#78 – It’s that time of year! The deadline for filing your 2021 taxes is quickly approaching.
Do you have your taxes figured out?
When we say “having your taxes figured out,” we don’t mean just for the past year. If you want to optimize your overall tax picture, you need to look at your total lifetime taxes.
In this episode, Jeremy Keil gleans meaningful insights from The Wall Street Journal Tax Guide 2022. He shares key things you need to keep in mind while filing your 2021 taxes and ways to minimize your overall taxes in retirement.
- How to manage your withdrawals from different accounts for a better tax outcome
- How to avoid potential penalties using quarterly estimated tax payments
- Gifting strategies to reduce capital gains taxes and estate taxes
- Various tax limits, deductions, and exemptions you should know about
- And more
5 Things to Know Before Filing Your 2021 Taxes
1) Understanding Income Tax Brackets
Tax brackets in the U.S. are both progressive and marginal. This means that they go up as your income increases, and the top portion of your income is taxed at a different rate (marginal rate) than the lower portion of your income.
Let’s discuss an example to help you understand this better:
For married filing jointly, the tax rate jumps from 12% to 22% when your income goes over $83,550. Let’s say your income is $83,551 i.e., only a dollar over the threshold. In this case, only one dollar of your income will be subject to the increased tax rate of 22%, not the entire income.
The two biggest jumps in tax rates are from 12% to 22% (when your income crosses $83,550) and from 24% to 32% (when your income crosses $340,100).
These rates are scheduled to increase in 2026. This means that the rates you have today are likely lower than what you’ll experience in a few years. So, you might want to consider paying more tax upfront at a lower rate today.
2) Gross Income vs. Taxable Income
Your gross income is different from your taxable income.
Simply put, taxable income is the portion of your gross income that is subject to taxes.
It can be significantly lower than your gross income after you have accounted for various deductions.
Why is this distinction important? Because your taxable income is the amount that actually determines your tax brackets, not your gross income.
Also, when computing your total gross income, it’s not just income that you earned by working. It can also include income from other sources such as real estate, interest, capital gains, pension, and Social Security.
3) The “Where” and “When” of Withdrawals
Income from different sources is often taxed differently.
For instance, withdrawals from a traditional IRA are taxed as regular income, but those from Roth IRAs are tax-free.
If you’re realizing long-term capital gains (increase in value of investments held for more than twelve months), the taxes payable are usually lower than regular income taxes. This means that realizing long-term gains can be more tax-effective compared to traditional IRA withdrawals.
In addition to “where” you withdraw your money from, it also matters “when” you make the withdrawals.
The tax year is from January 1 to December 31. As you approach the end of the tax year, you can get an estimate for your total taxable income during that year. If you feel it’s going to be a low-tax year, perhaps you might consider doing Roth conversions. If you expect it to be a high-tax year, perhaps it’s better to delay some taxable withdrawals until January of next year.
When it comes to selling investments, you need to wait at least twelve months and a day for it to qualify as long-term capital gains (which are taxed at relatively lower rates).
Remember, the day you spend your money doesn’t necessarily have to be the same day you incur the taxes.
4) Avoiding a Penalty With Estimated Tax Payments
When you’re working, your employer withholds part of your salary for taxes.
But when you get your income from other sources, such as unemployment benefits (very common during COVID-19), selling stock, or real estate, no one is withholding the taxes payable for you.
If you don’t withhold enough (or make quarterly estimated tax payments), you might be subject to a penalty!
In general, you ought to pay at least 90% of taxes owed throughout the year. The quarterly payments are due in April, June, September, and January. If you don’t want to make quarterly payments, make sure that you withhold enough on your Social Security or IRA withdrawals.
To get the withholding/estimated payments right and avoid the penalty, don’t leave your tax planning to a few weeks before the deadline!
5) Credits, Deductions, and Exemptions
In 2021, the government offered a stimulus payment of $1,400 per household member. If you did not take it, now’s the time for you to redeem it as a tax credit while filing your 2021 taxes. You’ll qualify if your adjustable gross income was less than $75,000 in 2021 as a single taxpayer or $150,000 as a married taxpayer.
When it comes to giving money to someone, you’re exempt from taxes up to a certain amount. In 2022, you can give away $16,000 every year without having to pay gift/estate taxes. The total exemption limit over your lifetime is $12,060,000 (nearly $24 million as a couple).
Plus, if you pay someone’s tuition or medical expenses, there is no gift tax. So, feel free to help your kids and grandkids with medical bills or college expenses without worrying about taxes!
You can also give away money to your favorite charities tax-free. When you transfer your money directly from your IRA to the charity (known as qualified charitable distributions), it is transferred tax-free.
Donor-advised funds are another great tool to reduce your gift taxes. Learn more about donor-advised funds here: 5 Reasons To Set Up a Donor-Advised Fund Today.
If you want to be exempt from capital gains taxes, consider giving away an appreciated asset directly to charities without selling them.
Finally, you also get to subtract some deductions from your gross income. In 2022, the standard deductions are $12,950 for single filers and $25,900 for married couples filing jointly. After age 65, this amount increases by $1,750 for single filers and by $2,800 for couples. For charitably inclined people, there is also a charitable deduction of $300 allowed per person.
Do you want to learn more about tax planning? Check out the resources below!
If you have any questions, feel free to contact us and we’ll be more than happy to assist you!
- The WSJ Tax Guide 2022 (You’ll need to subscribe to WSJ to access the full guide!)
- Ep. 60: “5 Reasons To Set Up a Donor-Advised Fund Today”
- Blog: “5 Ways to Improve Your Tax Picture in Retirement”
- 3 Things You Should Know Before Choosing A Financial Advisor
- 6 Questions Retirees Aren’t Asking But Should Be
- Subscribe to Retirement Revealed on Google Podcasts
- Subscribe to Retirement Revealed on Apple Podcasts
Connect With Jeremy Keil:
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