For many of us, the past year brought disruption and uncertainty to both personal and financial situations. After almost two years of a global pandemic, we continue to experience uncertainty around upcoming changes in tax legislation. In this article, we will discuss key tax considerations from recent tax policy, opportunities to maximize business deductions, and year-end planning strategies to consider.
Key tax considerations from recent tax legislation
At the time of writing this article, the American Rescue Plan Act and the Infrastructure Investment & Jobs Act were signed into law. The Build Back Better act was pending in the Senate.
American Rescue Plan Act
The American Rescue Plan Act (ARPA) was enacted in March of 2021 to help with the ongoing disruption of COVID-19. Below we will look at a few key points of the bill for tax planning.
Economic impact payments (EIP)
A third round of economic impact payments, commonly referred to as “stimulus payments,” were sent to qualifying individuals as part of the ARPA. As with last year’s payments, these are claimed on the 2021 tax return as an advance of the recovery rebate credit. Failure to properly disclose will cause significant delays in processing by the IRS.
Child tax credit
Changes were made to expand the child tax credit. In July, the IRS began paying this credit in advance to qualified taxpayers who did not opt out. Like the EIP, accurate disclosure of these payments will be necessary to avoid processing delays when filing your 2021 tax return. If you received either payment or are unsure of the amounts, please reach out to your tax advisor for instructions on how to request from the IRS.
The CARES Act created two temporary changes to the tax treatment of donations that were extended by the ARPA for 2021. These changes incentivize both those who itemize their deductions, and those who take the standard deduction by raising the charitable donation cap and allowing an above-the-line deduction for nonitemizers.
100% Cash Contributions
Individuals who itemize deductions in 2021 can deduct cash donations up to 100% of their adjusted gross income (increased from 60% in 2019). This change allows an individual to zero out their taxable income if they choose to make a large enough donation.
For example, if Alex has an adjusted gross income of $150,000, he can now deduct up to his full AGI of $150,000 if he gives that much to charity in 2021. Donations to a Donor Advised Fund and Private Foundations are excluded from the updated deductibility cap.
Individuals who take the standard deduction will be allowed an above-the-line $300 deduction for qualified charitable donations. Married filing jointly taxpayers will get a deduction of up to $600.
It is important to note that only donations given to a tax-exempt organization, as defined by section 501(c)(3) of the Internal Revenue Code, qualify for a tax deduction. Examples of qualified institutions include religious organizations, nonprofit organizations and educational agencies, museums, volunteer fire companies, donor advised funds, private foundations, and organizations that maintain public parks.
The tax treatment of unemployment compensation will change in 2021. In 2020, taxpayers were allowed an exclusion from income up to $10,200. There is no exclusion from income in 2021.
Required Minimum Distributions (RMDs)
For 2021, you must take an RMD if you are age 72 by the end of the year (or 70 ½ before Jan. 1, 2020). It’s important to plan ahead to determine the tax consequences of your RMD. If you did not take an RMD in 2020, either under the CARES act exception or because 2021 is your first year, plan for additional tax due in 2021.
Infrastructure Investment and Jobs Act
The Infrastructure Investment and Jobs Act was signed into law on Nov. 15. While only including two provisions related to tax policy, both are relevant enough to mention for compliance.
Employee Retention Credit (ERC)
Early termination of the employee retention credit was passed making wages paid after Sept. 30, 2021 ineligible for the credit, unless paid by an eligible recovery startup business.
A new requirement was included in the bill for brokers of digital assets to provide information returns on any transfers to accounts not maintained by a broker. We can expect this reporting to be similar to a consolidated 1099 or Form 1099-B. Cryptocurrency is a key target area for the IRS. If you own digital currency, discuss with your tax professional the disclosure requirements for Form 1040.
Build Back Better Act
As of Nov. 30, 2021, the House had passed the Build Back Better act, but legislation was still looming in the Senate. We know for certain the pending bill could result in tax law changes which impact planning for high-income individuals. For the discussion, we will consider high-income individuals to be those earning +/- $425,000 per year.
Opportunity to Maximize Business Deductions
The tax rates on earned income are often higher than investment income. Earned income includes wages, salary, and net earnings from self-employment. Because of these higher rates, it is important to properly keep track of allowable business deductions to reduce self-employment earnings. Here are some opportunities to take advantage of in order to maximize business expense deductions.
Deduction for Business Meals
Prior to 2021, the deductibility of business meal expenses was limited to 50%. As part of the Consolidated Appropriations Act, business meals purchased from a restaurant are 100% deductible for 2021 and 2022. It is important to note that this specifically applies to expenses at restaurants, and that entertainment expenses remains nondeductible.
