2021 Year-End Individual Tax Planning
2021 Year-End Individual Tax Planning
As we approach the end of another year, it is important to take some time to think of planning moves that may help lower your income tax costs this year.
Major changes in tax laws, from the CARES Act (March 2020) to subsequent stimulus focused legislation (e.g. ARPA March 2021), have included expanded and advanced payment of child tax credits, economic stimulus payments, and provisions associated with certain retirement distributions. These expansive legislative provisions contain many changes to the tax code designed to stimulate the economy.
Below we have compiled a list of items that may be helpful if taken into account before the end of the year. Not all will apply to you but many may. We recommend that you contact us to discuss the benefit and your eligibility before taking action to save or defer taxes.
- Defer Income and Accelerate Deductions. The standard of deferring income into a subsequent year while concurrently accelerating deductions to defer income tax costs will continue to provide quantifiable benefits that can be accomplished quickly. WARNING deferring income tax costs into a subsequent year does not always result in lower tax costs and may in fact increase your tax bill if the rates of taxation are higher in the subsequent year(s). Careful evaluation may be needed, especially for those who anticipate higher income or tax rates in the future.
- Retirement funding/conversions
- Contributions: Consider accelerating contributions to your employer provided retirement account up to the 2021 maximum of $19,500 ($26,000 if over 50 years old). In addition, if eligible, make contributions to your Traditional, Roth, and/or SEP IRA retirement accounts to maximize current and potential long term tax savings/deferrals.
- Roth IRA conversion: Conversion to a Roth IRA from a Traditional IRA may be taxable. Timing the conversion in a tax year in which your total anticipated taxable income will be low may be beneficial in the long term.
- Required Minimum Distributions (RMD): Remember to take your RMD before December 31 to avoid an excess accumulation tax. The SECURE Act delayed the requirement to take a distribution from any retirement account (IRA, 401(k), etc.) until age 72. Although you may not have a requirement to make a distribution, sometimes gaining access to retirement funds in years where your taxable income may be low may benefit you in the long term.
- RMDs are BACK in 2021, after being waived for 2020.
- If you are eligible, you may wish to consider a Qualified Charitable Distribution from your qualified retirement account to fulfill any RMD requirements and exclude the earnings from your taxable income concurrently.
- Capital gains tips: Consider holding appreciated capital assets for at least 12 months to take advantage of preferential long-term capital gains rates. In addition, consider utilizing any of the following methods to lessen your taxable gains prior to year-end:
- Timing capital losses: Consider disposing of securities or other capital assets with accumulated losses that you hold against taxable gains you may have already recognized in 2021.
- Maximize use of lower ordinary or capital gains tax brackets. You may be eligible for a 0% long term capital gains rate by avoiding jumps in marginal tax brackets.
- Contribution of appreciated stock: Avoid potential capital gains tax by contributing appreciated stock to charity. Donating appreciated stock entitles you to a charitable contribution at the fair market value of the stock, and also avoids the capital gains tax if you otherwise sold the stock. Although achievable, there may be limitations associated with contributions of privately held stock.
- Other: Consider ways to reduce your exposure to the 3.8% net investment income tax (NIIT) on passive income. One option, if you intend to sell appreciated assets that are not securities, is to consider structuring the sale as an installment sale so the gain recognized is spread over several years if this will allow you to stay under the income level that exposes you to the tax. Another option is to consider the advantages of a like-kind exchange of real property.
- Timing itemized deductions: The standard deduction in 2021 will be increased to $12,550 for single filers and $25,100 for taxpayers who are married filing jointly. Applying a bunching strategy to gather deductions into a single tax year in which you plan to exceed these thresholds and itemize your deductions can be beneficial. In the non-bunch year, you would then still obtain the benefit of the standard deduction and maximize use of all deductions, for both years (primary opportunities are state and local taxes, cash and non-cash charitable giving, and medical).
- Charitable giving: The CARES Act extended the limitation to a generous 100% of modified AGI on certain charitable contributions through 2021. As a result, you can accelerate any charitable giving plans in 2021 through direct contributions, donor advised funds, or other means to receive a deduction up to 100% of your income. Any unused deductible contributions are eligible to be carried over into subsequent years.
- $300 ($600 if married) above-the-line charitable deduction for individuals who do not itemize their deductions is available for cash contributions made in 2021.
- Arizona state tax credit contributions: In general, certain charitable contributions that provide for a dollar-for-dollar state tax credit remain non-deductible for federal tax purposes. However, you have flexibility in timing your tax credit contributions through April 15th, 2022 to still receive a 2021 tax credit. For contribution limits and an overview of several popular Arizona tax credit programs, please review our summary on our website.
- Gifts before year end: Make any gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $15,000 in 2021 ($16,000 in 2022) to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets (if they are not subject to the kiddie tax).
- Kiddie tax: In 2021, children with greater than $2,200 in unearned taxable income will again be taxed at their parents’ rate. Deferring or moving taxable income to your children does require some thoughtful consideration but can have the added benefit of reducing your exposure to higher tax rates. Tax exempt holdings such as municipal bonds can help in reducing your child’s unearned income below the threshold for reporting.
- Investing in education: Amounts contributed to a 529 plan grow tax-free and distributions from the plan are not treated as income to the extent they are used to pay for qualified education expenses. Contributions to a 529 account may also qualify for a state tax deduction.
- Health Savings Account (HSA): Contributions to an HSA account are deductible (within IRS-prescribed limits), earnings on the account may avoid taxation, and distributions are tax-free if made for qualifying medical expenses. The CARES Act expanded the use of these accounts for nonprescription medical products and eligible contributions to an HSA account can be made through April 15th, 2022 to receive a deduction on your 2021 income tax return.
Other items to consider – Ask us about:
- The Qualified Business Income deduction which could be as much as 20% of your self-employed business income, pass-through income from business operations, and/or rental real estate activities.
- Your employer-provided Flexible Spending Account should be checked to spend down any remaining funds before year end to avoid forfeiting the account balance. Contributions to FSAs provide use of tax-free dollars to pay medical expenses and dependent care costs. If you choose to participate in these plans, you can contribute up to $2,850 during the 2021 plan year.
- Modifying your income tax withholding from wages or estimated tax payments to avoid underpayment penalties.
- Track the miles you put on your personal vehicle for medical, charitable, and business purposes as each may be deductible to you based on published federal mileage rates.
- Count the days in which your vacation home was used personally and rented to third parties as it may impact your ability to deduct the operating expenses for the home. Remember that short term rentals (such as AirBnB) may NOT be considered a rental and may be subject to other reporting requirements.