2021 Year End Tax Planning for Businesses and Individuals
Year-end tax planning is always tricky, but pending legislation prior to year-end adds a whole new layer of complexity to the equation. At the current time, the House has passed the Build Back Better (BBB) Act with numerous changes related to business and individual taxation. While these proposed changes are likely to be modified in the Senate before being enacted, we’re sharing some key ideas that individuals and businesses should consider before the New Year. Every taxpayer’s situation is different, so we are here to help you evaluate your position so you can decide the best moves to take.
With so many potential changes in the tax law, it is strongly recommended that you have your tax plan in place. Even though most laws are likely to stay the same for 2021 as they have since 2018, your income and deductions may have changed which will make your tax results very different. The best way to start is by identifying any changes in your personal tax situation.
- For 2021, the maximum deferral is $19,500 with an additional catch-up contribution of $6,500 for those over 50 years old as of December 31, 2021.
- For 2022, the maximum deferral is increased to $20,500 while the additional catch-up contribution remains unchanged at $6,500.
- postponing income into 2022;
- increasing itemized deductions, such as charitable contributions;
- increasing retirement plan contributions;
- elect to aggregate several businesses together potentially allowing you a larger 20% deduction.
- Health Savings Accounts (HSA). If you become eligible on or before December 2021 to make HSA contributions, you can make a full year’s worth of deductible HSA contributions for 2021.
- Simplified Employee Pension (SEP) Contribution. If you have self-employed income, consider putting money into a SEP. This option is available to you even if you have already deferred the maximum amount into your employer-sponsored 401(k) plan. By contributing money to a SEP, you can typically avoid both current year federal and state taxes on the amount contributed. The maximum SEP contribution for 2021 is $58,000 and it can be funded as late as the due date of your federal tax return, including extensions.
- Student Loan Interest. You may be eligible to take an above-the-line deduction for student loan interest paid up to a maximum of $2,500.
- Self-Employed Health Insurance. Partners and S-Corp shareholders owning more than 2% of the entity stock and self-employed individuals are permitted a deduction for their health insurance for themselves and their dependents. This is different than the Schedule A itemized deduction since it is above-the-line and not subject to the 7.5% Adjusted Gross Income limitation.
- Charitable Deduction for Non-Itemizers. As part of the CARES Act, taxpayers were allowed a charitable deduction of $300 for gifts to qualified charitable organizations in 2020, even if you are not itemizing your deductions. This has remained the same for 2021, except married taxpayers are eligible for a deduction of $600.
- Medical Expense Deduction. For 2021, medical expenses are only deductible to the extent that they exceed 7.5% of your adjusted gross income, even for taxpayers over age 65. Medical expenses include health insurance premiums, Medicare premiums, amounts paid to doctors for medical care, prescriptions, etc. Unless you have a high amount of medical expenses, you most likely will not qualify for this deduction.
- State and Local Tax Deduction. The TCJA limited the total deduction for state and local income taxes and real estate taxes to $10,000. If you can itemize your deductions and have not reached the $10K limit, you may want to consider paying your real estate taxes in December 2021 as opposed to January 2022. If you have already met the $10K limitation, then there is no benefit to pre-paying these taxes. Please note that under the proposed BBB Act, the state and local tax deduction would increase to $72,500.
- Mortgage Interest Deduction. The interest you pay on your home is typically deductible to the extent that the average mortgage balance does not exceed $750,000. For mortgages placed in service prior to December 15, 2017, the limit is $1,000,000. Home equity loan interest is only deductible if the loan was used to buy, build or improve the home. The old rule allowing a deduction for the first $100,000 of home equity interest was eliminated. Also, don’t overlook mortgage points paid upon purchase or refinancing as these may be deductible as well.
- Charitable Contribution Deduction. Consider making charitable contributions before year-end either in cash or non-cash such as highly appreciated stocks. If you donate highly appreciated stock, you can get a donation deduction for the fair market value of the stock and avoid capital gains tax. You can also make contributions at year-end using your credit card, even if the credit card is not paid until 2022. You can write a check to charity and mail it on December 31, 2021, and take a 2021 tax deduction even if the check doesn’t clear your bank until January 2022. Non-cash donations valued over $5,000 (except publicly-traded stock) require a written appraisal and a letter from the charity acknowledging the donation to be deductible. If you are over age 70 ½, you can make a charitable contribution up to $100,000 directly from your IRA to satisfy the required minimum distribution requirement.
