Taxes in Your Practice : Year-end tax planning for 2021
Vol. 77, No. 6 / Nov. - Dec. 2021
Scott E. Vincent
Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.
As COVID-19 continued to impact us in 2021, legislation with pandemic-related tax relief highlights tax planning considerations for this year-end, including provisions in the Coronavirus Response and Consolidated Appropriations Act (CAA 2021) in December 2020 and the American Rescue Plan (ARP) in March 2021.
Some of the individual tax breaks include dependent care assistance, payroll tax credits for the self-employed, increases in the child tax credit and earned income tax credit, recovery rebates, student loan forgiveness exclusions, and other individual relief. Business tax relief provisions include deductibility of expenses paid with proceeds from forgiven Paycheck Protection Program (PPP) loans, which altered prior guidance. The ARP also extended and modified certain refundable payroll tax credits, allowing eligible business taxpayers to file amended returns for refunds. Many Coronavirus Aid, Relief, and Economic Security (CARES) Act provisions from 2020 continue to apply for 2021 as well.
Importantly, as this article goes to print, Congress and the White House are negotiating a variety of tax provisions in proposed budget and spending bills that could also have significant impact on certain taxpayers. Current tax provisions under consideration would primarily impact large corporations, high income taxpayers, and high net worth taxpayers, but none of the legislation is permanent yet. All taxpayers should carefully monitor this legislation and the potential impacts on year-end planning if the bills are enacted.
In addition to pandemic relief tax provisions and the potential for year-end legislation, taxpayers need to consider planning for current and potential tax rates, the standard deduction and limits on itemized deductions, and multiple other issues, including continuing provisions of the Tax Cuts and Jobs Act of 2017 (2017 Tax Act). The § 199A deduction for qualified income from pass-through entities may also impact individuals and their businesses.
With the backdrop noted, this article outlines several individual and business planning issues for consideration. Taxpayers should, of course, adjust planning for their individual circumstances and carefully monitor ongoing changes to the provisions outlined here and in other new legislation.
Year-end planning issues for individuals
- Review ARP Act rebates. Most individuals under applicable income levels already received stimulus checks for their recovery rebate tax credit. These checks were issued based on either 2019 or 2020 income tax returns, but the final calculation of the correct rebate amount is part of 2021 tax returns. If this calculation shows a larger rebate, a taxpayer can claim it as a credit against 2021 tax liability. If the calculation shows an excess rebate, repayment is not required.
- Review individual credits. The ARP increased the child tax credit for 2021 from $2,000 to $3,000, or $3,600 for children younger than 6 years old. The entire credit is refundable for taxpayers who qualify under the income thresholds. Eligibility for the earned income credit was expanded, and the ARP also expanded dependent care assistance tax benefits for 2021. A premium assistance credit is available for families purchasing health insurance through exchanges offered under the Affordable Care Act. The Families First Coronavirus Response Act included qualified sick leave and family leave equivalent income tax credits for self-employed individuals.
- Consider the expanded standard deduction, eliminated personal exemptions, and limits on itemized deductions from the 2017 Tax Act. For 2021, the basic standard deduction is increased to $25,100 for joint filers; $18,800 for heads of household; and $12,550 for singles and married taxpayers filing separately. For taxpayers either 65 or older or blind, there is an additional standard deduction of $1,350, increased to $1,700 for unmarried taxpayers that are not surviving spouses, and doubled for taxpayers that are blind and 65 or older. Many itemized deductions also remain either reduced or eliminated. So, unless allowable medical deductions (as limited by 7.5% of AGI), allowable state and local taxes (as limited), allowable charitable deductions, interest deductions on qualifying residence debt, and other allowable itemized deductions exceed the standard deduction, taxpayers may find that the increased standard deduction provides more tax benefit. For taxpayers with timing flexibility, there may also be an incentive for “bunching” allowable itemized deductions into one year and using the standard deduction in other years.
- Consider special charitable deduction rules. There is a $300 ($600 for joint returns) above-the-line charitable deduction for taxpayers that do not itemize. In addition, for taxpayers that itemize deductions, charitable contributions in 2021 are deductible to the extent the aggregate does not exceed a taxpayer’s charitable contribution base. Excess contributions are eligible for a five-year carryover.
- Have an employer increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end for deduction of those taxes this year. This can be beneficial if a taxpayer expects to itemize deductions this year and doing so will not cause state and local tax deductions to exceed the applicable limitation.
