Tax Strategies You Don’t Want to Miss Before the End of the Year

Many taxpayers will benefit from tax-loss harvesting this year, as well as changes in the rules around charitable giving

connecting the dots

Legislation that became effective last year includes a new break for charitable donations. ILLUSTRATION: MIKEL JASO

To paraphrase an old saying, nothing may be certain in this world except death, taxes and thorny questions about tax-saving tactics.

This is an especially perplexing time for many taxpayers trying to figure out the best strategies, such as timing income, deductions and other maneuvers, amid major uncertainties about possible tax-law changes. More will be coming on that once the legislative picture becomes clearer.

Until then, here are a few ideas and opportunities to consider.

Harvest time?

After another year of strong stock-market gains, many investors should consider what can be a “very effective” strategy known as tax-loss harvesting, says Robert S. Keebler, a certified public accountant and partner at Keebler & Associates LLP, a tax and estate-planning firm in Green Bay, Wis. While it’s more fun to think about your investment winners, set aside time to focus on your losers and consider selling them. While dumping disappointing stocks and other investments at a loss may feel like a painful admission of defeat, there are several reasons that this long-cherished technique can generate valuable tax savings.

For starters, realized capital losses typically can be used to offset realized capital gains. (“Realized” means losses and gains on securities that you have actually sold, not paper gains or losses.) Also, if your losses are even bigger than your gains, you typically can deduct as much as $3,000 of those net losses each year ($1,500 if married and filing separately) from other income, such as wages. And if your net losses are even larger, they typically get carried over into future years. (Check with your state, or a tax pro, on possible differences in state-tax laws.)

Caution: Many questions remain about what, if anything, will happen in Congress to proposals calling for higher capital-gains taxes for high-income investors. Who will be affected, and by how much and when? These and other questions involving what might be in the fine print could create complex investment-timing questions for upper-crust taxpayers who may be ensnared. Depending on their facts and circumstances, they may need to consult tax and investment pros. Stay tuned for further developments.

For those considering this technique, beware of creating a “wash sale” and having your loss “disallowed,“ as the IRS puts it. A wash sale occurs when you sell or trade stock or securities at a loss and buy the same or “substantially identical,” securities within 30 days before or after the sale, IRS Publication 550 states. If you create a wash sale, you can’t deduct the loss (unless it was “incurred in the ordinary course of your business as a dealer in stock or securities.”)

To paraphrase an IRS example, suppose you bought 100 shares of a stock many years ago for $1,000. Now, you sell those shares for $750, for a loss of $250. However, within 30 days before or after that sale, you bought 100 shares of the same stock for $800, hoping for the price to rebound. You can’t deduct that $250 loss. Instead, add it to the cost of the new stock ($800), and your basis on the new stock becomes $1,050.

Charitable giving

Part of legislation that became effective last year carved out a new break for taxpayers who donate to charity and claim the standard deduction, as most do, instead of itemizing their deductions, says Mark Luscombe, principal federal tax analyst at Wolters Kluwer Tax & Accounting. For the 2021 tax year, there are a few changes, says Eric Smith, an Internal Revenue Service spokesman.

• Married couples filing jointly for 2021 can deduct as much as $600 of charitable donations if they don’t itemize, while the limit is $300 for singles. For 2020, the maximum deduction was $300 per return for joint filers and singles.

• On federal income-tax returns for 2020, this deduction was an “above-the-line” deduction, meaning it was entered above the line for adjusted gross income, or AGI. That reduced AGI, a number that can affect many other tax items. Congress “wrote the law slightly differently for 2021, making it below the line—not reducing AGI, but still reducing taxable income,” says Mr. Smith. A draft of IRS Form 1040 for 2021 shows it on line 12-b.

A few reminders on points that haven’t changed: This provision applies to “cash” donations, such as cash, check and credit cards. Make sure you have the required documentation, says Stephen W. DeFilippis, owner of DeFilippis Financial Group, a wealth-management and tax firm. Contributions of “noncash” items, such as clothing or securities, don’t count, says Mr. DeFilippis, who is also an enrolled agent, which is a tax specialist authorized to represent taxpayers at all levels at the IRS. Gifts must go to “qualified” charities; donor-advised funds aren’t considered qualified for this provision.

Meanwhile, a popular provision known as a qualified charitable distribution, or QCD, remains alive and well, says Catherine Martin, lead tax research analyst at the Tax Institute at H&R Block. With a QCD, investors 70½ or older typically can transfer as much $100,000 a year directly from an IRA to charity without owing taxes on that transfer.

This move, which must be done directly from the IRA to a qualified charity, counts toward the taxpayer’s required minimum distribution for that year. Donations to donor-advised funds don’t count. Transfers of more than the exclusion amount are included in income, the IRS says. See IRS Publication 590-B for more details.

Tax Strategies for Retirement (GRA BLOG)

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