The past year has been challenging to say the least. Hopefully the
COVID-19 crisis, which affected all of us in some ways, is nearing the end. While it has been difficult to focus attention on much other than the health and safety of our loved ones, tax planning can’t take a back seat forever.
In addition to normal mid-year planning ideas, legislation enacted by both the current and former administrations may provide opportunities to save a little tax and keep a little more money in your pocket. President Biden has released a plan, that if enacted, would result in higher tax rates for both individual and corporate taxpayers. Time will tell if this proposal ultimately becomes law, but there is certainly a possibility that the rates in effect today will increase in the near future. At this time, it’s too soon to say what the new rates will be or when they will be effective, if at all. As always, we are monitoring these developments and will alert you as soon as any legislation is signed into law. For now, it’s a good time to get a handle on what your 2021 income might look like, so that, if legislation is passed, we will be able to project how it affects you.
Individual Income Tax Opportunities
Here are some strategies that may lower your individual income tax bill for 2021.
- Consider Adjusting Your Tax Withholding or Estimated Payments. If you owed taxes for 2020, you may want to revise your Form W-4. To help you do this, consider using the IRS’s “Tax Withholding Estimator,” available at www.irs.gov/individuals/taxwithholding-estimator. If you make estimated tax payments throughout the year (which is likely the case if you are self-employed, for example), we can take a closer look at your tax situation for 2021 to make sure you’re not underpaying or overpaying.
- Take Advantage of Lower Tax Rates on Investment Income. Gains from the sale of an investment held for more than one year (as well as dividends on certain stocks) are generally taxed at preferential capital gains rates. Those rates are 0%, 15%, and 20% for most investments. The applicable rate depends on your taxable income. If your income is too high to benefit from the 0% or 15% rates, try gifting investments (like appreciated stock or mutual fund shares) to children, grandchildren, or other loved ones. If these individuals are in the 0% or 15% capital gains tax bracket when they later sell the investments, any gain will be taxed at the lower rates, if you and your loved one owned the investments for more than one year. Dividends from any gifted stock may also qualify for the lower rate. However, beware of the “Kiddie Tax,” which applies to all children under age 18 and most children age 18 or age 19–23 who are full-time students. It may limit your opportunity to take advantage of this strategy. Also beware of a potential increase in both long-term capital gain rates and ordinary income tax rates heading into 2022.
- Time Investment Gains and Losses. As you evaluate investments held in your brokerage accounts, consider the tax impact of selling appreciated securities before the end of the year. President Biden has proposed a plan that would increase long-term capital gain rates to 39.6% for taxpayers making over $1 million. Combined with the Net Investment Income Tax (NIIT) of 3.8%, affected taxpayers could see a 43.4% marginal long-term capital gain rate, which is quite an increase from the current combined rate of 23.8%. Selling securities that have declined in value may need to wait until 2022 to offset the potential higher tax rate. Losses realized will offset any gains you may have realized. Your capital loss is limited to $3,000 annually, but any excess carries over indefinitely.
Take Advantage of Expanded Credits for Kids
Signed into law on 3/11/21, The American Rescue Plan Act of 2021
(ARPA) ushered in several provisions that could help save taxes, including the expansion of two familiar credits.
Child Tax Credit
ARPA expands the Child Tax Credit for 2021, making it fully refundable for eligible taxpayers. The credit is increased from a maximum $2,000 per eligible child to $3,000 or $3,600 in 2021 depending on the child’s age. Children under 6 qualify for the $3,600 credit while those between 6 and 17 qualify for the $3,000 credit.
The increased credit amounts are subject to phase-out. Married filing joint taxpayers with AGI of $150,000 or less will be able to take advantage of the full amount of the credit, as will heads of household with AGI of $112,500 or less. Single and married filing separate taxpayers will receive the full credit until AGI exceeds $75,000. The credit phases out at a rate of $50 for every $1,000, or portion thereof, that AGI exceeds the threshold.
Not only is the child tax credit refundable for 2021, the IRS will issue advanced payments (50% of the credit) to qualifying taxpayers. Payments are set to be delivered over a six-month period beginning in July 2021 with the balance claimed on your 2021 return. Beware, while eligibility for these advanced payments is based on the income reported on your most recently filed tax return (either 2019 or 2020), your actual eligibility for the credit will be determined when you file your 2021 return. Therefore, if you receive advanced payments and are later determined to be ineligible due to an increase in your income, you will need to repay the advances by increasing your tax liability on your 2021 return. If you anticipate this, please let us know. The IRS is also supposed to establish a method to allow you to let them know about a change in eligibility. Go to https://www. irs.gov/credits-deductions/child-taxcredit-update-portal to stop/manage future advance payments.
Child and Dependent Care Credit.
ARPA also expanded the Child and Dependent Care Credit for 2021 making it fully refundable for eligible taxpayers. For 2021, the amount of expenses that can be considered when computing the credit is increased from $3,000 to $8,000 for taxpayers with one qualifying child or dependent and from $6,000 to $16,000 for taxpayers with 2 or more qualifying individuals. Like the Child Tax Credit, this will also be phased out based on your income. For taxpayers with AGI above $125,000, the percentage is reduced by 1% for each $2,000 increment above $125,000 until AGI reaches $183,000. For taxpayers with AGI between $183,001 and $400,000, the applicable percentage is 20%. The applicable percentage begins to phase out again for taxpayers with AGI above $400,000, dropping 1% for each $2,000 above $400,000. Therefore, the credit is completely phased out when AGI exceeds $438,000.
