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2020-21 Tax & Investment Considerations

2020-21 Tax & Investment Considerations

February 19, 2021
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Benjamin Franklin said it best: “…in this world, nothing is certain except death and taxes.”

With each new year comes everyone’s favorite season: tax season. For many, tax season is confusing and stressful, often presenting the tough decision between filing yourself or hiring a tax professional.

Generally speaking, our clients tend to have more complex tax situations, which is why we encourage hiring a professional tax preparer. If you can find a good certified public accountant (CPA), it may be worth it to dip into your wallet—even if your situation is relatively non-complex.

I’ll start by stating that I am not a tax professional—if you have comprehensive tax questions, I recommend speaking with your tax professional. If you do not utilize a tax professional, we are happy to provide a couple of trusted references.

In this podcast, I discuss the potential benefits of working with a professional CPA. More importantly, I discuss several tax season investment considerations that all filers should make.

DON’T MESS WITH THE IRS

[1:28] Don’t mess with the IRS. That’s a Denver Wealth Management (DWM) principle by which I firmly abide.

I’m sure many taxpayers have faced their computer screens, wrestling with the notion of fudging a couple numbers—maybe adding an extra zero to charitable write-offs—in hopes of a small tax-break. Who’s going to call you out on that?

My advice: When you wade into that moral grey area, anxiety tends to follow. On the off chance that you are audited, and the IRS finds a mistake, it’s easier to own up to errors with sincerity.

In this situation, having a professional tax preparer can alleviate some of that stress. In the same event that the IRS audits you and they find a mistake, you can refer to your tax preparer to inquire about the reason for the error.

2021 TAX & INVESTMENT CONSIDERATIONS: TAX TIMING

[3:50] If you are a member of our weekly email club, Market Insights, you may have noticed an uptick in our recent reference to IRAs. You may have even benefitted from some of our fun financial trivia surrounding individual retirement arrangements (IRAs).

If you did not contribute to a traditional or Roth IRA in 2020, you have until April 15th of this year (2021) to make those contributions. Contribution limits for these tax-advantaged investment vehicles are determined based on an investor’s adjusted gross income (AGI), which is often calculated at the time of filing for taxes. Thus, the IRS gives investors some leeway to calculate their annual AGI as it pertains to their tax-advantaged accounts. How’s that for IRA trivia?

2021 TAX & INVESTMENT CONSIDERATIONS: TRADITIONAL IRA

Let’s briefly touch on the various account types and contribution limits, starting with the traditional IRA. For single-filers who earned less than $65,000 ($104,000 for joint filers) in the 2020 tax year, contributions to a traditional IRA are tax-deductible.

Deduction limits phase out between $65,000 and $75,000 ($104,000-$124,000 for joint filers). Beyond the phase-out limit, contributions are no longer tax-deductible. However, an investor may make nondeductible contributions to a traditional IRA, still benefitting from the tax-deferred growth.

Please note that the limits mentioned above are regarding plan participants (i.e., employees investing in a work-sponsored retirement account). If you do not participate in a work-sponsored plan—perhaps it’s not offered—tax-deductible contribution limits are higher. If this is your situation, we are happy to discuss it in further detail.

2021 TAX & INVESTMENT CONSIDERATIONS: ROTH IRA

A Roth IRA (and Roth 401(k), for that matter) is different in that contributions are made with post-tax dollars—they are not tax-deductible. The benefit to a Roth investment option is the tax-deferred growth as well as tax-free distributions. And, there is no required distribution age for a Roth IRA.

In the 2020 tax year (unchanged in 2021), investors can make contributions of up to $6,000 annually. Investors over the age of 50 can contribute an additional $1,000 “catch-up” annually.

Roth contribution limits do not refer to tax-deductions but rather the contributions as a whole. Individuals earning below $124,000 (AGI) annually ($196,000 for joint filers) may make full contributions. From $124,000 to $139,000 ($196,000 to $206,000 for joint filers), contribution amounts phase out. Individual filers who earned above $139,000 (joint, $206,000) in the 2020 tax year cannot contribute to a Roth IRA.

2021 TAX & INVESTMENT CONSIDERATIONS: SELF-EMPLOYED EARNERS

I won’t go too far into depth here, but self-employed workers or small business owners have other tax-deductible investment options, including SEP IRAs, SIMPLE IRAs, or 401(k)s that may help alleviate your potential tax liability. If you fall into this category, please reach out, and we would be happy to explore your options further.

2021 TAX & INVESTMENT CONSIDERATIONS: HEALTH SAVINGS ACCOUNTS

[5:18] Health savings accounts (HSA) are triple tax-advantaged in that they offer incentives on the way in, during, and on the way out.

An HSA is a facet of your health insurance. Essentially, contributions are deducted from your paycheck pre-tax. While in the account, earnings grow tax-free. Then, when used for qualified medical purposes, the deductions are taken out tax-free.

If you qualify, you can participate as an individual or family.

HOME OFFICE WRITE-OFFS

[5:57] As many folks have made the transition to remote working in the past year, I felt this would be a good point to touch on. Yes, you can generally write-off (deduct) your home office from your taxes, but the benefit is relatively over-hyped.

To calculate the deductible amount, you divide the square footage of your workspace from the total square footage of your home. If you can, certainly talk with your professional tax preparer about the deduction; however, don’t get too excited for a pile of money in the form of your tax return.

CHECK IN WITH YOUR FINANCIAL ADVISOR

[6:24] Tax season is a great time to check in with your financial advisor. While we don’t explicitly give tax advice, we can help you establish a financial plan that addresses your long-term financial objectives in a tax-efficient manner.

We would be happy to discuss your current investment vehicles, various options that may reduce your tax liability, and the various contributions you should make based on your income, lifestyle, family, etc.

FINAL THOUGHTS

[6:45] Before I wrap up, I want to make one last comment regarding saving your tax returns. The IRS states that you should keep returns on hand for at least seven years. If you don’t itemize (i.e., you’re strictly a W-2 earner), your W-2 or K-1 should suffice.

Once your tax situation becomes more complex—1099 and additional income sources—it becomes crucial to conserve itemized returns.

As we approach April 15th, it may be wise to consider alternative tax-advantaged investment vehicles. If you have any questions regarding the tax liability of your investment accounts, or if you would like to discuss your long-term financial plan, please call our office at (303) 261-8015. You may also request a free consultation here.

  

Disclosures

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing includes risk including the possible loss of principal. No strategy assures success or protects against loss.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Traditional IRA account holders should consider the tax ramifications, ages, and income restrictions in regard to executing a conversion from a Traditional to a Roth IRA. The converted amount is generally subject to income taxation.

The Roth IRA offers tax deferral on any earnings in the accounts. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may results in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

All information is believed to be from reliable sources; however, Denver Wealth Management, Inc. and LPL Financial make no representation to its completeness or accuracy.