Quick Year-End Tax Planning Ideas
Numerous news outlets have reported that the Biden Administration continues to seek a path forward for its “Build Back Better” economic stimulus and social spending plan, despite not having the support of key Democratic Senator Joe Manchin. In an evenly divided Senate, the Democrats will need the support of every member of their party in order to advance the legislation. But while 2021 was filled with a lot of talk of tax reform, 2021 will very likely conclude without any significant tax legislation getting passed and income and capital gains tax rates remaining the same.
With our newfound clarity, here are several year-end tax planning ideas for taxpayers to consider in order to reduce their potential tax bills.
- Defer income and accelerate deductions. This is usually an excellent strategy for taxpayers, except for wealthy taxpayers (see below).
- A proposed surcharge on wealthy taxpayers continues to gain momentum amongst lawmakers and might become effective in 2022. Taxpayers with modified adjusted gross income, defined as adjusted gross income less investment interest expense, in excess of $10 million would be assessed a 5% surcharge on the modified adjusted gross income. Taxpayers with modified adjusted gross income above $25 million would be assessed a 3% surcharge on the modified adjusted gross income. Wealthy taxpayers would be advised to accelerate their income, where possible.
- Minimize capital gains / tax loss harvesting. Consideration should be given to all investments and asset classes, including cryptocurrencies. Tax-loss harvesting generates capital losses by selling investments that are currently worth less than what was paid for them. These losses can be offset against capital gains that are recognized during the year. If a taxpayer’s capital losses exceed their capital gains, the taxpayer can use up to $3,000 of the excess loss to offset other income. Any remaining excess losses can be used as offsets in future years. Taxpayers with significant investment income may also be subject to the Net Investment Income Tax (3.8%).
- Explore strategies that spread income, such as installment sales. An installment sale is a sale of property where the seller will receive at least one payment after the tax year in which the sale occurs. Taxpayers are required to report a gain on an installment sale under the installment method unless the taxpayer chooses to “elect out” on or before the due date for filing your tax return (including extensions) for the year of the sale.
- Invest eligible gains into qualified opportunity zone funds. Subscribers to the blog know that we spend a lot of time covering opportunity zones. The rules of the program can be complex, but the benefits speak for themselves! The deadline to invest an eligible gain into a qualified opportunity zone fund and receive the 10% step up in basis on the original invested gain is imminent (December 31, 2021). Click here to learn more.
- Convert traditional IRAs to Roth IRAs. Considering the proposed surcharge discussed above, wealthy taxpayers might want to do the conversion now. As a reminder, withdrawals from traditional IRAs are taxed at ordinary income tax rates, whereas withdrawals from Roth IRAs are tax free.
- SEP-IRA retirement account contributions. Self-employed individuals may be able to contribute up to $58,000 to their SEP-IRA retirement account for 2021. And the best part? If the taxpayer extends the filing of their tax return, they will have until October 15, 2022 to fully fund their contribution!
- Align tax planning with charitable giving for those with philanthropic goals. In tax years with large income events, taxpayers should maximize their charitable gifts in order to generate larger charitable deductions.
- Utilize the estate and gift tax exemptions. The lifetime estate tax exemption amount is $11.7 million and allows transfers of property to non-spouse beneficiaries during the donor’s lifetime or upon their passing without paying any gift or estate tax. The exemption is set to expire after 2025. Taxpayers can also give $15,000 annually per person without any gift-tax consequences. That’s $30,000 for married filing jointly taxpayers!
- Maximize the Qualified Business Income deduction. This deduction, which was created by the Tax Cuts and Jobs Act of 2017, allows non-corporate taxpayers to deduct up to 20% of their qualified business income, plus up to 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income. This is also known as the Section 199A deduction. Taxpayers with projected income at or near the phase-out limits of the deduction ($329,800 for married filing jointly and $164,900 for single) should attempt to reduce their taxable income in order to generate the biggest possible qualified business income deduction.
For business owners and employers, the following strategies might make sense:
- Evaluate accounting method changes. Changing an accounting method may be a great way to reduce taxable income for a given tax year by accelerating deductions into the year or deferring income into a subsequent year. Under the right circumstances, this flexible tax planning strategy could generate immediate tax savings, improved cash flow, and in some cases, provide permanent tax benefits for businesses.
- Electing passthrough entity taxation. Several states responded to the federal state and local tax deduction limit ($10,000) by allowing passthrough entities the option of calculating and paying tax at the entity level. The IRS approved these elections as a legitimate workaround, which led to a multitude of states to enact pass-through entity tax elections. The summary and analysis found here can help taxpayers determine whether a state’s election makes sense for them.
- Work Opportunity Tax Credit. The credit was broadened in 2021 to include the newly extended authorized federal empowerment zones. Employees between the ages of 18 and 40 that reside in a federal empowerment zone are eligible to generate a federal income tax credit of up to $2,400. Other eligibility categories are increasingly relevant as a result of the COVID-19 pandemic, including the long-term unemployment category. To be eligible, new employees must be in a period of unemployment that has lasted at least 27 weeks and at some point have received either federal or state benefits. Categories also include food stamp recipients, temporary assistance for needy family recipients, certain veterans, and ex-felons.
- Employee Retention Credit. Although the credit was repealed for the fourth quarter of 2021, the Employee Retention Credit presents an opportunity for eligible employers that experienced a significant decline in gross receipts or were fully or partially suspended by a government order. As a reminder, employers have three years to amend payroll tax returns for refunds of up to $7,000 per employee per quarter in each of the first three quarters of 2021 – and up to $5,000 per employee in 2020. The IRS continues to issue notices and revenue procedures to help employers understand whether they qualify for the credit, and to expand relief qualifications for many organizations.
- Perform a cost segregation study. A cost segregation study identifies assets used in a trade or business that can be depreciated at an accelerated rate using a shorter depreciation life. These assets may be part of newly constructed buildings or existing buildings that have been purchased or renovated. If the expense of the construction, purchase, or renovation was in a previous year, taxpayers can complete a cost segregation study on a past acquisition or improvement, and take the current year’s deduction for the resulting accelerated depreciation not claimed in prior years. The 100% bonus depreciation amount remains in effect through January 1, 2023. After that, the first-year bonus depreciation amounts decrease by 20% each year through January 1, 2027.
- Evaluate the big change coming to the business interest expense limitation effective January 1, 2022. Click here to learn more.
Happy tax planning (oh, and happy new year too)! Thanks to Michael Prinzo, Leslie Boyd and countless others for their help with this post!
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