Last-Minute Tax Reduction Strategies
The calendar has rolled over to a new year, which means that tax season has officially started. Most ways for reducing your tax liability for the year that just ended have passed, but there are still a few strategies available to you that don’t expire until the tax filing deadline in April.
Contribute to a Health Savings Account
Health Savings Accounts are pre-tax accounts that provide an income tax deduction for contributions made. In 2020, the annual contribution limit is $3,550 per individual ($3,600 for 2021) and $7,100 for a couple ($7,200 for 2021). A $1,000 catch-up contribution applies if you are above age 55. You can make a contribution regardless of your income; however, you must be enrolled in a qualifying high-deductible health insurance plan.
If you have the ability to contribute to an HSA through your employer, you’ll need to designate the contribution amount from payroll deductions and have it marked for the tax year that just ended. This will require the assistance of your employer’s benefits coordinator, who may or may not allow such flexibility. However, if you have a private HSA, you can make the contribution yourself with much less effort. Note that if you were not enrolled in a qualifying high-deductible health insurance plan for the entire year, the “last-month” rule may allow you to make a full-year contribution so long as you meet the restrictions set by the IRS.
Contribute to a Traditional IRA
Traditional IRAs are pre-tax accounts, and under most circumstances, contributions are eligible for a tax deduction. In 2020 and 2021, the annual contribution limits are $6,000 per individual or $7,000 if you are age 50 or older. This limit applies to all Traditional and Roth IRA accounts combined.
You can make a contribution to an IRA so long as you have earned income, but whether the contribution is deductible depends on whether you (or your spouse) have access to a retirement plan through your (or your spouse’s) employer and the amount of income you (and your spouse) earned for the year.
In 2020, if you have access to an employer plan, the deduction is phased out once your AGI reaches $65,000 for a single person and $104,000 for a couple. If you do not have access to an employer plan, the phase out only applies to couples who file jointly and begins when AGI exceeds $196,000.
Contribute to a SEP-IRA Account
A SEP-IRA is a pre-tax retirement account available to the self-employed. Contributions are made by the business on behalf of the business owner and no employee contributions are permitted. Contribution limits to a SEP-IRA are much higher than those offered by Traditional IRAs. In 2020, the maximum amount that can be contributed annually is $57,000 ($58,000 in 2021) but the contribution amount cannot exceed 25% of compensation. For self-employed business owners, this limit is generally based on net earnings. Unlike other self-employed retirement accounts that have to be established and contributed to before the December 31 deadline, SEP-IRAs need only be established and contributed to by the tax filing deadline. If the business files an extension, then the deadline for establishing and contributing to the account is also extended.
One thing to keep in mind with SEP-IRAs is that the contribution rules require that all employees of a business receive a contribution that is an equal percentage of their salaries. That is to say, if you contribute 10% of your net earnings to your own SEP-IRA, you’ll be required to contribute 10% of your employees’ salaries to their accounts as well.
Strategies like those outlined are excellent ways to reduce tax liability and increase the amount of saving you do for the future. A comprehensive review of your financial situation might reveal additional opportunities that could help you minimize taxes and increase your contributions to tax-advantaged accounts. If you are interested in learning more about how a financial plan can benefit you, please contact us today.