Whether you’ve already completed your 2019 tax return or you’re nearly there, you’re probably feeling a sense of relief and accomplishment now that tax season is drawing to a close. But don’t stop yet! You’ve got momentum, and now is a great time to get organized for next year’s taxes. Because this year’s tax deadline is later than usual, the 2020 deadline is just 9 months away instead of 12.
Here are four ways you can start preparing for next year’s taxes today.
1. Make a plan for your retirement contributions
In order to have a comfortable retirement later, you’ll need to start saving now.
In 2020, taxpayers under 50 can contribute up to $6,000 to an IRA and $19,500 to a 401(k). When you have an IRA with Wealthfront, we make it easy to max out your contributions with the tap of a button. When you open and fund a Wealthfront IRA, you can contribute additional funds directly from your Cash Account. But even if you house your IRA elsewhere, set up automatic contributions that bring you to the maximum. You’ll be glad you did.
If you’re interested in funding an IRA but you’re not sure which kind to use, check out Wealthfront’s IRA Account Selection Tool to learn more about your IRA eligibility.
2. Consider a Roth conversion
Tax rates are relatively low right now. If you anticipate you’ll be in a higher bracket after retirement, you might want to convert your traditional IRA to a Roth IRA. While you’ll pay taxes on the amount converted, you won’t pay taxes on your withdrawals in retirement. Roth IRAs also come with superior liquidity as compared to other retirement accounts (although temporary provisions in the CARES Act currently make it easier to access funds from a range of retirement accounts early).
For more information on who might benefit from a Roth conversion, check out our blog post about the two most common situations in which they’re beneficial. Typically, the Roth conversion process is tedious and requires lots of paperwork. But Wealthfront’s Roth conversions are designed to be effortless and automated.
3. Strategize for an IPO or other windfall
Is your company about to go public? If so, in addition to celebrating, it’s a good idea to prepare for a potentially hefty tax bill. You’ll likely want to hire a qualified accountant to guide you through this process, but here are some tips to get you started.
Pay quarterly estimated taxes: If you anticipate owing money on your 2020 taxes because you received (or will receive) income that wasn’t subject to tax withholding, you’ll likely need to pay estimated taxes each quarter to avoid underpayment penalties and interest. Since the exact amount is difficult to predict, the “safe harbor rule” states you’ll be okay if you pay 100%-110% of the previous year’s tax liability (depending on your income). When it comes to state taxes, rules vary. In California, for example, the safe harbor rule doesn’t apply to people earning over $1 million.
Shoot for long-term capital gains: Short-term capital gains are taxed at the same rate as your regular income (up to 37%), and long-term capital gains are taxed at 0%, 15%, or 20%. You’ll likely want your gains to qualify for the latter, which means you’ll need to hold your investments for 366 days after purchasing them. You may owe an additional 3.8% Net Investment Income Tax (NIIT) on capital gain income if your modified adjusted gross income is over $250,000 (for married joint filers) or $200,000 (as a single filer).
In the case of IPOs and stock options, it gets more complicated. With Incentive Stock Options (ISOs), for example, you must wait at least one year and one day after exercising an option to sell it –– and at least two years and one day from when you were granted the option –– to have your profits taxed at the long-term capital gains rate.
Create a donor advised fund (DAF): Unsure of where to donate your money? Open a DAF. You can deduct your contribution this year, then spread out your giving over time. If you choose to contribute appreciated stock to your DAF, be sure to use long-term held positions, which will allow you to take a charitable deduction at the current fair market value. If you donate short-term held positions, your charitable deduction is limited to the lesser of fair market value or cost basis.
4. Start using a tax-loss harvesting service (if you don’t already)
Tax-loss harvesting takes advantage of investments in your portfolio that have declined in value and uses them to offset your other taxable gains, thus lowering your tax bill. If you don’t already use a tax-loss harvesting service, now is a great time to start. If you start tax-loss harvesting now, you can reduce your tax liability in the years ahead – beginning with your 2020 tax return. Tax-loss harvesting becomes even more valuable the more frequently you add deposits to your account.
That said, not all tax-loss harvesting services are created equal. We’ve tested Wealthfront’s service against our competitors, and the results lead us to believe that ours offers a superior benefit. Wealthfront’s Tax-Loss Harvesting is available for all Investment Accounts and takes advantage of daily market volatility (instead of waiting until the end of the year as a traditional advisor is likely to do). As a result, our service has historically generated estimated after-tax savings worth many times our annual advisory fee of 0.25% whether the market is up or down. In short, it pays for itself and will generate tax savings for years to come.
Some people dread tax season, but you don’t have to. Instead, use it as an opportunity to optimize your finances for the next year. You’ll be glad you did.
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About the author(s)
Scott Peterson is a Partner in Moss Adams Private Client Practice. He has practiced public accounting since 2009. He focuses on the tax aspects of estate planning, including gift planning and trust taxation, to help his clients achieve their financial goals and manage their tax liabilities efficiently. He can be reached at (408) 558-3274 or firstname.lastname@example.org. Assurance, tax, and consulting offered through Moss Adams LLP. ISO/IEC 27001 services offered by Cadence Assurance LLC, a Moss Adams company. Wealth management offered through Moss Adams Wealth Advisors LLC. View all posts by Scott Peterson, CPA
The Wealthfront Team believes everyone deserves access to sophisticated financial advice. The team includes Certified Financial Planners (CFPs), Chartered Financial Analysts (CFAs), a Certified Public Accountant (CPA), and individuals with Series 7 and Series 66 registrations from FINRA. Collectively, the Wealthfront Team has decades of experience helping people build secure and rewarding financial lives. View all posts by The Wealthfront Team