3 key tax moves to close out 2021

Seize the chance to help reduce taxes on your income and investments by acting now.

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Key takeaways

  • While potential tax law changes are making headlines, most of the proposals will probably not affect your 2021 tax return.
  • There are tax-planning strategies to consider before the end of the year, like maximizing deductions, making sure to avoid penalties and fees, and using tax-smart investing techniques.
  • A tax advisor and financial professional can help you build a tax-smart investing plan that works for you.

With potential tax reforms making their way through Congress, taxpayer eyes are focused on 2022, when most of the new provisions would likely take effect if they are enacted. But don't forget about 2021! There's time left to make tax-savvy moves for that tax year—and future years too.

"There's plenty you can do to make an impact," says Ann Dowd, CFP®, a vice president at Fidelity Investments.

Here are 3 key things to consider:

1. Do a checkup to plan for future tax changes

Doing a financial checkup before year-end, or really anytime throughout the year, can help you to pay the right amount of taxes as you go. The IRS has a handy tool to help taxpayers check their federal income tax withholding. Consult your state tax authorities to check your state tax withholding.

"You don't want to underpay for taxes, but you also want to avoid getting a large refund. That is like giving an interest-free loan to the government," says Christopher Williams, a principal at EY's Private Tax group.

This year, you may want to pay close attention to your tax bracket and your investment income, because Congress will soon be debating the particulars of proposed tax law changes. Many of these changes will pertain to high-net-worth families, earning above $400,000 for single and $450,000 for married couples filing jointly, and some will affect all taxpayers, but everyone may want to consider strategies for tax-savvy investing with the help of a financial professional.

Tax strategies can be complicated, so you should consult with a tax advisor and financial professional.

2. Look for tax savings

If you want to help reduce your tax liability this year, consider increasing your contribution to a 401(k) or any other tax-deferred workplace plans. You can use Fidelity's tool to see how your finances would be affected if you change your contribution level.

If you are working from home as a self-employed person—which includes many professionals like doctors and lawyers—you will want to keep track of any office space you are using and any expenses you incur if claiming a home office deduction. For all those full-time employees working from home and having to buy desk chairs, printers, and other supplies—sorry, you are out of luck for a federal income tax deduction. The deduction that would have covered you for home office and unreimbursed employee expenses was removed by the Tax Cuts and Jobs Act. (Note, however, that some states still allow it for state income tax purposes.)

If you are still working remotely in a different state from where you usually work, you may want to take a deeper look at your residency options and make a long-term decision about the best choice for your situation.

You might also want to consider tax-loss harvesting if you've got investments that are below their cost basis. If there's another investment (but not a substantially identical security) you could use to replace them without a material impact to your investment plan, you might want to consider selling at a loss and replacing them with the new investment. Consult your tax advisor about your situation and beware of the wash sale rule.

"The key takeaway is to get a handle on what your realized gains may be now, year-to-date. If you're going to take any action with losses, that would need to be done before December 31. You don't want to be waiting until you are filing next April to figure out your realized gains, because then it would be too late to offset with losses," says Williams.

3. Put your savings to work

Rather than "revenge spend" after being cooped up all of the COVID-19 pandemic, you may want to put the dollars you have saved to work for you with tax-efficient investing and charitable giving.

"It's OK to treat yourself a little, so you won't feel deprived," says Dowd. "But then be smart about the rest of what you have worked so hard to save during this difficult time."

On the savings side, consider contributing to a Roth IRA or a 529 college savings plan, where any growth accrues tax-free. Note that each of these come with various requirements and restrictions, so it makes sense to look into it ahead of time.

For high earners above the income limits for Roth IRA contributions it may be worthwhile to explore after-tax conversion strategies, because the rules may change in the future. The bill before Congress proposes to end many of these opportunities. The situation is still developing, so you may want to consult with a tax advisor and financial professional to see how your own situation will be affected.

If you have money to donate, you have many strategies to consider. With the standard deduction at $12,550 for single individuals and $25,100 for married filing jointly (for 2021), it may make sense to try to bunch your itemized deductions to maximize these benefits.

For example, paying additional medical expenses or making additional charitable contributions in one year versus being spread over several might help you be able to take a larger itemized deduction in a year. But with tax changes possibly coming, your situation may change, so you'll want to consider your options carefully.

Bottom line

Tax planning is not a one-and-done exercise. To help reduce taxes, it makes sense to be planning throughout the year. Need help? A tax advisor and financial professional can help you build a tax-smart investing plan that works for you.

Next steps to consider

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