Taxes are like vehicles in that they need a periodic check-up to make sure they are performing as expected, and if ignored, could cost you money.
The following is a list of potentially beneficial tax strategies. Every taxpayer’s situation is unique, and not all of the strategies suggested here will apply to you. However, opportunities for tax planning are available for all income levels and a variety of tax circumstances.
Maximize Education Tax Credits – If you qualify for either the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC), check to see how much you have already paid for qualified tuition and related expenses during the year. If you have not met the maximum amount allowed for computing the credits, you can prepay 2022 tuition if it is for an academic period beginning in the first three months of 2022 and use the expense for the 2021 credit.
Convert Traditional IRAs to Roth IRAs – If your income is unusually low this year, or even negative, you may wish to consider converting your traditional IRA to a Roth IRA. A Roth IRA allows earnings to grow tax-free, and distributions are tax-free at retirement. Lower income results in a lower tax rate, which provides you an opportunity to convert to a Roth IRA while minimizing taxes paid.
Don’t Forget Your 2021 Minimum Required Distributions – If you are 72 or older, you must take required minimum distributions (RMDs) from your IRA, 401(k) plan and other employer-sponsored retirement plans (but if you are still working, distributions from your current employer’s plan can be postponed in some circumstances). Failure to take a required withdrawal can result in a 50% penalty of the amount of the RMD not withdrawn. If you turned 72 in 2021, you could delay the first RMD to the first quarter of 2022, but if you do, you will have to take a double distribution in 2022 (one for 2021 and 2022). One should carefully consider the tax impact of a double distribution in 2022 versus a distribution in both this year and next.
Bunching Deductions – If your tax deductions normally fall short of needing to itemize because the standard deduction you are allowed is greater, or if itemizing is only marginally beneficial, you may benefit from adopting the “bunching” strategy. To be more proactive, you can time the payments of tax-deductible items to maximize your itemized deductions in one year and take the standard deduction in the next.
Take Advantage of the Zero Capital Gains Rate – There is a zero long-term capital gains rate for those with taxable income below the 15% capital gains tax threshold. This may allow you to sell some appreciated securities that you have owned for over a year and pay very little to no tax on the gain.
Defer Deductions – When itemizing deductions, you may only claim deductions you paid during the tax year (the calendar year for most folks). If your projected taxable income is negative and you plan to itemize your deductions, consider putting off some of your year-end deductible payments until after the first of the year to preserve the deductions for next year. Such payments might include house of worship tithing, year-end charitable giving, tax payments (but not those incurring late payment penalties), estimated state income tax payments, medical expenses, etc.
Increase IRA Distributions – Depending on your projected taxable income, you might consider taking an IRA distribution to add income for the year. For instance, if your projected taxable income is negative, you can take a withdrawal of up to the negative amount without incurring any income tax. Even if your projected taxable income is not negative and your normal taxable income would put you in the 24% tax bracket or higher, you might want to take out just enough to be taxed at the 10% or 12% rate. Since those are retirement dollars, consider moving them into a regular financial account set aside for your retirement. Also be aware that distributions before age 59½ are subject to a 10% early withdrawal penalty.
Defer Capital Gains by Investing in an Opportunity Zone Fund – A unique tax benefit is the ability to defer any capital gain into a qualified opportunity fund (QOF). QOFs are funds that invest in areas in need of development. If you have a capital gain from selling property to an unrelated party, you may elect to defer that gain by investing it into a QOF within 180 days of the sale or exchange. The gain won’t be recognized (i.e., you won’t be taxed on the gain) until you file for the tax year in which the QOF is sold, or 2026, whichever comes first. You can get up to 10% of the deferred gain forgiven by holding the investment for the required time period, and you will pay no tax on any additional gain if the investment is held for 10 years.
Sell Loser Stocks – Although the stock market has been performing well recently, you still may have stocks that have declined in value. If you sell them before the end of the year, you can use any losses to offset other gains for the year or produce a deductible loss. The net capital loss deductible on a tax return is limited to $3,000 ($1,500 if filing married separate) for the year, but any excess loss carries over to future years. You can repurchase stock in the same company from which you sold shares at a loss after 30 days have passed and avoid the wash sale rules.
