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End-of-the-Year Income Tax Checklist

David M. Brenner, ChFC®, CLU®

D. M. Brenner, Inc.

Phone : (858) 345-1001

Fax : (858) 345-1054

david@dmbrenner.com
www.dmbrenner.com

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By AMY FONTINELLE

Oct. 25, 2021

Every year we hear about the same old things we should do by Dec. 31 to save money on our taxes the following April. In this article, we'll address some items you should think about prior to Dec. 31 and provide some lesser-known tips and strategies for last-minute tax savings.

KEY TAKEAWAYS

Know your filing status and what that means for your eligibility for tax credits.
Be sure to save for retirement and maximize your tax savings.
If you're 72 or older in 2021, you will be subject to required minimum distributions (RMDs) from your retirement accounts.
If your medical expenses for the current year border on the minimum threshold of 7.5% of your AGI, it may be wise to bunch planned future medical expenses into the current year to maximize your tax savings.
If you anticipate a change in income tax brackets, planning certain expenses in the higher-tax bracket year is a wise tax-planning strategy.
If you believe you may be subject to the Alternative Minimum Tax (AMT), a tax planning professional can help you minimize its effect.

Your 2021 Year-End Checklist

Here are some items you will need to consider at year-end in anticipation of your 2021 tax filing season.

Know Your Filing Status

There are several ways to file your taxes. Depending on your marital status and dependent situation, you can file as a single filer, head of household (HOH), married filing separately (MFS), or married filing jointly (MFJ). Each of these comes with different tax-bracket income thresholds, standard deductions, and eligibility for certain tax credits.

Most notably, if you use the tax status MFS, you will not be eligible to claim certain education tax credits.

Retirement Planning

Pay attention to your annual contribution limits for employer sponsored retirement accounts such as 401(k)s and 403(b)s. For most employees, the limit is $19,500 for 2021. There is a special allowance for an additional $6,500 catch-up contribution for employees over the age of 50, for a total of $26,000. You may also be eligible to deduct contributions to a traditional IRA if you meet certain conditions.1

Required minimum distributions (RMDs), which were waived in 2020 due to the coronavirus pandemic, are back for 2021. Be sure you have taken RMDs from your retirement account if you are over the age of 70 ½ or 72, depending on your birthdate. The SECURE Act of 2019 made changes to the minimum RMD age, so if your 70th birthday was Jul. 1, 2019 or later, you are not obligated to take an RMD from your retirement account until you reach age 72.2

If you did not reach age 70 ½ in 2019 but are 72 years old before the end of 2021, your first RMD will be due by Apr. 1, 2022 and the second by Dec. 31, 2022. To avoid two withdrawals in the same tax year, you can take your first RMD by Dec. 31, 2021.3

Itemized or Standard Deduction?

It's beneficial to add up your potential itemized deductions before the end of the year to plan whether you might itemize or take the standard deduction. If your itemized deductions exceed the standard deduction for your tax status, you should itemize expenses on your tax return.

For 2021, the standard deductions are:

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If you are going to itemize, you will need to collect all your backup documents for your eligible expenses. Additionally, if you're itemizing, you may want to bunch medical expenses into the current year before Dec. 31.

Bunch Medical Expenses In One Year

For medical and dental expenses, your itemized expenses are only deductible to the extent they exceed 7.5% of your adjusted gross income (AGI).5 If your AGI is $50,000 and you have $7,000 in qualified medical and dental expenses, you don't get to deduct $7,000 from your taxable income; you only get to deduct the expenses that exceed 7.5% of your income. Since 7.5% of $50,000 is $3,750, you can deduct $7,000 - $3,750, or $3,250.

It's better to be able to claim something than to miss out on this deduction entirely. So, November-December is a good time to look at your actual medical expenses for the current year and your anticipated medical expenses for the upcoming year.

If you're close to crossing the 7.5% threshold for the current tax year, move your purchases of eyeglasses, dentist and doctor visits, surgical procedures, and other medical and dental expenses to December to gain a tax deduction, advises Scott M. Estill, author of the book Tax This! An Insider's Guide To Standing Up To The IRS and a former senior trial attorney for the Internal Revenue Service (IRS). Likewise, if you have few medical and dental expenses for the current tax year, defer what you can until the next one.

Numerous voluntary medical costs are tax-deductible, including LASIK eye surgery, doctor-prescribed weight loss programs, smoking cessation programs (but not patches or gum), and capital expenses for ramps, railings, and other features installed in a home to accommodate disabilities, says John T. Hewitt, founder, and CEO of Liberty Tax Service. "Don't overlook medical mileage to and from doctors, hospitals, and the pharmacy," he adds. For 2021, the standard rate for medical mileage is 16 cents per mile.6

Consider Next Year's Tax Brackets

Before bunching expenses together, taxpayers should consider their overall tax brackets for this tax year and next year, Estill says.

"For instance, if I know my income will go up next year and thus I will be in a higher tax bracket, it may make sense to wait until next year to take the deduction because it will be worth more to me as a percentage of my income," he says. If you will be in the 12% bracket in 2021 but might be in the 22% bracket in 2022, your deductions will be worth more in 2022. A major tax bracket change might apply if you were, say, unemployed for a chunk of 2021 due to the economic crisis that started in 2020 but you then started a new job, among other possible scenarios.

"Likewise, if my income is expected to go down next year, it may make sense to try to accelerate the purchases into the current tax year," Estill adds. This could happen if you know, for example, that you're going to retire next year.

Beware the Alternative Minimum Tax

The common advice to shift expenses from January to December to get the tax deduction a year earlier can backfire if you end up being subject to the alternative minimum tax (AMT).

What is the AMT? According to the IRS, "Under the tax law, certain tax benefits can significantly reduce a taxpayer's regular tax amount. The alternative minimum tax (AMT) applies to taxpayers with high economic income by setting a limit on those benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax."7

Determining if the AMT applies to you is tricky and may require professional tax assistance. If the AMT does apply to you, you'll need to rethink your tax minimization strategy. "If you are subject to AMT, the benefit of being able to deduct property taxes disappears. It may be more advantageous to wait until next year to make the payment. Make sure you consult with a tax professional before you assume prepayment will result in income tax savings," he adds.

The same is true of state income taxes for the fourth quarter of the current tax year that you might elect to pay in December instead of January, says Estill.

When should I start tax planning?

Year-end tax planning isn't as simple as it seems. Rather than scrambling to reduce your taxes in December, a better strategy is to consult with a tax professional to develop an ongoing plan that you can implement over the course of the entire year, and change along the way if your income or expenses don't meet your predictions.

If I file married filing separately, am I eligible for the American Opportunity Tax Credit?

You are not eligible for the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit if your filing status is married filing separately.

When is the deadline for taking a required minimum distribution from my retirement account?

If you are newly 72 in 2021, your first required minimum distribution (RMD) will be due by Apr. 1, 2022, and the second by Dec. 31, 2022. The later Apr. 1 deadline only applies to RMDs in your first year. For all subsequent years, your RMD must be taken by Dec. 31.

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