Roger Pine, Founder of Holistiplan, a tax analysis software for financial advisors:

1) It’s an invoice for the biggest expense all year.

2) You are responsible for preparing your own invoice, or hiring someone to do it for you.

3) The invoice forms are a design disaster with unintelligible instructions that take years of schooling beyond a college degree to completely understand.

4) Even when the invoice is done correctly, it’s difficult to see why you got charged what you did.

5) If you don’t do the invoice, or do it wrong, there are serious legal consequences.

6) If you want a smaller invoice next year, you have to know how to decipher the invoice forms for clues. (That must be why it’s called the tax “code.”)

7) It stinks to hear afterward, “If you had only done X, you would have saved Y,” if it’s too late to do X.

How do taxes make most of us feel? Helpless and uninformed. Not the most empowering feelings from a financial standpoint. Taxes are not helping us achieve a sense of financial wellness, or as they say in financial therapy circles, financial “self-efficacy.” 

What can you do this time of year? Autumn is a great time to consider a few year-end moves like: Roth conversions, taking capital losses or capital gains, doubling up on property taxes and charitable contributions, or making IRA and HSA contributions.

Sound like a lot? It could be, but it could save you hundreds or thousands in taxes. If you have a CPA and/or CFP®, all you have to do is gather a few documents and let them do the rest. Gather these:

1) Your September or October brokerage statements (the whole statement, not just screenshots);

2) Your latest paystubs, Social Security statements, or other items showing regular income; and

3) Any large one-time transactions that happened or will happen this year, like a real estate closing statement or estimate.

After reviewing these, you should receive several questions, such as any changes in your deductions. Don’t worry about exact figures – it’s ok to estimate right now. Based upon an autumn estimate of your 2020 income and deductions, your professional can begin to strategize. With an autumn check-in, it leaves you both plenty of time to nail down exact numbers and execute any recommendations before year-end.

Being proactive on taxes can be a vaccine against stress. It can reduce financial complexity in your life. Feelings of greater control can arise once you see how to make your bill much smaller. If you haven’t thought about taxes in autumn before, it might be worth your while to think again.