As we near the end of another turbulent year, it’s time to discuss the steps you need to take to reduce your tax burden for 2021 (and beyond). Unlike other years, 2021 presents many unique moving parts to the tax puzzle and will require strategic planning to favorably position you for the future.
Year-end tax planning will allow you to identify the necessary adjustments to make in preparation for the changes ahead. Of note, this year marks the end of notable provisions enacted in the Tax Cuts and Jobs Act (TCJA); many of the short-term COVID-19 relief initiatives are set to expire; and the current administration may have tax increases on the horizon.
This article will provide a high-level summary of the recent changes for your consideration.
Build Back Better Update – Draft Legislation
While there’s still much discussion surrounding the Build Back Better Act, here’s a few of the key changes that will affect individual income taxes that came out of the updated draft legislation released on November 3, 2021. These changes are set to be effective January 1, 2022.
- Plans to raise the cap on state and local tax (SALT) deduction from $10,000 to $80,000 through 2030. The $80,000 SALT cap would also apply retroactively to the 2021 tax year.
- Proposal to extend the Child Tax Credit through 2022, and allow the entire credit to be fully refundable on a permanent basis.
- Suggests a limit on IRA contributions when the account account balance reaches $10 million and an acceleration of required minimum distributions on those accounts.
- Plans to extend the Earned Income Tax Credit eligibility, amount, and phase-in rates in the 2022 tax year.
- Intends to implement a surcharge on modified adjusted gross income (MAGI) equal to 5 percent on MAGI in excess of $10 million plus 3 percent on MAGI above $25 million.
Re-Established Required Minimum Distributions (RMDs) from Retirement Accounts
RMDs are back for 2021. Last year, legislation stemming from COVID allowed seniors to skip their RMDs without having to pay a penalty. However, the temporary suspension only applied for 2020. This year, RMDs must be taken by taxpayers who are at least 72 years old by December 31, 2021, unless the taxpayer celebrated their 72nd birthday this year, then they can defer payment until April 1, 2022.
Taxpayers who are looking to reduce their tax liability this year can also use qualified charitable distributions (QCD) to count towards RMDs as well. Taxpayers can contribute up to $100,000 to a qualified charity directly from their retirement accounts (excluding Roth IRAs) to reduce overall AGI.
Repayment of Deferred Social Security Tax
Self-employed individuals who opted to defer a portion of their Social Security taxes in 2020 are now required to repay half of the amount owed by December 31, 2021. The remaining balance is due by December 31, 2022. It’s important to make a separate tax payment noting that the amount should be applied to previously deferred Social Security tax.
Extension of Charitable Giving Benefits
A number of tax provisions have been expanded in 2021 to incentivize charitable giving during a time when nonprofits need it most.
Taxpayers who take the standard deduction are eligible to deduct $300 (single filers) or $600 (joint filers) on top of the standard deduction when they make a cash contribution to a qualified charity.
For those who itemize, donors are now able to deduct up to 100% of their AGI for cash contributions to qualified charities. Under previous law, the deductibility amount was limited to 60% of the taxpayer’s AGI. Please note that this expansion of charitable deductions is set to expire at the end of 2021. Any unused charitable donations will carry forward to future years.
Donor advised funds and private foundations are excluded from the above expanded charitable giving benefits.
Child Tax Credit
The 2021 Child Tax Credit increased for families claiming the credit to up to $3,000 for each qualifying child ages 6-17 and up to $3,600 for each child under the age of 6. Under previous law, taxpayers received a child tax credit in the amount of $2,000 for qualifying children under age 17.
In addition, the IRS began distributing advanced monthly payments in July so that qualifying families could receive an immediate benefit. Payments will continue through December and the remaining 50% of the child tax credit will be claimed on 2021 returns.
Advance payments are based on either 2019 or 2020 tax returns, depending on which return was on file with the IRS at the time of distribution. If you believe that your monthly child tax credit payments will exceed the amount you qualify to claim on your 2021 return, you may consider making an adjustment or opting out before year end by visiting the IRS’ Child Tax Credit Portal. Otherwise, overpayments will need to be repaid by April 15, 2022.
Increased Lifetime Estate and Gift Tax Exemption Amount
The window of opportunity may be closing for taxpayers who seek to apply some or all of their lifetime estate and gift exemption amount. Currently, the federal estate and gift tax exclusion amount is $11.7 million per taxpayer (more than double since 2017 and ten times the amount in 2008).
While still in negotiations, the current administration has proposed tax changes for 2022 that could alter the gift tax amounts and limit the option to use some trusts as effective estate planning techniques. While this language was in the initial drafts, the November 3, 2021 version did not include any changes to estate taxation.
We recommend working closely with your estate planning attorney as legislation develops.
Continued Low Capital Gains and Qualified Dividend Rates
When considering how to lower your capital gains taxes you may benefit from using tax-advantaged retirement plan accounts, harvesting tax losses and gains, reinvesting in a Qualified Opportunity Fund to defer and minimize taxes, and closely monitoring mutual fund distributions prior to year-end. Proposed changes to the capital gains rates have also dropped off of the November 3, 2021 draft legislation. Until negotiations are complete, changes are still possible.
It’s Time for a Plan
This article only scratches the surface on year-end tax planning strategies as a result of the surmountable tax changes enacted over recent years and the potential changes that may lie ahead. With the right guidance and foresight, we can help you set the course for greater financial success. Please contact me at stu@erocktax.com or (781) 247-5569 to schedule a year-end planning meeting.
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About Stu: With more than 30 years of experience as a tax professional, Stu Steinberg brings a broad depth of knowledge to his work with his clients. Stu founded Erock Tax to help provide tax and financial planning strategies to individuals, families and small businesses and is passionate about empowering his clients through education about their money health. Stu is highly energetic and brings a sense of optimism, creative problem-solving and a deep level of commitment to every Erock client.