Potential changes in tax law weigh on year-end tax planning for individuals – Tax
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As if another year of the COVID-19 pandemic weren’t enough to produce an unusual landscape for year-end tax planning, Congress continues to negotiate the budget reconciliation bill. The Build Back Better (BBBA) bill will certainly include important tax provisions, but many uncertainties remain as to their impact. While we wait to see what tax provisions will ultimately be included in the BBBA, here are some year-end tax planning strategies to consider to reduce your tax liability for 2021.
ACCELERATE AND RETARD WITH CARE
One of the most trusted year-end tactics to reduce taxes has long been to speed up your deductible expenses and defer your income. For example, self-employed people who use cash accounting may delay invoices until the end of December and defer the planned purchase of equipment or the payment of estimated income taxes from the beginning of next year until this year.
This technique has always come with the caveat that you generally shouldn’t pursue it if you expect to be in a higher tax bracket the following year. The potential BBBA provisions may also cause some taxpayers to reverse the strategy for 2021, i.e. accelerate income and defer deductible expenses.
The current version of the BBBA would impose a new 5% “surtax” on modified adjusted gross income (MAGI) that exceeds $ 10 million, with an additional 3% on income over $ 25 million. Therefore, the highest earners could pay a marginal federal income tax of 45% on wages and business income (the current tax rate of 37% plus 8%). It could be even higher when combined with the tax on net investment income, which could be broadened to include active business income for flow-through entities.
In addition, there is a proposal to temporarily increase the $ 10,000 cap on the state and local tax deduction to $ 80,000. People living in high-tax states should consider whether there might be an advantage to speeding up the payment of a property or estimated state income tax in 2022 through 2021, or whether the deduction could be more attractive next year, especially if they face a higher effective tax rate.
VALUING YOUR LOSSES
Taxpayers with substantial capital gains in 2021 could benefit from the “harvest” of their losses before the end of the year. Capital losses can be used to offset capital gains, and up to $ 3,000 ($ 1,500 for married people reporting separately) excess losses (those that exceed the amount of the gains for the year) can be charged against ordinary income. The remaining losses can be carried forward indefinitely.
Be careful, however, to the rule of laundry sales. Generally, the rule prohibits deducting a loss if you acquire “substantially identical” investments within 30 days, before or after the date of sale.
Taxpayers who itemize their deductions could compound their tax benefits by donating the proceeds from the sale of a depreciated investment to a charity. They can both offset any gains made and claim a charitable contribution deduction for the donation.
SATISFY YOUR CHARITABLE TILTS
For 2021, charitable contributions can reduce taxes for retailers and non-retailers. Taxpayers who benefit from the standard deduction can claim an above-line deduction of $ 300 ($ 600 for married couples filing jointly) for cash contributions to qualified charities.
The adjusted gross income limit for cash donations is 100% for 2021; it is expected to return to 60% for 2022. This means that you could offset all of your taxable income with charitable contributions this year (donations to donor-advised funds and private foundations are not eligible, however). .
Taxpayers who generally do not detail can benefit by “bundling” their charitable contributions. In other words, delaying or speeding up contributions in a tax year to exceed the standard deduction and claim itemized deductions. For example, if you typically make your donations at the end of the year, you can group donations from other years together, such as January and December 2022 and January and December 2024.
Retired taxpayers aged 70 and a half and over can reduce their taxable income by making qualifying charitable contributions of up to $ 100,000 from their non-Roth IRAs. Retired or not, people aged 72 and over can use these contributions to meet their minimum required annual distributions (RMD). Note that RMDs have been suspended for 2020, but are effective for 2021.
As long as the assets would be considered long term if sold, donations of valued assets provide a tax benefit in two ways. You avoid capital gains tax on capital appreciation and can deduct the fair market value of the asset on the date of donation.
CONVERT TRADITIONAL IRAS INTO ROTH IRAS
Similar to 2020, when many taxpayers saw lower-than-normal income, 2021 might be a good time to convert funds from traditional pre-tax IRAs to an after-tax Roth IRA. Roth IRAs do not have an RMD and distributions are tax exempt.
You will have to pay income tax on the converted funds, but it is best to do so while being subject to lower tax rates. Likewise, if you convert securities that have lost value in value, your tax may well be lower now than in the future – and any subsequent appreciation while you are in the Roth IRA will be tax exempt.
It should be noted that President Biden had proposed including a provision in the BBBA that would limit the ability of high net worth individuals to engage in Roth conversions. There has been a lot of back and forth regarding these provisions and the latest version of the House bill includes some restrictions. It remains to be seen whether these provisions exceed Senate amendments, but the proposal could be a harbinger of future proposed restrictions.
PROCEED WITH CAUTION
The strategies outlined above still have their pros and cons, but perhaps never as many as they do today, as potentially important tax legislation that would come into effect next year is being negotiated. ORBA can help you chart the best course for you in light of any development.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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