As you can see, your ability to take advantage of these provisions depends on your 2021 income. If you know that you will be near one of these income phase-out amounts, we should meet to discuss scenarios where deferring income to 2022 or accelerating deductions into 2021 might make sense for you.
Check Your Deduction Strategy. It’s generally best to itemize your
deductions if you have significant personal expenses. However, don’t rule out the standard deduction. For 2021, joint filers can enjoy a standard deduction of $25,100. The standard deduction for heads of household is $18,800, and single taxpayers (including married taxpayers filing separately) can claim a standard deduction of $12,550.
Unfortunately, the TCJA suspended or limited many of the itemized deductions. Although there have been talks of possible legislation that might repeal or relax some of these limitations, to date, no changes are expected for 2021. The most discussed limitation at the moment is the cap on the deduction for State and Local Taxes (SALT), which is currently $10,000 ($5,000 if married filing separately). Nothing has been passed yet, so the $10,000 limitation continues to apply.
Taxpayers, who have itemized deductions just under (or just over) the standard deduction, should consider bunching state and local taxes into alternating years by paying two years’ worth of taxes in a single calendar year. But, the effect of the $10,000 cap must be considered.
In addition to bunching state and local taxes, consider bunching charitable contributions. In addition to merely timing when you make charitable donations, consider donating to donor-advised funds. Also known as charitable gift funds or philanthropic funds, donor advised funds allow donors to make a charitable contribution to a specific public charity or community foundation that uses the assets to establish a separate fund. Taxpayers can claim the charitable tax deduction in the year they fund the donor-advised fund and schedule grants over the next two years or other multiyear periods. If you have questions or want more information on donor-advised funds, please give us a call.
On another note, COVID-19 legislation temporarily increased the limit on cash contributions to public charities and certain private foundations from 60% to 100% of adjusted gross income for contributions made in 2021. Note that the donation doesn’t have to go to a COVID-19-related cause. So, for taxpayers who itemize deductions, 2021 is a great time to make charitable contributions, especially if the AGI limit would otherwise come into play.
For those who won’t itemize in 2021, there is an “above the line” deduction for cash charitable contributions up to $300 ($600 for those married filing joint). For older taxpayers (over age 70½) who won’t be able to itemize, but still want to make contributions, a qualified charitable distribution from an IRA is a great way to give to charity.
Planning for Small Business
If you own a business, consider the following strategies to minimize your tax bill for 2021.
- Employee Retention Credits (ERCs). The CARES Act created an Employee Retention Credit (ERC) that provides a payroll tax credit for business owners who continue to pay employees during a calendar quarter while their business was fully or partially shut down due to COVID-19 related restrictions or whose business suffered a significant decline in gross receipts. For 2021, the credit is refundable and capped at 70% of qualified wages and certain health insurance coverage up to $10,000 per employee. The credit is capped at $7,000 per quarter per employee ($28,000 for the year). If your business participated in the Paycheck Protection Program (PPP) and used the proceeds of your PPP loan to pay eligible costs, you can still claim the ERC. But, if your PPP loan was forgiven, the wages paid with the proceeds are not qualified wages for purposes of the ERC.
- Excess Business Losses. To ease the burden on small business owners, the CARES Act temporarily removed the limit on Excess Business Losses (EBLs) that the TCJA implemented for 2018 through 2020. Sadly, the reprieve is over and beginning in 2021, taxpayers could see a limit on their ability to deduct business losses from sole proprietorships or pass-through entities, such as partnerships and S corporations if the combined loss exceeds $262,000 ($524,000 for joint fliers). The excess loss is converted to a net operating loss, which is carried forward, subject to limits. Keep this limit in mind when you are projecting your 2021 income for estimated tax payments as well as for determining how any future tax increases (which the President has said will be targeted toward taxpayers with taxable income over certain amounts) may affect you.
- Section 179 Expense and Bonus Depreciation. If your business plans to purchase new or used machinery or equipment prior to year-end, you may be able to expense the entire cost in 2021. Under Section 179, taxpayers can elect to expense up to $1,050,000 of qualified purchases, subject to taxable income limitations. Alternatively, your business can take advantage of 100% first-year bonus depreciation. Unlike the Section 179 deduction, claiming 100% bonus depreciation is not limited to taxable income, although the excess business loss limitation discussed earlier could apply. Many factors can affect this decision, including current and future tax rates. With the possibility of higher rates in 2022, the best choice may be to wait and see if you are going to be subject to a higher tax rate in the future before you acquire assets, if it is feasible to hold off. If you’re thinking of acquiring business property between now and the end of the year, we can help you navigate that decision.
Please Contact Us
We hope you found some useful ideas here. If there is anything here that piqued your interest, please let us know. Our goal is to get you thinking about tax planning ideas and potential moves we can make to minimize your taxes before the end of the year. We are continuously monitoring future developments and will keep you informed of the latest tax law changes. Please don’t hesitate to contact us if you want more details about any of the topics discussed or just have questions or concerns.