Understanding Tax Terminology

By: Kate Welker, CFP®

Tax Time in America - Getting Organized

Tax Time in America - Getting Organized

By: Kate Welker, CFP®

It’s that wonderful time of year again - tax filing season! I tried to make that sound exciting, but it is generally a stressful time for people. Trying to see if you have everything you need, digging around for documents, and the threat of owing the IRS are common worries. This month we will be sharing information to help educate you around taxes and tips to make this time of year a little bit less stressful.

Let’s talk about getting yourself organized for filing your taxes. So much information comes in the mail throughout January and February it may be overwhelming knowing what to do with each item. Then there are receipts and situations you may run into throughout the year that you might make a mental note to “save this for tax season” and then forget about it by the end of the year. By working on an organizational system you can make sure you are filing a more accurate return and taking advantage of every deduction available to you. Your tax preparer will also thank you!

I recommend starting a file for each of the following major topics below. This can be an actual physical file or a digital file. Once you have a folder for each of the topics as you have things happen throughout the year you can just stick the paystub, receipt, or note in the file. Ideally you will set this up January 1st so that by the time the year ends you are already set and organized. Right now you are preparing for a year that has passed, but you can still use this system to get yourself organized with last year's information so that your tax return process is simpler. Folder categories and what type of information is included in that category are listed below.

Income: This file will be for all items related to any sources of income or money you are receiving. This includes:

• Wages

• Interest

• Dividends

• Capital Gains

• Unemployment

• Retirement Account Withdrawals

• Pension Payments

• Social Security 

• Gambling Winnings

• Any other money received, if in doubt make a note to ask your professional.

Above the Line Deductions: These are things that will reduce your taxable income and you don’t have to itemize to be able to deduct.

• Educator Expenses - For K-12 educators you can deduct up to $250 for classroom supplies and other required expenses.

• Health Savings Account (HSA) contributions

• IRA, SIMPLE, SEP contributions

• Self Employed Health Insurance

• Alimony

• Student Loan Interest

Itemized Deductions: These are deductions that you add together, if the amount of the total is more than the standard deduction you can subtract the total from your taxable income.

• Medical expenses

• Real Estate Taxes

• Personal Property Taxes

• Sales Tax on large purchases

• Mortgage Interest

• Charitable Donations

• Gambling Losses (to offset winnings)

Other Miscellaneous Items: This folder should contain information to support additional credits or any other miscellaneous information that may fit in a different category. Examples include:

• College expenses

• Childcare payments

• Energy Qualified Home Improvements

• Anything else that you have a question about

Business, Farm, or Rental: These require more extensive bookkeeping and you should keep separate detailed files for these types of activities. 

Year-End Tax & Financial Planning

As we close out the year, this is an ideal time to review where we stand financially, make adjustments, and prepare for greater financial success in 2021 and beyond. Here are some simple tax and financial planning topics and strategies to discuss with your advisor.

Review retirement accounts — Those under age 50 can contribute up to $19,500 for 2020 and 2021 in a 401(k), 403(b) and 457 plan; those 50 and older can contribute up to $26,000.  You may also be able to contribute up to $6,000 to an Individual Retirement Account (IRA), or up to $7,000 if you are 50 and older. If you’re not able to max out on your retirement savings, consider increasing it 2%-10% (or more) for 2021.

Boost your monthly income — If you receive a tax refund every year, you may want to use the IRS Withholding Calculator to determine the right amount to withhold every month. You can either use this extra money to contribute toward your retirement fund, pay down credit cards, build emergency funds or use it for other personal or family goals in 2021.

Saver’s Credit — To offset part of the first $2,000 voluntarily contributed to an IRA, 401(k), or similar workplace retirement program, the government will help low- or moderate-income workers begin saving by providing a tax credit up to $1,000 for individuals, or $2,000 for married couples. Deadlines for contributions are December 31, 2020, or April 15, 2021, depending on the plan. For more details, see IRS.gov: Saver’s Tax Credit.

Review your Flex Spending Account (FSA) — If you have more than $550 in your FSA, be sure to use it before December 31, 2020, as only $550 can be carried forward to 2021. However, check your specific plan for the rules as they may have retained allowing expenses to be utilized in first three months instead. The limits for 2021 are $2,750 for healthcare FSAs, and $5,000 for dependent care assistance plans (DCAPs) for qualifying individuals or those who are married and file a joint return. The FSA Store has an easy to follow list of permitted expenditures. Of course, they also want to sell you this stuff. While you don’t want to lose money by not utilizing the FSA, make sure you buy things that will be of value in the future. Remember if doctors write a prescription for over-the-counter materials, it is eligible for reimbursement.

Support your favorite charity —In addition to cash, evaluate whether year-end is a good time to donate appreciated stock or property to charities. Consider your favorite religious organization or a reputable charity listed in CharityWatch.org or CharityNavigator.org. Money-Saving Tip: If you donate a used car to a charity that is worth more than $500, your deduction is limited to the amount the charity receives when they sell it. However, if they use it to deliver meals or give it to a needy person, your deduction could be determined based on the vehicle’s fair-market value.  Under the CARES Act, you can make a cash donation for 2020 and it will be an “above-the-line” deduction.

Postpone income — Consider deferring income from capital gains, self-employment, etc., into 2021 to lower your taxes for this year.

Last-minute deductions — If you itemize rather than take the standard deduction, this may be a good time to pay ahead on deductible expenses. Sometimes bunching the deductions in one year will help you exceed the standard-deduction threshold, which will allow you to claim a larger write-off.  Some people alternate large donations or pre-payment of taxes to every other year in order to itemize.

Review IRA distributions for parents or grandparents — If money isn’t needed for current expenses, retirees will often leave money in their savings for future needs. For those over 70½, failing to withdraw enough can result in a 50% excise tax on the amount they should have withdrawn! This money that must be withdrawn will depend on the amount in the account, their current age, and their life expectancy, and must be withdrawn by the end of the year, EXCEPT for 2020 – the CARES Act waived RMD’s for this year. See IRS.gov: Required Minimum Distributions.

Avoid “kiddie tax” — If your child’s investment income exceeds $2,200, the earnings will be taxed at the parent’s tax rate until age 19, or age 24 if the child is a full-time student and provides less than 50% of his or her support. See Nolo.com: Kiddie Tax.

Consider converting to a Roth IRA — If you believe your income will rise dramatically in the future, discuss converting a regular IRA to a Roth with your advisor.

Review beneficiaries — If your marital or family status has changed in 2020, be sure to review the beneficiaries noted on pensions and other retirement plans, TOD (Transfer on Death) documents, insurance policies, wills, mortgages, and other important papers.

Plan for 2021 Transit Benefits — The combined monthly limit for transit passes and vanpooling expenses for 2021 will be $270.

Adoption assistance — If you are in the process of adopting, keep in mind that the limits in 2021 will rise slightly, to $14,440 (up from $14,300). Discuss strategies with your advisor on whether to accelerate payments (if possible) or delay them into 2021.

See the 2021 IRS update for new tax rates, educational credits, earned income credits, healthcare credits, low- income housing credits, exemption amounts for Alternative Minimum Tax (AMT), standard deductions, and more.

Review these and other issues with your advisor. This may also be an ideal time to prepare to capitalize on 2020 tax deductions and credits to minimize your tax liability for 2021. We hope these strategies help you build a stronger financial future as we move into 2021.