- Plan for the 3.8% tax on unearned income. This surtax is 3.8% of net investment income (NII) that exceeds modified adjusted gross income (MAGI) thresholds. Year-end planning for the 3.8% surtax depends on estimated MAGI and NII. Some taxpayers may want to defer additional NII until next year, some may want to reduce MAGI other than NII, and some may be able to minimize both NII and other MAGI.
- Consider the additional 0.9% Medicare tax. This applies to individuals receiving a combination of wages with respect to employment and self-employment income in excess of applicable thresholds. Employers must withhold the additional Medicare tax from wages in certain circumstances. Self-employed persons must include it in estimated tax payments, and some employees may need more withholding to cover the tax.
- Accelerate income into this year in cases where a taxpayer’s marginal tax rate is expected to be lower this year than it will be next year due to economic conditions or expected changes in filing status or applicable rates. Postponing income can produce savings for taxpayers who expect to be in a lower tax bracket next year.
- Consider lower long-term capital gain rates on sales of assets held for more than one year. Depending on taxable income levels, taxpayers may want to utilize these lower rates for capital gain sales and avoid selling capital assets with offsetting losses that reduce the benefits of the lower rates. The reduced rates apply to adjusted net capital gain to the extent that this amount, when added to regular taxable income, does not exceed certain thresholds based on filing status. So, analysis of taxable income, potential capital gains, and other applicable taxes is required to determine the best combination.
- Consider retirement plan contributions, including catch-up contributions of additional amounts for taxpayers 50 and older.
- Certain retirement plan distributions are excepted from the 10% early withdrawal penalty, such as a limited qualified birth or adoption distribution. The CARES Act allowed a special coronavirus relief withdrawal of up to $100,000 from retirement plans, which is includable in income over a three-year period or eligible for tax-free rollover to an eligible retirement plan within the three-year period.
- Review required minimum distributions (RMDs) from retirement accounts. RMDs were waived for 2020 but are required for 2021. The RMD beginning date for taxpayers changed from 70.5 to 72 starting with the 2020 tax year. Participants who are still working and making contributions to an employer-sponsored retirement account also may be able to further delay RMDs on that account. Taxpayers who fail to take RMDs can be subject to a penalty of 50% of the required amounts that are not withdrawn.
- Consider making charitable donations from traditional IRAs. Qualified charitable distributions are made directly to charities, and the amount is not included in gross income or itemized deduction calculations and limits. In addition, the qualified charitable distribution may reduce RMDs when applicable. Taxpayers can plan for this benefit by maximizing contributions to traditional IRAs with amounts that may later be used for qualified charitable distributions.
- Consider a Roth IRA conversion. A taxpayer that would prefer a Roth IRA can convert traditional IRA investments into a Roth IRA if eligible. This will increase AGI for this year, so taxpayers should consider the impact on other AGI tax calculations.
- For taxpayers eligible to make health savings account (HSA) contributions, consider deductible HSA contributions before the end of the year. These are deductible from AGI, so the benefits are available even if a taxpayer does not itemize deductions.
- Increase the amount set aside for next year in a health flexible spending account (FSA) if the taxpayer did not set aside enough for this year. This can allow payment of medical and dental bills with pre-tax earnings.
- Complete annual gift tax exclusion before the end of the year to save gift and estate taxes. For 2021, taxpayers can give $15,000 each to an unlimited number of individuals but cannot carry over unused exclusions from one year to the next. These transfers also may save family income taxes where income-earning property is given to family members in lower-income tax brackets not subject to the kiddie tax.
- Consider education deductions and credits. Tax-free distributions from § 529 qualified tuition programs of up to $10,000 were expanded to elementary or secondary public, private, and religious schools, as well as expenses for participation in certain apprenticeship programs and limited amounts of qualified education loan repayments. For taxpayers under certain income thresholds, there are several credits and deductions available and limited student loan interest may be deductible. For 2021-25, the ARP also excludes certain discharges of student loans from income.
- Consider home-related tax provisions. Working from home increased significantly during the pandemic; self-employed workers and business owners may be able to deduct related expenses, although these would not be deductible for employees. Mortgage interest is limited to the level of acquisition indebtedness depending on when the home was acquired ($750,000 for homes acquired after Dec. 14, 2017; $1 million for homes acquired before that date), but mortgage interest allocable to the portion of a home used to operate a business is not subject to this limitation. Interest on home equity indebtedness may be deductible to the extent the debt was used to buy, build, or substantially improve the home. Gain of up to $500,000 for married taxpayers ($250,000 for other taxpayers) on the sale of a home is excluded from income, but the portion of the home used for business or rented reduces this exclusion from gain. Discharges of qualified principal residence indebtedness in 2021 are not included in gross income.
