- There are tax-planning strategies you can consider throughout the year, like maximizing deductions, making sure to avoid penalties and fees, and using tax-smart investing techniques.
- The extension of the 2020 federal tax filing deadline and IRS processing delays may result in delayed refunds. If you have extra savings, there are tax-savvy options other than "revenge spending."
Like so much else in life of late, the tax landscape has been unusually unpredictable, with an emergency extension of the 2020 tax filing deadline and now a big debate in Washington over the future of tax policy. Still, there are tax-smart moves you can make now to help set you up for success this year and beyond.
"There's still plenty of time to make an impact with careful planning for the 2021 tax year," says Ann Dowd, CFP®, a vice president at Fidelity Investments.
Here are 7 strategies to consider:
1. Track your missing payments
Are you waiting for a refund? Outstanding money from past stimulus checks? Reimbursement for overpaid taxes on unemployment income? The Internal Revenue Service (IRS) says it has started sending out more than 2.8 million refunds to taxpayers who overpaid taxes on unemployment compensation before the American Rescue Plan Act of 2021 (ARPA) changed the limits, but delays abound for other money you may be waiting to arrive.
You can check the status of your return if you input your details into the IRS tool. If the response is that it's still in process, that means they have your return and are still working on it.
"That's the good news, but then you just have to wait," says Chris Williams, principal at EY Private Client Services.
If you get any other response, you can download more information about your tax return from the IRS. If that still does not answer your questions, you can call, but be patient, as call volumes are high.
If you think you are still due payment from the third stimulus round that passed in March, you will have to wait to reconcile the amount on your 2021 tax return, which will be due at the next tax filing deadline.
2. Prep for the child tax credit
Starting in July, the IRS says it will begin sending out advance payments on the enhanced 2021 Child Tax Credit, as outlined in the American Rescue Plan. For 2021, families will receive up to $3,600 per qualifying child under 6 and $3,000 per qualifying child between the ages of 6 and 17, up from $2,000 per child. The increased amounts are phased out for incomes over $150,000 for married filing jointly, $112,500 for heads of household, and $75,000 for single taxpayers.
The payments will be based on your most recent tax return, so if you haven't filed for 2020, you may want to speed up that process if that helps you qualify. If you don't normally file, the IRS will have a tool to input your information. No matter your situation, you will also want to make sure the IRS has your correct payment information, so the money makes it to the right place. But there are no other steps you should need to take, according to the IRS.
If you do not wish to receive the advance payments, the IRS says there will be a way to opt out and, instead, you can reconcile what's due to you on your 2021 tax return. This may be important if your financial circumstances change in 2021 or you are close to the income threshold for the 2021 Child Tax Credit. If you end up receiving too much money in the payments from July to December, the IRS will ask for the money back on your next federal tax return. You may want to check with a tax professional to understand your options.
3. Check your estimated taxes
The economic situation in the US is still highly variable because of the COVID-19 pandemic, and that means you may still have income fluctuations in 2021.
"If you received unemployment benefits in 2021, don't forget that is federally taxable income," says Williams.
Even if you are now reemployed, you will want to make sure you pay the estimated taxes due or adjust your tax withholding at your new job to account for that income. Unemployment rules and payments vary by state, so make sure to check the situation in your local area.
4. Do a paycheck checkup to plan for future tax changes
Doing a midyear financial checkup is always a good plan to make sure you are paying the right amount of taxes as you go throughout the year. The IRS has a handy tool to make sure you are having the right amount of taxes taken out of your paycheck for your federal tax payments. You'll have to do some back-of-the-envelope math to figure out what you owe for state taxes, as you will if you're currently unemployed.
This year, you may want to pay attention to your tax bracket and your investment income, because Congress will soon be debating the particulars of the Biden administration's proposed tax law changes. Most of these changes will pertain to high-net-worth families, but everyone may want to consider strategies for tax-savvy investing with the help of a financial professional.
5. Reset your RMD
Congress allowed people over the age of 72 to suspend taking required minimum distributions (RMDs) for 2020 as part of COVID-19 relief, but RMDs are back on for 2021. Everyone's RMD situation will be different, but if you don't take your required amount by December 31, you could face IRS penalties.
"Plan ahead for what you want to do with the money—if you don't see a need for it right away, consider tax-efficient options for reinvesting it in a taxable account," says Matt Kenigsberg, vice president, investment and tax solutions at Fidelity.
6. 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 pre-tax retirement accounts and other tax-deferred plans. You can use Fidelity's tools 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 the space you are using and any expenses you incur to file for 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 one 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 this deduction 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 options for your situation.
You might also want to consider tax-loss harvesting: If you've got assets (including cryptocurrency) that are below their cost basis, and there's a reasonable proxy (but not a substantially identical security) you could use that to replace them without a material impact to your investment plan, consider selling at a loss and replacing them with the proxy. 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.
7. Stash your savings
Rather than "revenge spend," you may want to put the dollars you have saved to work for you with tax-efficient investing. You may, for instance, want to contribute 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. You may also want to use any cash you have to bulk up an emergency fund, invest for long-term goals, or give to charity.
"Make sure 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."