Year-End Tax Planning Tips for Individuals and Small Businesses
With the holidays fast approaching, tax planning might not be high on your priority list. However, there are a few tax planning strategies that you can still execute before year-end to help you breathe easier when tax time rolls around in April.
Tax Planning Tips for Individuals
- Lower your taxable income by contributing to your retirement plan. One of the easiest ways to reduce your tax bill is to maximize your tax-advantaged retirement savings accounts. These accounts include: employer-sponsored 401(k), 403(b), SIMPLE IRA, and individual IRAs. Traditional 401(k)s or 403(b)s allow contributions of up to $19,500 in 2021, plus an additional $6,500 as a “catch-up” contribution if you are 50 or older. For IRAs, the contribution limit is $6,000, plus a $1,000 catch up for those 50 and older. These contributions are pre-tax – meaning they lower your taxable income for the year, and distributions are taxed at ordinary income rates in the future. By contrast, Roth 401(k)s and Roth IRAs provide no current tax benefit, but withdrawals are tax-free (with some caveats). Consult your financial advisor or retirement plan administrator for the specifics on which option is right for you.
- Contribute to your Healthcare Savings Account (HSA). If you participate in a high-deductible health insurance plan, you may also be able to contribute to a Healthcare Savings Account, or HSA. These accounts offer triple tax benefits while helping you save for current or future healthcare costs. Here’s how they work: In 2021, individuals with high-deductible health plans may contribute up to $3,600 (and married couples can contribute up to $7,200) in pre-tax dollars. Your investment grows tax-free, and you can spend the money tax-free on qualified healthcare costs. You can also invest HSA funds and use them to pay for qualified healthcare expenses in the future. Check with your plan administrator or financial advisor to learn which type of healthcare plan makes sense for you.
- Use a donor-advised fund (DAF) for charitable giving. DAFs are an effective tool to pursue tax breaks for charitable giving. Instead of giving smaller amounts annually, you can establish a DAF and fund it with a large, lump-sum contribution (increasing your chance to itemize and take advantage of other tax deductions). You may distribute funds from your DAF to your charities of choice in the future. We recommend speaking with your CPA or financial adviser to determine the optimal DAF contribution to maximize tax savings.
Tax Planning for Small Businesses
- Review your corporate set-up. How is your business structured? Are you a sole proprietor or a single-member LLC? Do you own a partnership? Would it make more sense to form an S-Corp? Although your business structure was appropriate when you first set it up, your business may have evolved and your needs may have changed. Consider sitting down with your CPA and your financial advisor to determine whether a different structure would work better for you now. This is worth reviewing periodically over the life of your business, particularly if you’re experiencing rapid growth or you’ve taken on a partner.
- Lower your taxable income by contributing to a retirement plan. Business owners have flexible retirement plan options with different contribution limits than individuals. If you are self-employed, you may set up a SEP-IRA, which, in 2021, enables you to make a maximum contribution of $58,000 (catch-up contributions are not possible with SEP-IRAs). You can set this up in 2022 and make contributions for the prior year. In addition to SEP-IRAs, Solo 401(k)s are another fantastic alternative. Solo 401(k)s enable business owners to contribute both as an employee and an employer. The “employee” may contribute up to $19,500 for 2021, plus a catch-up contribution of $6,500 (and if the plan allows, these contributions can go to a Roth account). Your business can also make a profit-sharing contribution of up to 25% of your wages (with an overall limit of $58,000. Defined contribution plans are complicated, so it’s best to consult your tax or financial advisor for assistance.
- Do you work out of your home full-time? If so, you can claim the home office deduction. Many business owners shut down their offices and worked from home as a result of COVID-19. If your home is now your principal place of business, you may qualify for a home-office deduction. The IRS has specific rules and requirements for this type of deduction, which you can find here.
- Accelerate planned asset purchases to 2021. The Trump administration’s Tax Cuts and Jobs Act (TCJA) continues to enable business owners to take 100% first-year bonus depreciation on qualified assets purchased and placed into service during the year. If your income is higher than usual, it may make sense to accelerate planned purchases to offset your income.
Laws and taxpayer circumstances are constantly changing, so tax planning often requires attention year-round. The tips listed above in this article just scrape the surface of all the ways an adviser and CPA can work together to seamlessly integrate tax saving strategies into your financial plan.
This is intended for informational purposes only and should not be construed as personalized tax or investment advice. Please consult your financial professional regarding your unique situation.