- Child Tax Credit. The BBB Act would extend the child tax credit through 2022. This would include the advanced payments that rolled out in 2021. The Bill would also extend the refundability of the child tax credit beyond 2022.
- State and Local Cap Deduction. The Bill would increase the allowed state and local tax deduction from $10,000 to $72,500 ($36,250 for married taxpayers filing separately and for trusts and estates).
- Net Investment Income Tax. The Bill would make taxable net investment income derived in the ordinary course of a trade or business for taxpayers with taxable income over $400,000 for single filers, $500,000 for married filing jointly or $250,000 for taxpayers married filing separately.
- Excess Business Losses. The Bill would make permanent the limitations on excess losses for all noncorporate taxpayers.
- High-Income Surcharges. The Bill would impose a surcharge on high-income taxpayers. The surcharge tax would be 5% of the amount of the taxpayer’s modified adjusted gross income that exceeds $10 million ($5 million for married taxpayers filing separately and $200,000 for estate and trusts). There would also be a 3% surcharge on the amount of a taxpayer’s modified adjusted gross income that exceeds $25 million ($12.5 million for taxpayers filing separately and $500,000 for estates or trusts).
Estate Tax Planning
Businesses have been greatly affected by the TCJA and CARES Acts. While the rules for 2021 are mostly the same as in 2020, it is imperative to consider the TCJA and CARES rules as part of your tax plan. Under the TCJA, corporate tax rates were cut to a flat 21% (previously 35%) and the addition of the Qualified Business Income (QBI) deduction (20% business income deduction) for other taxpayers is the most profound.
The TCJA also expanded the small business gross receipts threshold to $26 million for 2021, which allows businesses to elect or remain eligible for various accounting methods, such as utilizing the cash method of accounting and treating inventory as non-incidental materials and supplies or to avoid the uniform capitalization rules for resellers and manufacturers. Your business’ taxable income could be much lower under the cash method of accounting or through various other method changes allowed for small businesses.
- Section 179. Allows you to expense otherwise depreciable property if placed in service in 2021. You may elect to expense up to $1,050,000 of fixed asset costs (with a dollar-for-dollar phase-out for purchases greater than $2,620,000). If the cost of your Sec. 179 property placed in service during 2021 is $3,670,000 or more, you cannot take the deduction. Additionally, the deduction is limited to business income. Certain real estate improvements can be “Qualified Improvement property” (QIP) and still be eligible for the Sec. 179 deduction.
- Bonus. In addition to the Sec. 179 deduction, your business can also deduct first-year bonus depreciation equal to 100% of the cost of most fixed assets with a tax life of 20 years or less. Under the TCJA, the law has eliminated the requirement that eligible property must be new to qualify for bonus depreciation (if the property was not acquired from a related party). The 100% first-year bonus depreciation will remain in effect through 2022, in which the applicable percentages will then be phased out through 2026. The CARES act has clarified this further by confirming that QIP is a 15-year property eligible for 100% bonus depreciation. QIP includes most non-residential improvements to the interior of a building.
- R&D Credit. Businesses that incur certain research and development (R&D) costs, such as wages, supplies and contract research, are eligible for this general business R&D tax credit. Eligible small businesses with $50 million or less in gross receipts, may also be able to claim the R&D credit against the employer’s payroll tax (i.e. FICA) liability under TCJA rules.
- Work Opportunity Tax Credit. Businesses that hire individuals from targeted groups (i.e. qualified veterans, long-term unemployment recipients, ex-felons) are eligible for a tax credit equal generally to 40% of up to $6,000 of the individual’s first-year wages paid (per employee).
- Employee Retention Credit. A credit is available of up to 70% of wages paid before September 30, 2021, by employers forced to close or partially close by government order or experiencing a 20% or greater quarterly reduction in sales. This credit is now available to PPP loan recipients if the same wages used for the credit are not used for forgiveness of the PPP loans.
These are some of the year-end steps that can be taken to minimize your tax burden. We can help tailor a customized plan that will work best for your tax planning goals. Additional ideas and information may be found in our 2021 Tax Planning Guide.
Please contact your BMF Advisor if you would like to review any of the items mentioned, schedule a tax planning strategy session or discuss potential implications of the various tax law changes.
John E. Jenkins?>
Melissa G. Dunham?>
CPA, MTax, MBA
About the Authors
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