The 2021 tax filing season is here! When preparing your 2020 taxes returns, consider these last-minute ideas to lower last year's federal income tax liability.
1. Contribute to a Traditional IRA
If you've not yet made a deductible traditional IRA contribution for the 2020 tax year, you can still do so until April 15. Then you can claim the resulting write-off on your 2020 return, assuming last year's income wasn't too high to qualify. You also can potentially make a deductible contribution of up to $6,000 or up to $7,000 if you were age 50 or older as of December 31, 2020. If you're married, your spouse can do the same.
There are two ground rules for deductible IRAs. First, you must have enough 2020 earned income (from jobs, self-employment or taxable alimony received) to equal or exceed your IRA contributions for the 2020 tax year. If you're married, either you or your spouse (or both) can be the source of the necessary earned income. Second, deductible IRA contributions are phased out (reduced or eliminated) if last year's income was too high. Here are the phaseout ranges for 2020:
- If you're unmarried and were covered by a tax-favored retirement plan in 2020 (whether an employer-sponsored plan or a self-employed plan), your eligibility to make a deductible contribution for last year is phased out between adjusted gross income (AGI) of $65,000 and $75,000. For married filing separately, the phaseout range is $0 to $10,000.
- If you're unmarried and weren't covered by a plan in 2020, your eligibility to make a deductible contribution isn't affected by your AGI. You can make a fully deductible contribution up to the applicable limit, assuming you have enough earned income.
- If you're married and both you and your spouse were covered by retirement plans in 2020, the eligibility of both you and your spouse to make deductible contributions for last year is phased out between joint AGI of $104,000 and $124,000.
- If you're married and weren't an active participant in an employer-sponsored retirement plan for 2020, but your spouse was, your deductible IRA contribution phases out with AGI of between $194,000 and $206,000. (The participating spouse's eligibility is phased out between joint AGI of $104,000 and $124,000.)
If you're married and neither you nor your spouse were covered by a plan, your eligibility to make a deductible contribution isn't affected by your AGI. You and your spouse can both make fully deductible contributions up to the applicable limit, assuming you have enough earned income.
2. Make a Deductible Health Savings Account (HSA) Contribution
If you had a qualifying high-deductible health plan (HDHP) last year, you could still make a deductible HSA contribution for your 2020 tax year if you've not already done so. The contribution deadline is April 15.
For 2020, the maximum deductible HSA contribution is $3,550 for self-only coverage or $7,100 for family coverage (anything other than self-only coverage). More specifically, if you're eligible to make an HSA contribution for last year because you had a qualifying HDHP, you have until April 15 to establish an account and make your rightful deductible contribution.
Important: The write-off for HSA contributions is an above-the-line deduction. That means you can take the write-off even if you don't itemize.
3. Deduct State and Local Sales Taxes (Instead of State and Local Income Taxes)
If you live in a jurisdiction with low or no personal income tax or if you owe little or nothing to state and local income tax collectors, you have options. You can potentially claim itemized deductions on last year's return for either:
- State and local general sales taxes, or
- State and local income taxes.
The sales tax option is only relevant if your allowable itemized deductions for last year would exceed your allowable standard deduction for last year. The standard deduction for 2020 was:
- $24,800 for most married couples who file jointly,
- $12,400 for most singles and those who use married filing separate status, and
- $18,650 for most heads of households.
Higher standard deductions apply for those who were age 65 or older on December 31, 2020.
If you can benefit from choosing the sales tax option, you can use an IRS-provided table (based on your income, family size, state of residence, and local sales tax jurisdiction) to figure your allowable sales tax deduction. But if you kept receipts from 2020 purchases and that gives you a bigger write-off, you can add up the actual sales tax amounts and deduct the total.
Even if you use the IRS table, you can add on actual sales tax amounts from major purchases, such as:
- Motor vehicles (including motorcycles, off-road vehicles, and RVs),
- Boats,
- Aircraft, and
- Home improvements.
In other words, you can deduct actual sales taxes for these major purchases on top of the predetermined amount from the IRS table.
4. Add Up Health Insurance Premiums and Medical Expenses
If you itemize deductions on your 2020 tax return, you can potentially claim a deduction for qualifying medical expenses you paid last year. This includes premiums for private health insurance coverage and premiums for Medicare health insurance.
Specifically, you can claim an itemized medical expense deduction if your total qualifying expenses exceed 7.5% of your adjusted gross income (AGI) for the year. Under current tax law, the standard deduction amounts have been significantly increased for 2018 through 2025. So, fewer individuals will be itemizing on their 2020 returns. But having significant medical expenses may allow you to itemize and collect some tax savings.
Important: If you're self-employed or an S corporation shareholder-employee, you can probably claim an above-the-line deduction for your health insurance premiums, including Medicare premiums. That means you don't need to itemize to get the tax-saving benefit.
5. Take Advantage of COVID-19 Tax Relief for Certain Small Business Owners
Several COVID-19 federal tax relief measures are potentially available to eligible S corporation shareholders and owners of unincorporated businesses, including:
- Sole proprietorships,
- Single-member limited liability companies (LLCs) treated as sole proprietorships for tax purposes,
- Partnerships, and
- Multi-member LLCs treated as partnerships for tax purposes.
These relief provisions can significantly improve your personal tax situation. For example, you can carry back a 2020 business net operating loss (NOL) for up to five years and recover some or all the personal federal income tax paid for the carryback year(s).
April 15th is coming soon
The federal income tax filing deadline for individuals is just around the corner. If you haven't yet filed (or extended) your 2020 return, contact a R+R tax advisor to help soften your tax hit with these and other planning moves.
About Reynolds + Rowella
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve.
Our mission is to operate as a financial services firm of outstanding quality. Our efforts are directed at serving our clients in the most efficient and responsive manner possible, delivering services that exceed the expectations of those we serve. The firm has offices at 90 Grove St., Ridgefield, Conn., and 51 Locust Ave., New Canaan, Conn. For more information, please contact Elizabeth Bresnan at 203.438.0161 or email.