Don’t Waste the 2021 Annual Gift Tax Exemption – To limit your estate’s exposure to inheritance taxes, you can give $15,000 each to an unlimited number of individuals in 2021, but you can’t carry over unused exclusions from one year to the next. Taxpayers and their spouses can use their gift tax exemptions together to give up to $30,000 per beneficiary. For example, if you are married and have four children and four grandchildren, you can remove $240,000 from your estate tax-free this year. The transfers may also save family income taxes when income-earning property is given to family members who are in the lower income tax brackets and are not subject to the kiddie tax.
Not Needing to File May Be an Opportunity – If your income and tax situation is such that you don’t need to file for 2021, don’t overlook the opportunity to bring in some additional income (to the extent it will be tax-free). For instance, if you have appreciated stock that you can sell without incurring any tax, consider selling it. Another option is to take a Roth IRA distribution if you are 59½ or older, or if you are younger and qualify for an exception to the early withdrawal penalty.
Utilize IRA-to-Charity Transfers – If you are 70½ or over, you can request that your IRA trustee directly transfer funds from your IRA to a charity. Although not deductible as an itemized charitable deduction, the distribution is not taxable. If you are 72 or over when a direct transfer is made, the distribution can count towards your required minimum distribution for the year. This also reduces your AGI, which in some circumstances can reduce the amount of taxable Social Security income. There is no minimum charitable distribution, but the maximum amount per individual is limited to $100,000 per year. There are some complications if you are 72 or older, have earned income and make a contribution to the IRA. Check with our office for the details.
Maximize Tax-Deductible Medical Expenses – If you have outstanding medical or dental bills, paying the balance before year-end may be beneficial, but only if you already meet the 7.5% of the AGI floor for deducting medical expenses, or if adding the payments would put you over the 7.5% threshold and you are itemizing your deductions. You can even use a credit card to pay the expenses, but you would only want to do so if the interest you would incur if you don’t pay off the card right away is less than the tax savings.
Make Business Purchases – You can reduce taxable income if you make last-minute business purchases, such as office equipment, tools, machinery and vehicles, and write them off using 100% bonus depreciation or Sec. 179 expensing, provided you place the item(s) into business service by the end of the year. However, you must consider the impact that expensing the items will have on your taxable income and the Sec. 199A 20% pass-through deduction. It may be appropriate to contact us in advance of any last-minute business acquisitions.
Divorced or Separated During the Year – A divorce or separation can have a significant impact on a couple’s tax filings. Issues to be considered include whether to file joint or separate returns, who will claim the children, whether to take the standard deduction or itemize, how income and tax prepayments are to be allocated, etc.
Increased Charitable Giving Opportunities – 2021 is the final year that the normal 60% of AGI limit on cash contributions has been increased to 100%, providing an opportunity for those with the means and desire to increase their normal charitable contributions and deduct them as an itemized deduction. The normal 5-year carryover applies to any excess over 100% of AGI.
Those who don’t itemize (currently about 90% of income tax return filers), are allowed to claim a deduction of up to $300 ($600 on a joint return) for cash charitable contributions made in 2021. Normally, only itemizers can deduct their charitable contributions.
Take Advantage of Energy Credits – Two of the major green credits are the solar tax credit and electric vehicle credit. The solar credit for 2021 is 26% of the cost of the installed solar system, but the system must be complete and functional before year’s end to claim the credit in 2021. The credit is not refundable, and any excess has a limited carryover. The credit for electric vehicles must be determined using the IRS website since the credit begins to phase out once 200,000 of the vehicle type by manufacturer have been sold.
Other Considerations – If you have obtained medical insurance through the government’s marketplace, employing some of the strategies mentioned could impact the amount of your allowable premium tax credit.
Residents of states that have an income tax will also need to consider the impact of some of these strategies on their state return.
If you would like to schedule a tax planning appointment to determine strategies that best fit your circumstances, please give our office a call.
