Ready to talk about fall tax planning strategies to set you up for the new year? Taxes are like vehicles – they need a periodic check-ups to make sure they are performing as expected. And if ignored, little issues can turn into BIG ones, costing you money. It’s smart to be proactive and stay on top of your tax situation, especially this year as pandemic benefits begin to wane and President Biden’s tax proposals loom.
The following is a list of potential fall tax planning strategies that you might benefit from – especially if you start soon. While every taxpayer’s situation is unique, not all the options suggested here will apply to you. Fall tax planning opportunities are available for all income levels and a variety of tax circumstances. But wait too late in the year to start, and you may not have enough time to take advantage of these strategies.
Fall Tax Planning: Here’s Your Starting Place
Maximize Education Tax Credits
Qualify for either the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC)? First check to see how much you have already paid for qualified tuition and related expenses during the year. If you haven’t paid the maximum allowed for computing the credits, consider prepaying 2022 tuition. You can do this if it is for an academic period beginning the first three months of 2022. Then use the expense for the 2021 credit.
Employer Health Flexible Spending Accounts
Consider increasing the amount you set aside for next year. Especially if you didn’t contribute enough to cover expenses this year. Amounts paid after 2019 for over-the-counter medicine and menstrual care products are considered medical care and are considered a covered expense. The maximum contribution for 2021 is $2,750.
Maximize Health Savings Account Contributions
Eligible to make health savings account (HSA) contributions? Consider making a full year’s worth of deductible HSA contributions now. Even if you were not eligible to make HSA contributions for the entire year, you can do so now. This opportunity applies even if you first become eligible in December. In brief, if you qualify for an HSA, contributions to the account are deductible, or nontaxable if made by your employer (within IRS-prescribed limits); earnings on the account are tax-deferred; and distributions are tax-free if made for qualifying medical expenses. Amounts paid after 2019 for over-the-counter medicine and menstrual care products are considered medical care. These are considered a covered expense. However, only medical expenses you incur after you establish an HSA are eligible for tax-free distribution. An HSA can become a supplemental retirement plan if the funds are left to accumulate.
Convert Traditional IRAs to Roth IRAs
Income unusually low this year or even negative? You may wish to consider converting your traditional IRA to the more favorable Roth IRA. The Roth IRA provides tax free accumulation, and the distributions are tax-free at retirement. NOTE: lower income results in a lower tax rate, which provides you an opportunity to convert to a Roth IRA at a lower tax amount.
Fall Tax Planning – Deductions and Distributions
2021 Minimum Required Distributions
If you are age 72 or older, you must take required minimum distributions (RMDs) from your IRA, 401(k) plan. (Distributions from your current employer’s plan may be postponed if you are still working). Failure to take a required withdrawal can result in a 50% penalty of the amount of the RMD not withdrawn. If you turned age 72 in 2021, you could delay the first required distribution to the first quarter of 2022. HOWEVER, if you do, you will have to take a double distribution in 2022; the one for 2021 and the 2022 RMD. Carefully consider the tax impact of a double distribution in 2022 versus a distribution in both this year and next.
Bunching Deductions
Do your tax deductions normally fall short of needing to itemize? You may benefit from adopting the “bunching” strategy if the standard deduction you are allowed is greater than itemizing. To be more proactive, you can time the payments of tax-deductible items to maximize your itemized deductions in one year. Then take the standard deduction in the next.
Take Advantage of the Zero Capital Gains Rate
There is a 0 long-term capital gains rate for taxpayers whose taxable income is below the 15% capital gains tax threshold. This may allow you to sell appreciated securities that you have owned for over a year and pay zero tax on the gain.
Defer Deductions
When itemizing deductions, you may claim only the deductions paid during the tax year (the calendar year for most folks). If your projected taxable income is going to be negative and you are planning on itemizing your deductions, consider putting off some of those year-end deductible payments until after the first of the year. Then preserve the deductions for the following year. Such payments might include house of worship tithing, year-end charitable giving, or tax payments and more.
Increase IRA Distributions
Depending upon your projected taxable income, you might consider taking an IRA distribution to add income for the year. For instance, if the projected taxable income is negative, you can take a withdrawal of up to the negative amount without incurring any income tax. You might want to consider taking out just enough to be taxed at the 10% or even the 12% tax rates. Of course, those are retirement dollars; consider moving them into a regular financial account set aside for your retirement. Also be aware that distributions before age 59½ are subject to a 10% early withdrawal penalty.