Depreciation is an annual income tax deduction for a portion (or all) of an asset’s cost each year and can be a powerful tax savings tool. Property acquired in 2021 may be eligible for bonus or section 179 treatment to increase the deduction amount in the year the asset is placed into service. If you have fixed asset purchases on the horizon, discuss opportunities to maximize deductions by strategically selecting the year for purchase.
Bonus Depreciation allows a business to write off 100% of the purchase price of qualified depreciable property in the year of acquisition. Qualified property includes property with a recovery period of 20 years or less, qualified improvement property, computer software, and certain used property.
The section 179 deduction applies to tangible personal property purchased for use in a trade or business and certain improvements to the interior portion of a nonresidential building after the building is placed in service. Taxpayers can deduct the full cost of these assets up to $1,050,000 for qualifying property placed in service in 2021.
One way to amplify the effects of bonus depreciation & the section 179 deduction is to utilize a cost segregation study on a building. This allows a business to reclassify the components of a building from an asset with a long depreciable life into assets with shorter depreciable lives that may qualify for bonus depreciation or the section 179 deduction. As always, please consult your tax advisor as cost segregation studies can be expensive and require a cost-benefit analysis along with detailed reporting.
Year-end Planning Strategies
Planning around the timing of income, deductions, and investment transactions to avoid higher income tax brackets is crucial as new tax laws are expected to target high income taxpayers. Discussing significant financial events with your tax practitioner can ensure steps are taken to structure transactions to minimize the related tax liability and be prepared for any upcoming tax law changes.
Itemized deduction timing
Historically, there’s been an emphasis on accelerating tax deductions to offset income as soon as possible. Over the past few years, law changes have resulted in a shift to focus on the timing to maximize deductions.
With the possibility of a change to the $10,000 cap on state & local tax deduction, consider delaying any state tax payments or real estate taxes to the end of the year. This will preserve the opportunity to push these payments to 2022. Consult your tax advisor at the end of December to determine the best course of action for your specific tax situation.
Bunching is a strategy to maximize the impact of itemized deductions. It is best implemented when the taxpayer will not leave any deductions on the table by itemizing every other year. For example, a taxpayer with mortgage interest expense is less likely to benefit from this strategy. To implement, expenses that qualify as itemized deductions are paid in January and December every other year to double up on deductions.
Let’s look at how this works with an example.
In this scenario, the taxpayer would like to give $20,000 a year to charity. In addition, she has annual property taxes of $6,500.
Option 1: Taxpayer pays these amounts annually and itemizes every year. Total tax due with this strategy is $419,504 over four years.
Option 2: Taxpayer uses a bunching strategy to pay the amounts in every other year. In 2021 and 2023, the standard deduction will be used instead of itemizing. Total tax due with this strategy is $404,171.
By bunching payments, the taxpayer saves $15,336 in taxes.
Gain & Loss Harvesting
Pending tax legislation hints we should expect to see higher tax rates on capital gains in upcoming years. For some ultra-wealthy taxpayers, the potential for a 3% or 8% surtax gives cause for careful year-end planning around gains.
When does it make sense to harvest gains or losses?
- To fill up tax brackets and take advantage of preferential capital gain rates at 0% or 15%
- To accelerate income when the future tax rate is expected to increase
- To recognize losses at risk due to taxpayer death
To maximize the benefit, seek to use long-term losses to offset short-term gains, which are taxed at the ordinary rate. Connecting your LBMC wealth advisor and investment team is the best way to ensure harvesting to minimize tax liability.
Estate & Gift Planning
As of today, the lifetime estate exemption is $11,700,000. Each taxpayer is allowed to gift up to the annual exclusion amount tax-free each year without impacting the lifetime exemption.
For 2021, the annual exclusion amount is $15,000. A married couple can give $30,000 ($15,000 from each) to one recipient and remain under the annual exclusion amount for the year. For 2022, the annual exclusion amount will be $16,000.
It’s best to make annual exclusion gifts early in the year to avoid unintended consequences. If planning to gift the annual exclusion, start making plans now to complete any 2021 gifts by the end of the year and 2022 gifts in January.
Medical and education expenses paid directly to the provider on behalf of another are allowed without using the annual exclusion or lifetime exemption. Consider opportunities of gifting by direct payment of these expenses to maximize your tax-free transfer of wealth.
In times of rapid change, reviewing your estate plan periodically is necessary. The LBMC wealth advisors team coordinates with insurance brokers, estate attorneys, and other professionals to provide a coordinated effort on each client’s estate plan.
Keeping your tax liability to a minimum requires planning and is key to your overall financial health. It is imperative to notify your tax advisor as early as possible if any life-changing events have occurred that may impact your taxes. While tax law uncertainty can complicate tax saving strategies, it is never too early to start planning.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.