Year-end planning issues for business owners
- Review possible payroll tax credits. Businesses with less than 500 employees that offered paid sick or family leave through Sept. 30, 2021, to employees who took COVID-19 leave may qualify for refundable payroll tax credits. An employee retention tax credit (ERTC) also may be available for 2021 to businesses impacted by COVID-19 that kept employees on payroll. The “impact” requirement may include suspended operations and comparisons of gross receipts in 2021 to prior periods. To claim these credits and potential refunds, businesses will need to review and possibly amend payroll tax returns to account for the detailed requirements and calculations. These credits may also be available to qualifying self-employed individuals.
- The CARES Act included the Paycheck Protection Program (PPP). The PPP generally provides tax-free loan forgiveness based on expenditures in qualifying categories. For taxpayers participating in the PPP, forgiveness applications and timing should be considered, including carefully compiling records of PPP expenditures. CAA 2021 confirmed that taxpayers may deduct expenditures paid with proceeds from forgiven PPP loans, and “catch up” deductions may be available in 2021 for taxpayers that did not deduct these expenditures on 2020 tax returns. There is also overlap between expenditures that qualify for PPP loan forgiveness and eligibility for the ERTC, so careful analysis of the interplay between these programs is important.
- Consider the §199A qualified business income deduction for non-corporate taxpayers of up to 20% of qualified business income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. For 2021, the deduction may be limited (with a phase-in for the limitation) if taxable income is over $329,800 for married couples filing jointly; $164,295 for married filing separately; and $164,900 for other filers. These deduction limitations may apply depending on whether the taxpayer has a service-type trade or business such as law, accounting, health, or consulting, or whether the trade or business meets W-2 wage and qualified property (like machinery and equipment) requirements. Because there are taxable income thresholds and phaseouts for certain taxpayers, there may also be significant tax savings from deferring income or accelerating deductions into this year, depending on the taxpayer’s circumstances. Similarly, a taxpayer may be able to increase the deduction available by increasing W-2 wages or qualified property before year-end.
- Consider making expenditures before year-end that qualify for § 179 business property expensing. For tax years beginning in 2021, the expensing limit is $1.05 million, reduced dollar for dollar for property placed in service over $2.62 million. This expensing is available for most depreciable property and qualified improvement property, which generally includes interior building improvements and roofs, as well as HVAC, fire protection, alarm, and security systems. Property acquired and placed in service before year-end is eligible for full expensing for the year.
- Consider 100% first-year bonus depreciation for new and some used machinery and equipment purchased and placed in service in 2021. Like expensing, bonus depreciation is available for the full year, even if the asset was placed in service late in the year, so year-end purchases can receive a full first-year bonus write off.
- Consider changing to the cash method of accounting, rather than the accrual method. “Small businesses” with less than $26 million of average annual gross receipts over a three-year period may be eligible for the cash method if they meet other requirements. Generally, the cash method of accounting allows more flexibility in timing income and deductions.
- Consider meal and entertainment deductions. CAA 2021 allows a 100% deduction in 2021 and 2022 for properly documented expenses relating to food and beverages purchased from restaurants.
- Consider timing for a debt-cancellation event, including whether lower effective tax rates are expected this year or next year.
- Consider timing for disposition of a passive activity to allow a deduction for suspended losses to reduce current year taxable income.
- Review partnership and S corporation basis to make sure it is sufficient to deduct losses in current and future years.
- Review S corporation salaries to ensure that shareholders receive reasonable wages for their work for the business. The IRS often audits S corporations that pay all their profits as distributions without accounting for reasonable wages to shareholders.
- Consider setting up a retirement plan and health insurance plan if they are not currently offered. These plans can provide key benefits for retention of employees and for owners of a business.
Recent tax law changes and pandemic-relief legislation require continuing consideration for 2021 year-end planning. As noted, significant budget and spending legislation is also currently proposed, which could provide additional and different considerations for year-end planning this year. Taxpayers need to carefully consider these issues in light of their specific circumstances and watch for continuing tax law changes as we close out this unusual year.
1 Scott E. Vincent is the founding member of Vincent Law, LLC, in Kansas City.