Tax Savings Opportunities for Executives, Entrepreneurs, and Small Businesses
Uncertainty surrounding tax change has made year-end tax planning somewhat of a guessing game for the past few years. Year-end 2021 is shaping up to be no exception; clouded by the uncertain fate of the President’s tax proposals, made even more uncertain by the outcome of the governor’s race in Virginia, where newcomer Glenn Youngkin (R) upset a prior governor Terry McAuliffe (D). Even with all the uncertainty clients should think about possible year-end tax planning strategies.
Tax Planning Considerations for Individuals
Tax Brackets (possible higher rates)
Conventional wisdom is to defer income and accelerate deductions. However, if you will be in a higher tax bracket in 2022 than in 2021 this thinking should be reversed. President Biden at one point had proposed raising the ordinary income and capital gain tax rates on individuals, for those with income over certain thresholds, effective in 2022 (maybe retroactive to September 13, 2021, for capital gains). Regardless of whether you accelerate or defer income, don’t forget to consider the effect on Adjusted Gross Income (AGI) which effects many other tax benefits.
Warning: The President’s tax proposal seeks to ensure that all pass -through business income of an individual with more than $400,000 of Adjusted Gross Income (AGI) is subject to the 3.8% Medicare Tax, either through the tax on Net Investment Income (NII) or the Self-Employment Contributions Act (SECA) Tax for taxable years beginning after December 31, 2021.This would be achieved by amending the definition of NII to include the individual‘s gross income and gain from any pass-through business that is not otherwise subject to employment taxes.; in other words, S corporation shareholders who are active in the corporation’s business but who do not draw down sufficient compensation to eliminate income, and limited partners (plus their LLC member equivalents) who materially participate in their partnership (LLC). This would include the taxpayer’s gain from the sale of S corporation stock as well as their share of the gain from the sale of the corporation’s business even where the shareholder materially participates in the business. Therefore, accelerating income into 2021 and deferring expenses to 2022 for pass-through entities could be extremely important if this provision passes.
Bunch Itemized Deductions
For 2021 the standard deduction amounts are as follows:
- $12,550 single and married filing separate (MFS)
- $25,100 married filing joint (MFJ)
- $18,800 head of household (HOH)
If your itemized deductions will be close to these amounts consider bunching expenditures so they exceed the standard deduction in one year, then use the standard deduction in the other year. If you think your tax rate will be higher in 2022, then use the standard deduction in 2021 and bunch expenditures into 2022.
What Itemized Deductions Should You Bunch?
- Charitable Contributions – Probably the easiest to bunch. Setting up a Donor Advised Fund is one way to bunch deductions in the year you itemize, but still pay out to charity over several years. For some added tax benefit, consider donating low basis stock to charity in the year you itemize. Not only do you get the charitable deduction, you also avoid recognition of the gain you would realize if you sold the stock and gave cash instead. Note: a $300 “above the line” deduction is available for charitable contributions even if taking the standard deduction in 2021 ($600 is MFJ). More information about charitable giving.
- Property Taxes – Property tax bills may come out before year end but can be paid after year end.
- State and Local Income Taxes – The state fourth quarter estimated income tax payment, not due until January, can be paid before year end. However, keep in mind the current limitation on state and local income taxes of $10,000 ($5,000 MFS). Also, watch out for the alternative minimum tax (AMT) since this deduction is not allowed under the AMT regime. Note: On November 3, 2021, Nancy Pelosi revised the Build Back Better bill to increase the state and local tax deduction to $80,000 (the latest) from $10,000 cap through 2031.
- Mortgage Interest – The January mortgage payment can be accelerated giving you thirteen months of interest in any given year. In the year you take the standard deduction there would only be eleven payments. Only one month can be accelerated.
- Medical Expenses – Defer or accelerate elective medical procedures, dental work, routine physicals, purchase of glasses, contact lenses or hearing aids to the year itemizing. Keep in mind that they are still subject to a 7.5% of AGI limitation.
Capital Gains/Qualified Dividends
Long Term capital gains/qualified dividends are taxed at a preferential rate, meaning taxed at a lower rate than Short Term capital gains and wages; either 0%, 15% or 20% depending on income thresholds (see below). Selling investments to take advantage of the 0% bracket will not result in additional tax due, but will increase your basis if you chose to rebuy the same position. If you have net Short Term capital gains, consider harvesting some losses to offset them, as they are taxed at ordinary rates. Keep in mind the 30-day wash sale rule before rebuying any positions sold at a loss. Also look for capital loss carryovers from the prior year when determining whether to sell investments. Regardless of whether you think you will be in a higher bracket in 2022 decisions to buy or sell should be based on sound investment principals. The rate brackets on taxable income are as follows:
2021 Capital Gains Tax Rates and Thresholds
Marginal Tax Rate Single Filers Married Filing Jointly Head of Household Married Filing Separately 0% $0 to $40,400 $0 to $80,800 $0 to $54,100 $0 to $40,400 15% $40,401 to $445,850 $80,801 to $501,600 $54,101 to $473,750 $40,401 to $250,800 20% $445,851 or more $501,601 or more $473,751 or more $250,801 or more
- Qualified Charitable Distribution (QCD)
Taxpayers over age 70 ½ can make a charitable donation directly from their traditional IRA. This effectively allows them to net the charitable donation from their RMD resulting in a lower AGI and no potential limitation of the charitable deduction based on some % of AGI.
