3 Methods for Year-End Tax Planning

How to make last-minute moves to maximize your tax return

Couple preparing taxes
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Year-end tax planning is the practice of trying to maximize tax returns, avoid tax penalties, and make the most of any possible tax deductions. While this can take place at any time during the year, there are last-minute actions that taxpayers can take to tilt the tax situation in their favor.

These year-end strategies include withdrawing from or contributing to a retirement account to take advantage of tax-free withdrawals or reduce Social Security taxes. You might be able to convert a traditional IRA to a Roth IRA to take advantage of a lower tax rate. You may want to trigger capital gains while you qualify for a 0% tax rate or harvest capital losses to offset gains earlier in the year.

The specific year-end financial moves you choose to make will depend on your unique situation, but you will never discover these opportunities without doing year-end tax planning. Below are three ways you can go about it.

Use An Online Tax Prep Program

Pros
  • The software will be updated with the latest regulations.

  • As long as you input the correct information, you will get accurate solutions.

  • Software programs can prompt you to find credits or deductions you may not think of.

Cons
  • It can be cumbersome to gather tax documents and information.

  • You may need to use third-party resources to calculate more complicated situations such as the taxation of Social Security benefits.

According to the IRS, 81.3% of all tax-related filings in 2020 were filed electronically, which was a 5.7% increase from the year before. For individual taxpayers, online tax preparation software has become the most popular way to file taxes.

One of the major draws of using online software is simple and easy access, and this process will be much easier if you gather the information before sitting down to calculate your taxes. Here is the information you should collect before you get started:

  • Last year's tax return: Use this as a template to estimate what should be included in the current year's returns.
  • Pay stubs: These will show your year-to-date income and retirement plan contributions.
  • Investment statements: Forms from brokerage firms will show interest, dividends, realized gains and losses, and unrealized gains and losses in any trading or investment accounts you use.
  • Any miscellaneous information on expected income and deductions: These statements could include anything related to healthcare expenses, mortgage interest, an estimate of net income from self-employment, and information about any other tax-related transactions that occurred during the year.

To get a rough estimate of your federal tax liability for the current year, an online calculator can be a handy tool to help estimate your deductions, exemptions, and tax credits. You need to have your information on hand and input your information to the relevant text fields on the calculator.

Use Last Year's Tax Return

Pros
  • It's a quick process.

  • It takes very little effort to arrive at an estimate with this strategy.

Cons
  • You may not be aware of changes to the tax code that could impact the calculations.

  • You must have your prior year's tax information on hand.

One easy way to conduct year-end tax planning is to print last year's return, and in the margin, write in your estimate of this year's numbers. You can do a ballpark estimate by comparing this year's numbers to last year's. You can control how detailed you get by adding more information on each line entry. If you need a rough idea of your tax situation, keep things simple by only updating the line items that differ significantly from the year before.

Once you've written in your numbers, do the calculations with the new numbers to estimate your taxable income and then see what tax bracket your top tier of income falls into.

Your tax rate is determined by your income bracket. This figure alone will affect all other calculations on your return. Marginal brackets tend to change yearly, so check the IRS website for the most recent figures.

If it looks like you've landed in a higher tax bracket or otherwise have more tax liability than last year, you should look for any last-minute ways you can use deductions to reduce your liability. Alternatively, if you have room in your tax bracket to realize more income, you may decide to trigger a capital gain or otherwise increase your income.

Hire a Professional

Pros
  • A professional will know what questions to ask to help you gather the correct information.

  • They will offer specific advice for your exact situation, and can help with complex issues.

  • You won't have to do any calculations yourself.

Cons
  • This is the most expensive option.

  • Most professionals charge an hourly rate, so the longer you spend getting it right, the more it'll cost.

You can ask your CPA or qualified financial advisor to run a year-end tax projection for you. This is the most expensive option, but it's also one of the simplest ways to get the best results. You are likely to get an accurate result, as well as sensible recommendations about any options you have to improve your tax situation.

If you choose this option, you will need to provide the advisor with an estimate of everything you think will impact your tax return. Then ask them for advice about the types of retirement plans to contribute to, ways to increase deductions, or if you should intentionally realize capital gains or losses.

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