Last month, billionaire (and sometimes a little bizarre) entrepreneur Elon Musk raised eyebrows when he asked his Twitter followers whether he should sell 10% of his Tesla stock. More than half, or 58%, of his followers said yes, he should sell.
This tweet was actually more than a publicity stunt. Musk owns 23 million shares of Tesla stock options that will expire in August of next year. If sold, these would generate a capital gain of close to $28 billion and a tax bill of about $15 billion for Musk. Before the end of this year, he has to decide the most tax-efficient way to sell the shares.
If he sells all the shares this year, he’ll owe the full $15 billion in capital gains tax in 2022. But if he splits the sale between this year and next year, he can split the tax payment. Musk will eventually pay the same amount of tax, but splitting the sale would let him hold onto some of his billions for a little longer and invest the money to generate a return that could help offset his tax bill.
Tax Lessons for Non-Billionaires
While it’s not likely that you are currently faced with making billion-dollar year-end tax decisions, there are some lessons that you might be able to take away from Musk’s situation. This is especially true if you own stock options. Exercising all of your stock options before the end of this year could bump you into a higher tax bracket for tax year 2021, which could boost your federal income tax bill.
Now is also a good time to consider whether you should sell any stocks that have declined in value and use the loss to offset gains in other stocks. You can use this strategy, which is referred to as tax loss harvesting, to offset up to $3,000 in taxable gains per year. If you don’t have this much in capital gains, you can use the loss to offset up to $3,000 per year in ordinary income.
You can also carry investment losses forward to offset capital gains and ordinary income in future years. For example, if you sell a stock before December 31 and book a $5,000 loss, you could use $3,000 of the loss to offset a capital gain on another stock this year and carry $2,000 forward to offset capital gains on another stock next year.
If you believe that a stock will bounce back and don’t want to give up on it just yet, you can buy it back as long as you wait 30 days after the sale date. This is known as the IRS “wash sale” rule. Or you could buy a similar stock or mutual fund in the meantime. If you’re selling stock in Intel, for example, you could buy shares in a semiconductor index fund.
Three More Strategies to Consider
Here are a few more year-end tax strategies to consider between now and December 31:
1. Defer income and accelerate expenses. This is the classic year-end tax move designed to push some income into next year and accelerate some deductible expenses into this year in order to lower current income. If you will receive a year-end bonus, for example, ask your employer to pay it in early January. Or if you’re self-employed, wait until after the new year to send out December invoices.
To accelerate deductible expenses, you could make your January 2022 mortgage payment before December 31 and pre-pay property taxes that will be due early next year.
2. Make a last-minute charitable donation. Act quickly to take advantage of charitable giving tax breaks that expire at the end of this year. In 2021, you can deduct up to $300 (or $600 if you’re married and file jointly) in cash donations made to qualified charitable organizations even if you don’t itemize deductions on your tax return. Normally, Schedule A must be completed in order to deduct charitable contributions.
Also, you can deduct up to 100% of your adjusted gross income (AGI) in charitable contributions you make in 2021. The normal limit is 60% of AGI and the law will revert to this limit in 2022 unless Congress acts to extend the tax break.
3. Max out your retirement plan. This is one of the best ways to save current taxes while also boosting your retirement savings. This year, you can contribute up to $19,500, or $26,000 if you’re 50 years of age or over, to your 401(k) plan. If you have an IRA, you can contribute up to $6,000 this year, or $7,000 if you’re 50 years of age or over (this is the annual limit for combined traditional and Roth IRA contributions).
Note that these contributions don’t have to be made by December 31. You have until your tax-filing deadline (including extensions) to make deductible retirement plan contributions. However, now is a good time to think about how to maximize your contributions for tax year 2021.
Be sure to consult with your tax professional and financial advisor about these and other year-end tax planning strategies.