Your Tax Strategy for 2021
Reading time: 4 minutes
Every new year is an opportunity for a new tax strategy. With most of us preparing to file our 2020 taxes, it’s a great time to strategize about your post-tax routine. Any good post-tax routine should include preparation for your 2021 taxes. Having a strategy in place will help you avoid missing opportunities and relieve tax prep stress later in the year.
Here are five things you can do before April 15, 2022 to simplify your tax filing preparations and maximize tax reduction opportunities.
1. Project your 2021 income.
Keeping tabs on your income will help you determine your tax liability and develop a strategy to reduce it before tax time comes. If you’re employed, your payroll stubs are a wealth of information regarding salary and deductions.
If you are self-employed, you can use your 2020 income to gauge 2021: do you expect any large orders or projects? Have you lost any clients? Do you have prospects that might bring in additional revenue?
2. Track your deductible expenses.
Start by taking a quick inventory of the expenses you used as tax deductions in 2020, then create a method for tracking and retaining your expense records throughout 2021. For example, you might sort receipts by the type of deductible expense: medical, property taxes, charitable contributions, car odometer readings for business travel, etc.
Other variables such as anticipated life changes (marriage, birth or adoption of a child), life enhancements (purchasing of an electric vehicle or home solar panels), and health insurance changes could have a dramatic effect on your tax strategy.
3. Set aside money for your 2021 tax liability.
Meet with your tax advisor to estimate your tax liability in 2021.
Be aware of the amounts being withheld from your paychecks. Self-employed individuals: determine how much you should set aside for taxes. With the changes in tax law and deductions, taxpayers need to evaluate whether the amounts being withheld from paychecks or amount being set aside are sufficient to meet their tax liability.
Read about tax law changes in IRS Publication 5307 and use the IRS withholding calculator to figure out your projected tax liability for the coming year.
The sooner you estimate your tax liability, the better chance you have of covering it through withholding or quarterly estimates. However, if you realize later in the year that you haven’t been withholding enough, you can send electronic payments directly to the IRS to help reduce or eliminate any interest or penalties you may owe.
4. Contribute to tax-advantaged retirement savings accounts.
Increase your contributions to employer retirement plans such as a 401(k), 403(b), or governmental 457(b) plan if you can. Making contributions to these plans will reduce your federal and state taxable income. They do not however, reduce your Social Security liability, FICA, and FUTA deductions.
As an individual, you can also contribute to a Traditional IRA, which could reduce your taxable income.
If you have a small business or are self-employed, consider establishing and contributing to an employer-sponsored plan such as a Simplified Employee Pension Plan (SEP), Savings Incentive Match Plan (SIMPLE) or an Individual 401(k) plan. Contributions to these plans are tax deductible.
The Department of Labor encourages small businesses to establish employer-sponsored plans. Read about the plans in IRS publication 560 or talk with your tax advisor about the best plan for your situation.
5. Optimize your finances by participating in these programs.
Many taxpayers overlook tax-advantaged programs that can make a huge difference in their finances.
For example, enrolling in a high deductible health plan (HDHP) qualifies you to make contributions to a Health Savings Account, or HSA. You may want to consider contributing to an HSA and using it to pay your medical expenses. Money put into an HSA is a straight-line deduction on your personal tax return. Some employers even match HSA contributions through their cafeteria plans.
If you’re helping pay for a child’s education you can take advantage of an Education Savings Account (ESA). An ESA, also known as a Coverdell ESA, is an account where the money set aside for a child’s education grows tax-deferred. Anyone can open an ESA on behalf of a minor--whether they’re a parent, grandparent, other relative, friend, or acquaintance. Contributions to an ESA are not tax deductible, but the tax-deferred investment earnings become tax-free when used for educational purposes.
Low-income individuals can take advantage of the Retirement Saver’s Tax Credit. It’s a non-refundable tax credit available to eligible taxpayers who make salary-deferral contributions to employer-sponsored SEP, SIMPLE, 401(k), 403(b), or governmental 457 plans. The credit is also available to those who contribute to Traditional and/or Roth IRAs.
Avoid tax season stress by getting an early start on planning this year. Open an Entrust Self-Directed IRA and start taking advantage of the tax benefits now.