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The end of the year is here, which means that tax season is right around the corner. And as taxes become more complicated during the pandemic with newly added exemptions and deductions, it's more important than ever to get ahead of the game.
Select interviewed Jackson Hewitt's Chief Tax Information Officer, Mark Steber, on what Americans should be doing now to wrap up their tax year, to have a simple and effective tax return for the 2021 year.
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1. Get started early
Steber is adamant about how important it's to get started early, especially as this tax season is proving to be more complicated than ever — with new additions to the tax code like the Child Tax Credits, the return of required minimum distribution from retirement accounts and accounting for economic stimulus payments.
And Steber reiterated this urgency applies to everyone. "The stakes have never been higher when it comes to Americans having a successful tax season", he said.
Getting started early doesn't mean waiting until the calendar turning to 2022 either, as you can create a plan before the current tax year ends. This means creating a checklist of any W2, 1099, Schedule K-1, and any other documents related to income you receive from work or investments. Many of these documents will be sent out at the beginning of 2022, for the year prior.
But prior to them being mailed, make a list of expected income documents. Forgetting one of these documents and not including it on your return could result in an unwanted audit from the IRS.
2. Do an estimate of what your tax owed/refund will look like
Taxes can be a difficult puzzle to solve, leaving many Americans unsure of what to expect when they file their return. According to the National Opinion Research Center at the University of Chicago, 32% of those surveyed said they're unsure if they'll receive a refund or owe money.
Steber told Select that Americans should do an estimate of what they might anticipate when they submit their taxes. By doing this, you can begin planning what you'll do with your refund money, or how you'll pay your tax bill.
There are several automated tax calculators available for free online which can give you a rough idea of what your tax bill, or refund, may be. However, this shouldn't be relied on as a final number, or used in lieu of a certified tax professional.
A few reputable calculators you can use are:
3. If you're investing, consider selling your losing stocks
2021 was the year of meme stocks, where retail investors ran towards crazed stocks that shot up in price over the span of a few days. From this, millions of Americans became interested in the stock market and started regularly buying and selling stocks on popular apps like Robinhood. As much fun as some people were having with it, and in some cases making real money, there are tax implications that come along with this.
Let's say you bought a share of Tesla on Jan. 8 of this year for $880, and sold it on Nov. 8 for $1,162. While that is a solid $282 profit, you will need to pay short-term capital gains on that figure because you held the stock for less than a year. However, if you have shares that you're losing money on, you can sell those stocks and capture losses to offset the income you made on Tesla. This is also known as "tax loss harvesting."
This means that you're intentionally selling off assets for a loss, in order to offset the gains you've made elsewhere. So in the eyes of the IRS, you might be breaking even or making less of a profit than initially expected. This strategy can help reduce your tax burden, although there are limits to how much you can write off with this strategy.
Steber's suggests for all investors to take this strategy into consideration, even if you're buying cryptocurrency. But like in the first step mentioned above: Keep good records or your trading activity, as the IRS will know about your profits, and be sure to collect on them.
At the end of the year, your brokerage should send you a list of your trades, including your profits and losses.
4. Fill up your tax-advantaged retirement accounts
If you're investing in a 401k or Health Savings Account (HSA), do your best to fill up those accounts to their limits before the end of the year to either defer taxes or secure a tax write off.
With a 401k, your dollars go in pre-tax, meaning that your taxable income for 2021 will be lower with the more money you put into it. However, since a 401k is an employer-sponsored account, be sure to check with your company's human resource department to see if you can stuff a few extra dollars in your account before the end of the year to lower your tax liability.
Additionally, if you have a high deductible health plan (HDHP), you can enroll in a HSA through your employer or open one yourself. If your employer offers one, you can have money put away pre-tax for healthcare-related expenses. If your employer doesn't offer one, you can open one yourself, and all money put away will earn you a tax write-off.
- A Health Savings Account (HSA) is also known as the triple tax advantage account, as there are three levels of savings. First, you can put money away tax free, or earn a tax-write off. Second, if you invest the balance of your HSA, all gains are tax-free if you decide to sell investments to pay for health-related expenses. Third, if you keep that money working until age 65, you can make withdrawals without any penalty. However, non-qualified withdrawals will still be taxable as ordinary income.
When filling up your retirement accounts, keep in mind IRA accounts as well —including both traditional and Roth IRAs. Each of these accounts have different tax advantages, where traditional IRA's will earn you immediate tax deductions, while a Roth IRA gets you tax-free gains that cannot be touched until you're 59 and a half years old. However, these are both important to fill up as you have until tax day (Apr. 15) of the following year to maximize your contributions.
5. Consider donating to a charity for tax benefits
As you're collecting your tax documents, if you realize you haven't donated to your favorite charity, you still have time.
If you donate to a verified nonprofit, like a 501(c)(3), you can deduct that donation against your adjusted gross income (AGI). However, because roughly 90% of Americans take the standard deduction on their taxes, it doesn't make much of a difference. But there is one notable change for the 2021 tax year.
If you choose to take the standard deduction, you can also deduct an additional $300 (for those filing single or married filing separately) or $600 (for those filing as joint married couples) on eligible donations.
If you decide to donate, be sure to get documentation of the donation for your tax return.
Bonus: Find a reputable CPA
There is an abundance of do-it-yourself tax software options available for consumers like TurboTax and QuickBooks, and for small businesses as well. And you may think your tax return is simple, but Steber reiterates how important it is to have a professional — because in his eyes, "no tax return is that simple."
He strongly believes a professional tax professional is worth the investment, and he even has another tax professional review his own tax returns. "One [mistake] can cost you thousands," he said.
When searching for a tax professional, keep in mind these points:
- Check online reviews for local CPAs.
- If you're facing a unique tax situation (inheritance, selling a business, death in the family, moving, etc.), ask around to find a CPA that specializes in those areas.
- Be weary of "hucksters" promising you a guaranteed tax refund.
- Ask for an exact price for their services when shopping around.
There are two things guaranteed in life: death and taxes. While organizing and preparing your taxes is probably low on the fun scale, it's a key component to your financial wellbeing and future. And with a small amount of effort, you can easily reap the rewards of a concise tax plan.
Additionally, by planning your tax filing ahead, you can begin building your budget for 2022, including how much you'll receive for your return or how much you'll owe.