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It’s Not Too Late to Lower Your 2020 Tax Bill – If You Do This Now

Budget a few hours to straighten out your 2020 tax liability.

The turn of the calendar from 2020 to 2021 is nothing more than a flip of the proverbial page, but your CPA may beg to differ. 2021 marks the start of a new accounting period, which in and of itself can bring a flurry of confusion to the average taxpayer. Given that we still have a few months until tax returns are due, it’s advisable to think now about how you can lower your 2020 tax liability — even though 2020 has already come to a close. Below we’ll explore a popular way you can lower your taxes due — contributing to a traditional IRA.

Retroactively contribute for 2020

The calendar year has obviously concluded, but the IRS gives you a three-and-a-half-month “regrouping” period before your tax return actually needs to be filed (that is, Jan. 1 through April 15). During this time, you should be thinking of your spending activity in 2020: Did you make any charitable contributions? Did you have any medical expenses that were not covered by insurance? These questions, among others, are central to the “look-back” process that occurs before April 15.

One widely applicable and simple way to lower your tax liability for 2020 is to contribute to a traditional IRA. Assuming you meet the income limits and eligibility criteria to do so, a maximum contribution of $6,000 ($7,000 for those over age 50) will lower your gross income by the same amount . If you have cash available to make such a contribution, or if you have low-risk money in a taxable brokerage account, you might consider moving money to a traditional IRA to receive an immediate tax benefit for 2020.

Cartoon of man swinging sword at the word Tax

Image source: Getty Images.

Read the fine print

This strategy works for people in very specific circumstances. In the simplest example, assume you are a single taxpayer. If you are covered by a workplace retirement plan, such as a 401(k) or 403(b), you are eligible to contribute to a traditional IRA if your AGI (Adjusted Gross Income) is less than $61,000; if you are not covered by a workplace retirement plan, your contribution is fully tax deductible .

Furthermore, the $6,000 limit on IRA contributions applies to the sum of contributions to traditional and Roth IRAs, meaning that if you have already contributed the maximum to a Roth IRA, the traditional IRA contribution and corresponding deduction will not be available to you. Simply put, you need to look at your traditional and Roth contributions as a single number when comparing it to the annual limit.

Right for some, but not for others

The deduction will work for some, but not for all taxpayers, and will generally benefit single taxpayers making less than $61,000 and married taxpayers collectively making less than $98,000. This deduction will also work for those who are not covered by a workplace retirement plan. Additionally, for a traditional IRA to be preferable to a Roth IRA, you would also need to expect your tax rate to be higher now than it is in retirement.

If you find yourself outside of this scenario, it definitely makes sense to look at a Roth IRA contribution — or, if you’re above the income limits to contribute directly to a Roth, a Backdoor Roth IRA contribution. While you will receive no immediate tax benefit for adding to a Roth IRA, you will reap significant benefits over the long term, as the account will never be taxed again.

Do this by April 15

If you do fall into an eligible category for IRA contribution and deduction, make sure to actually make the contribution by April 15 to lower your tax liability for last year. Many of the popular tax programs will prompt you to do this if you fall into a tax scenario that calls for such a contribution.

Even if you fall outside the parameters for inclusion, there is still time for you to improve your overall tax profile, including contributing to a Roth IRA or considering a Backdoor Roth IRA. Regardless of the road you take, there is still time to affect the 2020 accounting period.

Source: The Motley Fool

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