IRS Tax Relief: Federal tax deadlines and payments have been extended to May 17, 2021. Residents and businesses affected by severe winter storms in Texas, Oklahoma, and Louisiana have until June 15, 2021 to file, make tax payments, and make 2020 IRA contributions.
When it comes to finances, taxes are often overlooked as a ripe area for savings. Setting aside money in tax-advantaged accounts, for example, can drop you into a lower tax bracket and help you keep more of what you’ve earned—even if you wait until tax time to do it.
“As an investor, it’s important to take advantage of every factor you can influence, and your tax situation certainly qualifies,” says Hayden Adams, CPA, CFP®, and director of tax and financial planning at the Schwab Center for Financial Research. “Taxes are one of those areas where even a little forethought can yield significant savings.”
We’ve already started the new year, but it’s not too late to impact your 2020 tax situation. Here are four tax-smart moves you can still make between now and April 15, the IRS filing deadline.
#1 – Consider Contributing to a traditional IRA
One way to potentially save on your 2020 taxes and put away money for later, is to contribute to a traditional individual retirement account (IRA).
If you qualify, these accounts can give you upfront tax deductibility on your contributions, plus tax-deferred growth of your earnings. For 2020, you can contribute up to $6,000 to a traditional IRA (plus a $1,000 catch-up if you’re age 50 and over), and you have until April 15 to do so.
Contributions to a traditional IRA reduce your taxable income dollar for dollar, and could be enough to drop you into a lower tax bracket. Given that some gaps between tax brackets are quite large—for instance, the drop from 22% to 12%—those savings can be significant.
Depending on your goals, a Roth IRA might also be an option (though it won’t lower your taxable income today). Says Hayden, “In some cases, a Roth may make more sense than a traditional IRA. For example, if you’re in a low tax bracket today but expect to be in a higher tax bracket when you withdraw the money.”
#2 – Consider a SEP IRA, if you’re self-employed
As a small business owner, you may be eligible for a traditional or Roth IRA. But you might be able to save even more by opening a Simplified Employee Pension (known as a SEP IRA), if you meet certain requirements.
Like a traditional IRA, contributions to SEP IRAs are made with pre-tax dollars. So they reduce your taxable income up front and you won’t pay taxes until you withdraw the money. For 2020, you can set aside up to 20% of your net income from self-employment or $57,000, whichever is less.
If you have employees, you can also use a SEP IRA to set aside retirement savings for them (up to 25% of their compensation or $57,000 in 2020).
You have until the due date of your return (including any extensions) to make contributions and get a tax deduction for 2020.
#3 – Max out your HSA
Health savings accounts have risen in popularity in recent years to help offset the costs of high-deductible health plans. These accounts offer a triple-tax advantage, in that contributions generally reduce your taxable income, any growth on money invested in the HSA is tax-free, and withdrawals are tax-free as long as they’re used for qualified medical expenses.
Some savers may not realize they have until April 15, 2021, to contribute to their HSA for the 2020 tax year. For 2020, individuals can sock away $3,550 in tax-free HSA contributions, and up to $7,100 for families. If you’re over age 55, you can set aside an additional $1,000.
If you haven’t maxed out your HSA for 2020, closing the gap before the filing deadline could result in a lower tax bill.
“Because HSAs let you roll over your savings from year to year, that money will be available to you if you need it for medical expenses,” Hayden says. “And if you don’t need the money right now, you can invest a portion of it and potentially enjoy tax-free growth.”
#4 Don’t rule out itemizing too quickly
Tax-code changes from the 2017 Tax Cuts and Jobs Act (TCJA) raised the standard deduction, while reducing expenses taxpayers can itemize. Despite these changes, itemizing your deductions could still make sense.
One of the biggest deductions, for mortgage interest, is still on the table. If you bought your home after December 15, 2017, you can deduct interest on up to $750,000 of indebtedness. And the limit for homes bought on or before that date is still $1 million. Medical expenses that exceed 7.5% of your adjusted gross income (AGI) can also be deducted.
You may also be able to deduct a combined total of $10,000 in property tax, state and local income tax, or sales tax paid in 2020. The sales tax deduction lets you deduct sales taxes you paid all year on things like food, clothing, home improvements, or a new car. If you live in a state with lower income tax, it might get you a bigger tax break than the state and local tax deduction.
If you’re a single filer and your deductions exceed $12,400 (or $24,800 for married couples filing jointly), then itemizing would save you more money than the standard deduction. Just be sure to keep receipts for each expense you’re itemizing, and check with an accountant if you’re not sure which costs are deductible.
With taxes, it’s always best to double-check your math and assumptions. If you have questions, talk to a tax professional. Mistakes can quickly erode the potential benefits of tax-saving moves, especially if you miss IRS deadlines. Well before April 15, be sure to:
- Determine if a traditional IRA, Roth IRA, or SEP IRA is right for you and how to get the most out of one.
- Check with your employer or qualified HSA provider to find out about opening an HSA account if you’re part of a high deductible health plan, or upping your contributions, if you haven’t hit the 2020 limit.
- Gather any documents, forms, or receipts you’ll need to help you decide if you should itemize your deductions.