Update: After the completion of this article, the Treasury Department and Internal Revenue Service announced that the deadline for filing your federal personal income tax return has been automatically extended from April 15, 2021 to May 17, 2021. Personal income taxes due for 2020 can be paid by May 17, 2021 without incurring additional interest and penalties. This deadline extension does not apply to first quarter estimated tax payments for 2021 that are due April 15, 2021. This IRS announcement does not extend state income tax filing deadlines.
Now that the deadline has passed for employers, banks, and investment firms to issue their tax reporting forms, many of you are now finalizing your income tax returns for the 2020 tax year. Most tax planning items must be completed before the close of the tax year; however, there are still a few last-minute ideas that could result in tax deductions as you approach April 15
th. There are also things to keep in mind as you move through 2021 to make filing easier next year. While most of us only focus on taxes this time of year, staying alert to tax planning all year can help with your long-term financial goals. Creating a team that coordinates your investments, taxes, and financial planning should be a priority as you wrap up your 2020 filings. With that in mind, please consult your tax advisor to see if the points below can be beneficial given your specific situation.
Items that can impact your 2020 filings by April 15, 2021
- For taxpayers that are still working, certain contributions to retirement plans can be made after the close of the tax year and be eligible for a current deduction. If you have a traditional IRA, you can still make adjustments for the prior year up until April 15, 2021. You may contribute up to $6,000 for those under 50 and $7,000 for those 50 and older to your IRA. If you are contributing to a SEP IRA or a Keogh plan, the deadline for making a 2020 contribution does include any extension of the due date of the tax return. For married taxpayers, if the working spouse is not a participant in a qualified retirement plan, the nonworking spouse may also qualify to make an IRA contribution to a plan in his/her own name, without being subject to phase outs for deductibility.
Planning Point: For taxpayers needing to save more for retirement in excess of these contribution limits, a non-deductible IRA contribution, followed by a Roth conversion, can be a solution. This is often referred to as a “back door” Roth conversion. A Roth IRA is an IRA where assets grow tax free but with an added feature in that future withdrawals are not subject to income tax. Also, the owner of the Roth will not be forced to take required minimum distributions from the account. This non-deductible IRA contribution with a Roth conversion helps taxpayers avoid the AGI limits that prevent many from contributing directly to a Roth. The contribution to this type of IRA does not result in a current year income tax deduction. Deciding if this option is advantageous in your situation, as well as complying with the conversion rules, should be done with the assistance of both your tax and financial advisors.
- Contributions to certain state-sponsored 529 college savings plans made prior to April 15th can be deducted on your 2020 state income tax return. For example, contributions to the South Carolina Future Scholars program by a South Carolina taxpayer are fully deductible on their 2020 income tax return if made by April 15, 2021. The deadline for making a contribution does not change if you extend your tax return. The rules on deductibility of 529 plan contributions vary by state so check with your tax advisor to determine if your contributions would be eligible for a 2020 state income tax deduction. While contributions to a 529 plan can result in an income tax deduction, these contributions are also considered gifts for IRS gift tax reporting purposes.
- The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act enacted in 2020 created the option to forgo your 2020 required minimum distribution (RMD) from your retirement accounts. For many taxpayers, the RMD was already withdrawn from the IRA prior to the passing of The CARES Act. The IRS later issued guidance that taxpayers would be allowed the opportunity to return the RMD to the retirement account by August 31, 2020. If you took advantage of this rule and returned your RMD to your retirement account, you must let your tax preparer know. The tax reporting forms issued by your IRA custodian will only reflect the withdrawal. You must note that the money was returned and manually reduce the reported taxable portion of your distribution by that amount.
- If you need additional time to prepare a complete and accurate return, you can file for an automatic extension using Form 4868. While this extension will allow you to file your return by October 15, 2021, the extension of time does not apply to the payment of your taxes. You need to make your best effort to estimate the tax that will be due and pay that balance with Form 4868 to avoid possible interest and penalties. If you make quarterly estimated payments, your first quarter estimated payment for 2021 will also be due by April 15, 2021, even if you request an extension to file your 2020 tax return.
Ways to use “Tax Time” to Enhance your Financial and Tax Planning
- When gathering your tax documents for your tax preparer, take time to make note of any changes in your financial or family life. Even though this time of year is busy for tax professionals, it is a perfect time to communicate with them the information necessary to take full advantage of potential tax savings during the preparation of your return. With a change in administration in Washington, D.C. comes the possibility of new tax legislation. The more familiar your tax preparer is with your financial life, the better suited he or she will be to recommend any necessary adjustments upon the enactment of new tax policy.
- As mentioned previously, creating a financial team around you that communicates on a regular basis can be helpful in attaining financial goals. Once your income tax return is finalized, share a copy with your financial advisor. It is important that tax attributes such as capital loss carryforwards, or marginal tax rates, are known to your advisor so they can be factored into your investment strategy. Facilitate communication between these two members of your advisory team as a good working relationship and understanding of your tax situation can maximize results.
- Ways to make tax planning and filing your taxes easier in 2021:
- One of the most time-consuming tasks related to filing your income tax return can be compiling a list and finding the proper documentation of deductible items (ex. business expenses, medical expenses, charitable contributions, mileage log). Maintaining a recordkeeping system throughout the year to capture those expenses as they are paid can prevent missing items if this is done after-the-fact. Having accurate records and running totals of certain items throughout the year may also provide information that could be used in tax planning prior to the close of the tax year.
- The IRS requires income taxes be paid throughout the year as income is earned. For taxpayers with wages or other income eligible for withholding, the taxes withheld meets the IRS requirement to “pay as you go.” For taxpayers with other income such as self-employment income, interest, dividends, and rental income, quarterly estimated tax payments may need to be made to avoid interest and penalties when you file your return. Work with your tax advisor throughout the year to determine the proper amount and timing of those payments for 2021.
- As stated above, the Biden Administration is likely to propose new tax legislation that could impact current tax rates, deductible items, phase out limitations, and many other aspects of the current Internal Revenue Code. As these proposals become clearer, staying in contact with your tax advisor and financial advisor become even more important as strategies around income recognition, charitable giving, capital gain recognition, and timing of tax deductions could be impacted.
Completing your income taxes each year is often looked at as a “necessary evil” and something most of us want to get done as quickly as possible. However, taking time to partner fully with your tax and financial advisors can go a long way in reducing current year taxes as well as meeting your long-term financial goals. Building a team of professionals that communicate and work well together can take the chore of filing taxes each year and make it a productive part of your financial and investment planning.
