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 midyear 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 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/tax-withholding-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 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.
Expanded Credits for Children and Child and Dependent Care Expenses. The American Rescue Plan Act expanded these credits and made them refundable. Eligibility depends on your income and begins to “phase-out” around the $125,000 to $150,000 range. If you think 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. Generally, it’s best to itemize your deductions if your personal expenses, such as mortgage interest, charitable contributions, medical expenses, and taxes exceed 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. However, “bunching” your deductions may offer the best of both worlds. For example, you can pay two years’ worth of property taxes in a single calendar year, or double up on charitable giving every other year. If that is enough to get over the standard deduction amount, you’ll get a bigger deduction every other year, yet part with the same amount of cash.
Planning for Small Businesses
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) 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 in this letter. 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.