February 17, 2021
Goodbye, 2020. Hello, tax season. Individual taxpayers have until April 15, 2021, to pay Uncle Sam for taxes owed for 2020. (Remember, you can extend the deadline for filing your return until October 15, but you can’t extend the deadline for paying what you owe without penalty.)
Unfortunately, many people are struggling to make ends meet during the COVID-19 pandemic. If cash is tight, consider these six last-minute ideas to lower last year’s federal income tax liability.
1. Contribute to a Traditional IRA
If you’ve not yet made a deductible traditional IRA contribution for the 2020 tax year, you can still do so until April 15. Then you can claim the resulting write-off on your 2020 return, assuming last year’s income wasn’t too high to qualify. You also can potentially make a deductible contribution of up to $6,000 or up to $7,000 if you were age 50 or older as of December 31, 2020. If you’re married, your spouse can do the same.
Important: Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, you can now make traditional IRA contributions regardless of your age. Before the SECURE Act, you lost the right to make traditional IRA contributions after reaching age 70½. Thankfully, that restriction is now gone.
There are two ground rules for deductible IRAs. First, you must have enough 2020 earned income (from jobs, self-employment or taxable alimony received) to equal or exceed your IRA contributions for the 2020 tax year. If you’re married, either you or your spouse (or both) can be the source of the necessary earned income.
Second, deductible IRA contributions are phased out (reduced or eliminated) if last year’s income was too high. Here are the phaseout ranges for 2020:
- If you’re unmarried and were covered by a tax-favored retirement plan in 2020 (whether an employer-sponsored plan or a self-employed plan), your eligibility to make a deductible contribution for last year is phased out between adjusted gross income (AGI) of $65,000 and $75,000. For married filing separately, the phaseout range is $0 to $10,000.
- If you’re unmarried and weren’t covered by a plan in 2020, your eligibility to make a deductible contribution isn’t affected by your AGI. You can make a fully deductible contribution up to the applicable limit, assuming you have enough earned income.
- If you’re married and both you and your spouse were covered by retirement plans in 2020, the eligibility of both you and your spouse to make deductible contributions for last year is phased out between joint AGI of $104,000 and $124,000.
- If you’re married and weren’t an active participant in an employer-sponsored retirement plan for 2020, but your spouse was, your deductible IRA contribution phases out with AGI of between $194,000 and $206,000. (The participating spouse’s eligibility is phased out between joint AGI of $104,000 and $124,000.)
If you’re married and neither you nor your spouse were covered by a plan, your eligibility to make a deductible contribution isn’t affected by your AGI. You and your spouse can both make fully deductible contributions up to the applicable limit, assuming you have enough earned income.
2. Make a Deductible Health Savings Account (HSA) Contribution
If you had a qualifying high-deductible health plan (HDHP) last year, you can still make a deductible HSA contribution for your 2020 tax year if you’ve not already done so. The contribution deadline is April 15.
For 2020, the maximum deductible HSA contribution is $3,550 for self-only coverage or $7,100 for family coverage (anything other than self-only coverage). More specifically, if you’re eligible to make an HSA contribution for last year because you had a qualifying HDHP, you have until April 15 to establish an account and make your rightful deductible contribution.
Important: The write-off for HSA contributions is an above-the-line deduction. That means you can take the write-off even if you don’t itemize.
The HSA contribution privilege isn’t phased out for high-income taxpayers, as long as they have qualifying HDHPs and meet other eligibility requirements.
3. Deduct State and Local SalesTaxes (Instead of State and Local IncomeTaxes)
If you live in a jurisdiction with low or no personal income tax or if you owe little or nothing to state and local income tax collectors, you have options. You can potentially claim itemized deductions on last year’s return for either:
- State and local general sales taxes, or
- State and local income taxes.
Important: Under current tax law, you can’t deduct more than $10,000 for all categories of state and local taxes combined ($5,000 if you used married filing separate status).
The sales tax option is only relevant if your allowable itemized deductions for last year would exceed your allowable standard deduction for last year. The standard deduction for 2020 was:
- $24,800 for most married couples who file jointly,
- $12,400 for most singles and those who use married filing separate status, and
- $18,650 for most heads of households.
Higher standard deductions apply for those who were age 65 or older on December 31, 2020.
If you can benefit from choosing the sales tax option, you can use an IRS-provided table (based on your income, family size, state of residence, and local sales tax jurisdiction) to figure your allowable sales tax deduction. But if you kept receipts from 2020 purchases and that gives you a bigger write-off, you can add up the actual sales tax amounts and deduct the total.
Even if you use the IRS table, you can add on actual sales tax amounts from major purchases, such as:
- Motor vehicles (including motorcycles, off-road vehicles and RVs),
- Aircraft, and
- Home improvements.
In other words, you can deduct actual sales taxes for these major purchases on top of the predetermined amount from the IRS table.
4. Add Up Health Insurance Premiums and Medical Expenses
If you itemize deductions on your 2020 tax return, you can potentially claim a deduction for qualifying medical expenses you paid last year. This includes premiums for private health insurance coverage and premiums for Medicare health insurance.
Specifically, you can claim an itemized medical expense deduction if your total qualifying expenses exceed 7.5% of your adjusted gross income (AGI) for the year. Under current tax law, the standard deduction amounts have been significantly increased for 2018 through 2025. So, fewer individuals will be itemizing on their 2020 returns. But having significant medical expenses may allow you to itemize and collect some tax savings.
Important: If you’re self-employed or an S corporation shareholder-employee, you can probably claim an above-the-line deduction for your health insurance premiums, including Medicare premiums. That means you don’t need to itemize to get the tax-saving benefit.
5. Take Advantage of COVID-19 Tax Relief for Certain Small Business Owners
Several COVID-19 federal tax relief measures are potentially available to eligible S corporation shareholders and owners of unincorporated businesses, including:
- Sole proprietorships,
- Single-member limited liability companies (LLCs) treated as sole proprietorships for tax purposes,
- Partnerships, and
- Multi-member LLCs treated as partnerships for tax purposes.
These relief provisions can significantly improve your personal tax situation. For example, you can carry back a 2020 business net operating loss (NOL) for up to five years and recover some or all of the personal federal income tax paid for the carryback year(s). Your tax pro can help you maximize tax-saving benefits of available COVID-19 relief provisions.
The federal income tax filing deadline for individuals is just around the corner. So, if you haven’t yet filed (or extended) your 2020 return, contact your tax advisor. He or she can help soften your tax hit with these and other planning moves.