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Seven Low-Key Year-End Tax Moves to Make in 2021

Dec. 16, 2021, 9:45 AM

At this time of year, there are tons of articles explaining how you can reduce your tax bill in 2021. I know: I’ve seen them, too. And after the year we’ve had, it all feels like so much work.

I get it: We’re all tired. But tax planning doesn’t have to be time-consuming or complicated. Sometimes, it can be a simple adjustment or a quick glance at your accounts to make sure you’re on track. That’s what you really want, right?

So here’s a look at seven low-key year-end tax moves to make in 2021—some that you can even accomplish from the comfort of your sofa.

Give to Charity

One of the easiest ways to reduce your taxable income is to make a charitable donation to a qualifying organization. While that might have required some strategic planning in prior years, in 2021, you don’t even have to itemize. A temporary change in the law means that all taxpayers can potentially claim a charitable deduction. Taxpayers who itemize can claim a deduction on Schedule A, just like always. But those taxpayers who claim the standard deduction can still benefit from cash donations made in 2021—up to $300 for single filers and married taxpayers filing separately and up to $600 for married taxpayers filing joint returns. You can find more on charitable giving in 2021 here.

Spend FSA Dollars

FSAs, or flexible spending arrangements, are tax-favored accounts set up by an employer. They can be funded by an employer, an employee, or both—subject to some restrictions. Employer contributions are excludible from gross income, while employee contributions taken out of your paycheck are not subject to employment taxes or federal income taxes. FSA dollars are intended to pay for qualified medical expenses—those withdrawals are income tax-free—while distributions from a health FSA that are not used for qualifying medical expenses will be subject to tax and a penalty.

So what’s the drawback? You must spend the money in the account each year, or you forfeit the remainder—this is sometimes called the “use it or lose it” rule. If you still have a balance in your account, consider scheduling last-minute medical procedures or picking up prescriptions, including contacts or glasses. If you don’t have time, don’t panic: While FSA funds typically have to be used by the end of the year, there’s pandemic-related flexibility which expands the deadline to December 31, 2022 to spend FSA money earmarked for 2021.

Top Up HSAs

Unlike FSAs, health savings accounts can be rolled over from year-to-year, making it a smart idea to top up accounts at the end of the year if you haven’t yet met your limits. Typically, to qualify, you must be covered under a high deductible health plan.

There are no income limits to contribute to an HSA, nor is there a requirement that the account owner have earned income. You and your employer can contribute to your HSA in the same year. If family members or other folks want to contribute on your behalf, that’s okay, too, subject to contribution limits. For 2021, those limits are $3,600 for self-only coverage or $7,200 for family coverage—plus $1,000 if you’re age 55 or older.

No matter who makes the contributions, funds in an HSA will grow federal income tax-free—so it can be treated like a retirement account. Plus, an HSA is portable, which means that you get to keep it even if you change employers, retire, or otherwise leave the workforce.

Take Your RMDs

You can’t hold on to money in your retirement accounts forever—even if you want to. By law, you must take required minimum distributions, or RMDs, from your traditional IRAs and certain employer-sponsored plans such as 401(k) plans each year once you reach age 72, or if you are a beneficiary of specific accounts. While there may be some wiggle in the first year, you must take your RMD by Dec. 31 each subsequent year. It might be tempting to skip your RMD in 2021 if you waived your RMD in 2020, but don’t. The temporary change in the law only applied to 2020, and there is no RMD waiver for 2021.

It’s important not to forget: If you fail to withdraw the full amount of your RMD by the deadline, you’ll be taxed on the balance at a whopping 50%.

If your only IRA is a Roth, you’re fine: Roth IRAs aren’t subject to RMDs until after the owner’s death.

Put Money Away for Retirement

A stress-free way to lower your taxable income—while still maintaining ownership of the funds—is to contribute to your 401(k), 403(b), or IRA plan. Contributions made with pre-tax dollars will lower your income, while after-tax contributions may be deductible. Either way, the money grows inside the plan, tax-deferred—or in the case of a Roth, tax-free.

While many taxpayers take advantage of employer matching plans or automatic withdrawals at work, you aren’t limited to those contributions. Most taxpayers can contribute up to a total of $6,000 to an IRA in 2021—$7,000 if you’re age 50 or older—but you don’t have to fund at the max amounts. The limit on employee elective deferrals for 401(k) and similar plans is $19,500 in 2021—plus $6,500 in catch-up contributions if you’re 50 or older. Check your plan to see how much you’ve socked away and whether there’s room for any more funds by year-end.

Dec. 31 is the deadline for contributions to a 401(k) and 403(b) plan, but you have until Tax Day—April 15, 2022, to contribute to an IRA and still benefit from the deduction for the 2021 tax year. Why wait? The sooner you get started, the better.

Harvest Your Losses

It sounds complicated, but the concept is really pretty simple: If you own stocks or other investments—including cryptocurrency—that lost value in 2020, consider selling them before year-end to offset any realized gains. But be careful: If you see an increase, make sure that it reflects a real gain from a taxable event—a sale, disposition, or other event—that triggered a tax consequence. If that’s the case, you may want to offset those gains with losses. Keep in mind that there may be other, non-tax reasons for selling winning or losing stocks or other assets, but if you’re doing it as a tax strategy, make sure that you’re buying or selling when it makes good tax sense.

Pay Attention to Mutual Funds

If you like to play the market—but don’t relish the stress of choosing your own stocks—you might be tempted to buy mutual funds. And at any other time of year, that could be a good investment since they’re operated by professional money managers who do the investing and allocations for you. So rather than buying a specific stock, you’re buying the equivalent of a piece of a managed portfolio.

But timing matters. Mutual funds pay out in two ways: dividends and capital gains. And, mutual funds are legally required to pay out accumulated dividends at least once a year, which means they may wait until year-end, while many mutual funds tend to pay out capital gains in the final week of December. Both are considered income and will be taxable in the year of the payout—even if you reinvest them.

If you’re not sure how mutual funds work, or if you’re not sure whether you’ll owe tax, you might want to postpone a purchase until after the new year, or after you’ve spoken with your tax or financial advisor.

One More Thing

If you’re a regular reader, you know that I often say not to let the tax tail wag the dog, meaning that you shouldn’t make a big decision based solely on the tax consequences. You should, however, consider how you can take advantage of available tax breaks and how the timing of related decisions might impact your tax bill.

This is a weekly column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl.

To contact the reporter on this story: Kelly Phillips Erb in Washington at kerb@bloombergindustry.com