As the recovery from the COVID-19 crisis takes hold and the economy and life begin to return to normal, now is an ideal time to focus on tax planning for the remainder of 2021. 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 the rates in effect today will increase soon. At this time, it’s too soon to say what the new rates will be or when they will be effective, if at all.
There are many tax planning opportunities available to help you reduce your individual federal and state tax burdens, especially as Congress has enacted various provisions designed to help taxpayers recover from the pandemic.
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
Your 2020 tax return is a great starting point. Did you owe money to the IRS or the state or did you receive a big refund? The answer to this question may mean that you should look at your tax withholding and adjust to avoid a repeat in 2021. 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.
Time Investment Gains and Losses
Capital gains on property held for more than one year are taxed at more favorable capital gains tax rates depending on the taxpayer’s regular income tax bracket. For 2021, the maximum capital gains rate is 20% for a taxpayer with taxable income above $501,599 (in the case of a joint return or surviving spouse), $250,799 (in the case of a married individual filing a separate return), $473,749 in the case of an individual who files as head of household, or $445,849 in the case of any other individual. For taxpayers in the lower tax brackets, the capital gains rate is 0% or 15% (depending on the taxpayer’s income)
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.
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.
Maximize Retirement Savings
If the maximum retirement plan contribution for 2021 was not selected, you still have time to increase contributions for the remainder of 2021 to lower your AGI to take advantage of some of the tax breaks
Traditional IRA. Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The deadline for 2021 contributions is April 15, 2022. The annual deductible contribution limit for an IRA for 2021 is $6,000. A $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the close of 2021, making the total limit $7,000.
Deferring the Receipt of Income Until 2022
If you expect AGI to be higher in 2021 than in 2022 or anticipate being in the same or a higher tax bracket in 2021, you may benefit by deferring the receipt of income until 2022. Deferring income is advantageous so long as the deferral does not bump you into a higher tax bracket in the succeeding year(s).
If you are self-employed and file Schedule C (e.g., as a sole proprietor or single-member LLC) and operate on a calendar year, cash basis accounting method, consider delaying 2021 year-end billings to clients so that payments will not be received until 2022
Accelerating the Receipt of Income into 2021
In limited circumstances, you may benefit by accelerating income into 2021. For example, if you anticipate being in a higher tax bracket in 2022 than in 2021 or may need additional income to take advantage of an offsetting deduction or credit that will not be available in future tax years, it may make sense to accelerate the receipt of income. However, accelerating income into 2021 may be disadvantageous if you expect to be in the same or lower tax bracket for 2022.
2021 Recovery Rebate Credit
You may be eligible for an additional tax credit on your 2021 return, like the previous rounds of tax credits and Economic Impact Payments (EIPs) for 2020. The third EIP amount is: (1) $1,400 for an eligible individual ($2,800 for married couples filing a joint return) and (2) $1,400 for each qualifying dependent. However, this third round is different than the prior credit EIPs. Generally, you may be eligible for the full amount of the third EIP if you (and your spouse, if filing a joint return) are: (1) a U.S. citizen or U.S. resident alien, (2) not a dependent of another taxpayer, and (3) your AGI is not more than $150,000 if married and filing a joint return or if filing as a qualifying widow or widower, $112,500 if filing as head of household or $75,000 if filing as single or married filing separately.
Another difference is that an additional $1,400 is available for each dependent, including adult dependents. (Only taxpayers with “qualifying children” were eligible for the additional amount under the first two rounds of EIPs.)
Payments will be phased out above these AGI amounts. This means you will not receive a payment if your AGI is at least: $160,000 if married filing a joint return or if filing as a qualifying widow or widower, $120,000 if filing as head of household, and $80,000 if filing as single or married filing separately.
You will need to reconcile the amount of any EIPs you received during 2021 (if any) when you file your 2021 tax return to determine whether you received the full amount of EIPs that you may have been entitled to or whether you may be entitled to an additional amount.
Expanded Credits for Children
The American Rescue Plan Act expanded these credits and made them refundable. For 2021, families claiming the Child Tax Credit (CTC) may receive up to $3,000 per qualifying child between the ages of six and 17 at the end of 2021. You may receive $3,600 per qualifying child under age six at the end of 2021. The additional $1,000 per child between ages 6 and 17 and the additional $1,600 per child under age 6 are reduced (phased out), for incomes over $150,000 for married taxpayers filing a joint return and qualifying widows or widowers, $112,500 for heads of household, and $75,000 for all other taxpayers.
The CTC is fully refundable for 2021. If your 2021 AGI is too high to qualify for the additional CTC amount for 2021, you are still eligible for the basic $2,000 per child tax credit under the same rules applicable in 2020, with the higher phase-out amounts ($400,000 for married filing joint returns, $200,000 for all other returns). Beginning in July 2021, advance payments of the 2021 CTC will be made monthly through the end of December 2021 for up to 50% of the CTC as determined based on estimates using information included in your 2020 tax returns (or 2019 returns if 2020 return information is not available).
You may want to decline advance payment of the CTC if you think your income will be higher in 2021 than your 2019/2020 income (or you will have fewer qualifying children in 2021 than you did in 2019/2020) as you may have to repay some of the advance payments received when reconciling the credit on your 2021 return. Using the IRS’s child tax credit and update portal, taxpayers can update their information to reflect any new information that might impact their child tax credit amount, such as filing status or number of children. Parents may also use the online portal to elect out of the advance payments or check on the status of payments.
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 standard deduction is $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.
Business Income Tax Opportunities
If you own a business, consider the following strategies to minimize your tax bill for 2021.
Qualified Business Income Deduction (QBI Deduction)
Individual taxpayers with qualified business income from a pass-through entity or a sole proprietorship may be entitled to a 2021 deduction equal to the lesser of the deductible amount of the QBI (generally 20% subject to the W-2 wage basis limit) or 20% of net taxable income from the business.
For 2021, if taxable income does not exceed a threshold of $329,800 (joint filers), $164,925 (married filing separately), or $164,900 (all other taxpayers), the deduction is generally the lesser of 20% of QBI or 20% of taxable income. If taxable income exceeds the threshold amount, the deduction is subject to a wage basis limit that is phased-in ratably, and only a portion of the income from a specified trade or business is eligible, the W-2 wage limitation applies, and specified service trades or businesses are excluded. However, if taxable income exceeds the threshold amount by $100,000 or more for married taxpayers filing jointly, or by $50,000 or more for other filers, the wage basis limit applies in full, and income from a specified trade or business is not eligible for the QBI deduction.
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. Beginning in 2021 the excess business loss limitation is back, 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 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.
Tax planning early in the year makes it much easier to minimize your taxes before the end of the year. We are monitoring future developments and will keep you informed of the latest tax law changes. Please don’t hesitate to contact your Boyum Barenscheer Advisor if you would like us to assist you with your planning.