You might not have to pay your taxes until April, but making some money moves before the end of 2021 could lower your final bill. And if you're really savvy about your finances, you'll make moves that take into account your future tax liabilities as well.
If you're looking to boost your refund from Uncle Sam next spring and for years to come, here are five things you should consider doing right now.
1. Capital loss harvesting
If you have some investments that have gone down in value since you bought them, you might consider selling them and taking a loss. You're allowed to offset any capital gains you've taken this year with the losses, as well as up to $3,000 in personal income. Any unused losses are carried forward to future years.
But what if you don't really want to sell? Unfortunately, you can't sell a stock, ETF, or mutual fund and buy back your shares the next day. This violates the wash-sale rule, which stipulates that if you buy back a substantially similar asset within 30 days of a loss-making sale, it's as if the sale never happened.
What you can do, however, is buy a slightly different but mostly similar asset, such as a stock in the same sector, or instead of an ETF tracking the S&P 500, one that tracks a total stock market index.
Interestingly, the wash-sale rule doesn't apply to cryptocurrency. So if you have a loss on a crypto investment, you may book the loss and buy back the currency in short order. Note that there's currently legislation in Congress that would apply the wash-sale rule to crypto.
2. Capital gain harvesting
Capital gain harvesting follows the same idea as capital loss harvesting, but you intentionally book a capital gain instead. Why would anyone purposefully take a capital gain today when they could defer it until later years? Because long-term capital gains have a preferred tax rate, including a 0% tax bracket.
If you expect your 2021 adjusted gross income to fall below $40,400 for a single filer or $80,800 for a couple filing jointly, you have an opportunity to lock in capital gains at a 0% tax rate. While that won't lower your tax bill for 2021, it will lower your taxes in the future when you go to liquidate the asset.
The wash-sale rule doesn't apply to sales for a gain. You can freely buy back shares immediately after selling, and you'll still record the gain on your taxes.
3. Retirement plan contributions
If you have extra savings you can live on right now, you may consider increasing your 401(k) salary deferral. The contribution limit for 2021 is $19,500 for those under age 50, or $26,000 for those 50 or older.
Contributing more to your 401(k) may be your only opportunity to lower your adjusted gross income before the end of the year. And getting your AGI below certain thresholds can help you qualify for tax credits like the Child Tax Credit or the 2021 stimulus. So not only would you get the tax deduction for your retirement plan contribution, you'd also save money by qualifying for more credits.
If you haven't contributed to an IRA this year, you have until April 15, 2022 to make that contribution. If you qualify for a deduction for a traditional IRA, that's another way to lower your AGI and possibly qualify for more tax credits, like the saver's credit or the ACA credit.
If you make over the income limit to contribute to a Roth IRA or think you might, you may want to do a backdoor Roth IRA before the end of the year. Current legislation in Congress would close the backdoor Roth loophole starting in 2022. So, even though you could make an IRA contribution for 2021 up until the tax deadline, you won't be able to do the backdoor Roth after Dec. 31 if the legislation doesn't change before it's passed.
4. Charitable donations
Even if you're not itemizing your deductions in 2021, you can still get a tax benefit for your charitable giving. For 2021, you're able to make a deduction up to $300 for single filers or $600 for a married couple filing jointly without itemizing. If you do itemize, you can deduct the full amount of charitable donations made in 2021.
The most tax-efficient way to give to charity is by donating appreciated assets like stocks. When you donate stock, you don't have to pay capital gains taxes, and you get to write off the full value of the stock at the time of donation. So you get extra tax savings on top of the tax deduction.
One strategy you might employ is loading your charitable donations up in 2021 and itemizing your deductions. In 2022, you might donate considerably less, but take the standard deduction. Or you might donate to a personal donor-advised fund this year and grant donations at a later date.
5. Prepay itemized deductions
If you have bills that could qualify as an itemized deduction, it may make sense to pay them a little early to ensure you can take the deduction in 2021. For example, you may be better off paying a big medical bill in December even if it isn't due until January. Likewise, you might pay your state estimated taxes or property taxes in December instead of waiting for the deadline in 2022.
That said, the limit on state and local tax deductions remains $10,000, and current legislation in Congress would raise that limit. So in fact, it may be worth delaying those payments if they're above that threshold and you expect to itemize in 2022.
It's important to note the standard deduction will go up in 2022 by $400 for single filers and $800 for joint filers, so it'll be harder to hit that standard deduction cutoff with itemized deductions. Therefore, paying those items in 2021 could save you more in taxes than paying them in 2022.
Pick the low-hanging fruit
Optimizing your taxes down to the last penny isn't a practical exercise. It's best to take these tips and apply the ones that you can easily achieve and provide the biggest tax benefits for you. But with a little bit of planning, you can save yourself thousands of dollars in taxes, both this year and for years to come.