Warning: Making a deductible IRA contribution, of earnings when over age 70 ½, will affect your ability to exclude future QCD’s from your AGI. Also something to point out is that the Secure Act made major changes to the RMD rules. If you reached the age of 70½ in 2019 the prior rule applies, and you must take your first RMD by April 1, 2020. If you reach age 70 ½ in 2020 or later you must take your first RMD by April 1 of the year after you reach 72, but you can still make QCD at age 70 ½.
- Tax Credits
Credits for the following have been extended through 2021:
- Energy efficient home improvements
- Residential energy efficient property (including solar energy equipment) extended through 2023
- Fuel-cell vehicles
- Electric motorcycles
- Alternate fuel vehicle refueling equipment
- Roth Conversion
If you believe withdrawals from your retirement funds would be taxed at a higher rate in the future, either by yourself or your beneficiaries, than your tax rate if you converted to a Roth now, then a Roth conversion may make sense for you. You should also consider the time value of paying the tax early when making your decision. Conventional wisdom was that if you left a Roth to your heir’s they would benefit from tax free growth over their long-life expectancy and then would withdraw that growth tax free. The Secure Act shortened the payout period for heirs of traditional and Roth IRAs to no longer than 10 years. While heir’s have lost extra years of tax-free growth in an inherited Roth IRA, it’s better than withdrawing an inherited Traditional IRA taxed at ordinary rates over the shorter 10-year period, possibly bumping them up into a higher tax bracket. For clients in jeopardy of owing estate transfer taxes at death a Roth conversion has the added benefit of reducing their estate by the taxes due on the Roth conversion. Also, Roth’s don’t have a minimum distribution requirement during the account owner’s lifetime, so a conversion can help keep traditional IRA RMD’s down if rates are expected to increase. Roth conversion is a decision with many complexities, so if you are considering a conversion please contact Keiter to help weigh the pros and cons.
- Estate Planning
Under the Tax Cuts and jobs Act (TCJA), the lifetime estate tax exemption was doubled; $11.7 million per taxpayer in 2021. This higher exemption is scheduled to expire after 2025 and revert to pre-2018 levels, and there is no guarantee the current estate tax exemption will remain in effect until then. The Biden administration has proposed various changes throughout the year which include reducing the lifetime exemption, increasing the estate tax rate, elimination the step up in basis, taxing unrealized gains on assets transferred during life or at death, and curtailing the use of grantor trusts as an effective estate planning technique. These all appear to have been eliminated from his latest tax proposals, but the legislative proposals in these areas remain very fluid so stay tuned. Year end is a good time for all taxpayers to review and update their estate plan. If you could potentially owe estate transfer taxes, if/when the exemption drops down to pre-2018 levels, there are various gifting strategies available to transfer wealth before the exemption drops. The most widely used gifting techniques include the following: Spousal Lifetime Access Trusts (SLAT), Irrevocable Life Insurance Trusts (ILIT), Grantor Retained Annuity Trusts (GRAT), Qualified Personal Residence Trust (QPRT), and Intentionally Defective Grantor Trusts (IDGT). Year end is also a good time to consider making annual exclusion gifts. This is the amount you can give each person annually without using up your lifetime exemption. The annual exclusion is $15,000 for 2021 and increases to $16,000 in 2022.
Small Business Tax Planning
Below are planning opportunities for small businesses to consider in addition to planning for possibly higher tax rates.
- Establish a Retirement Plan
If your self-employed and set up a SEP-IRA, you can contribute up to 20% of your earnings for a maximum contribution of $58,000 for 2021. If employed by your own corporation, up to 25% of your salary can be contributed for a maximum contribution of $58,000. Other options to consider are group 401(k)s, single 401(k)s, defined benefit pension plans, and SIMPLE-IRAs.
- Asset Purchases
Defer asset purchases, if rates are expected to increase.
- 100% first-year bonus depreciation is available to qualified new AND used property that is acquired and placed in service in calendar-year 2021 (and currently 2022). There are deduction limitations for purchases of new and used “passenger vehicles”. These limitations can be avoided if you purchase a “heavy vehicle” which has a manufacturer’s Gross Vehicle Weight Rating above 6,000 pounds. Only vehicles used more than 50% of business qualify for bonus depreciation. Note: Virginia generally does not conform to bonus depreciation.
- Section 179 expensing is available for property that doesn’t qualify for bonus deprecation. For qualifying property placed in service the maximum deduction is $1.05 million. The deduction begins to phase-out when the cost of Section 179 property placed in service exceeds $2.62 million.
Questions on tax planning for your unique situation?
All the above strategies have special nuances and should be carefully considered as part of your broader financial picture. This listing is intended as a starting point for discussion and is by no means a complete list of ideas and nuances. If any of the strategies discussed here are of interest to you, or if they trigger questions about other tax situations, please reach out to your Keiter Opportunity Advisor or Email | Call: 804.747.0000 for advice on year end tax planning opportunities.
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.