Defer Capital Gains by Investing in an Opportunity Zone Fund
A unique tax benefit is the ability to defer any capital gain into a qualified opportunity fund (QOF). QOFs are funds that invest in areas in need of development. If you have a capital gain from selling property to an unrelated party, you may elect to defer that gain by investing it into a QOF. This needs to happen within 180 days of the sale or exchange. You won’t be taxed on the gain until your return for the earlier of the year of sale of the QOF or 2026. You can get up to 10% of the deferred gain forgiven entirely by holding the investment for the required time period. Additionally, you will not pay tax on additional gains if the investment is held for 10 years.
Even MORE Fall Tax Planning Opportunities
Sell Loser Stocks
Although the stock market has been performing well recently you still may have stocks that have declined in value. If you sell them before the end of the year, use those losses to offset other gains for the year. Or you can produce a deductible loss. The net capital loss deductible on a tax return is limited to $3,000 for the year. ($1,500 if filing married separate). However any excess loss carries over to future years. You can repurchase stock in the same company for which you sold shares at a loss after 30 days have passed and avoid the wash sale rules.
Take Steps to Avoid Underpayment Penalties
If you are going to owe taxes for 2021, take steps before year-end to avoid or minimize the underpayment penalty. The penalty is applied quarterly, so making a fourth quarter estimated payment only reduces the fourth-quarter penalty. However, withholding is treated as paid ratably throughout the year, so increasing withholding at the end of the year can reduce the penalties for the earlier quarters. This can be accomplished with cooperative employers or by taking a non-qualified distribution from a pension plan, which will be subject to a 20% withholding, and then returning the gross amount of the distribution to the plan within the 60-day statutory rollover limit. Please consult this office to determine if you will be subject to underpayment penalties (there are exceptions) and, if so, the best strategy to avoid or minimize them.
Fall Tax Planning Ideas To Jump On Today
Prepay State and Local Taxes
If you are not subject to the alternative minimum tax and you itemize your deductions, you are eligible to deduct both your property taxes and your state income tax. But did you know that you can increase the amount that you deduct on your 2021 tax return by prepaying some taxes? Consider asking your employer to boost your state withholding tax by a reasonable amount. Or, if you are self-employed, pay your 4th-quarter state estimate tax in December (it’s due in January.) Then increase your deduction. The same is true for your real estate taxes: if you pay your first 2022 installment in 2021, you can take it as part of your 2021 deduction.
But be aware! The state and local tax deduction is limited to a maximum of $10,000, so any amount more than $10,000 would be wasted as a tax deduction.
Don’t Waste the 2021 Annual Gift Tax Exemption
Part of President Biden’s tax plan is to reduce the lifetime gift and estate tax exemption. Whether for that reason or you simply want to limit your estate’s exposure to inheritance taxes, you can give $15,000 each to an unlimited number of individuals in 2021, but you can’t carry over unused exclusions from one year to the next. Taxpayers and their spouses can use their gift tax exemptions together to give up to $30,000 per beneficiary. For example, if you are married, have four children and four grandchildren, you can remove $240,000 from your estate tax-free this year. The transfers also may save family income taxes when income-earning property is given to family members who are in the lower income tax brackets and are not subject to the kiddie tax.
Unique Fall Tax Planning Strategies To Consider
Not Needing to File May Be an Opportunity
If your income and tax situation is such that you do not need to file for 2021, don’t overlook the opportunity to bring in some additional income, to the extent it will be tax-free. For instance, if you have appreciated stock that you can sell without incurring any tax, consider selling it, or perhaps take a tax-free IRA distribution if you are 59½ or older or if younger and qualify for an exception to the “early withdrawal” penalty.
Utilize IRA-to-Charity Transfers
If you are age 70½ or over, you can request that your IRA trustee directly transfer funds from your IRA to a charity. Although not deductible as an itemized charitable deduction, the distribution is not taxable. If you are age 72 or over when the IRA to charity direct transfer is made, the distribution can count towards your required minimum distribution for the year. This also reduces your AGI, which in some circumstances can reduce the amount of taxable Social Security income. There is no minimum charitable distribution, but the maximum amount per individual is limited to $100,000 per year. There are some complications if you are age 72 or older, have earned income and make a contribution to the IRA. Check with our office for the details.
Maximize Tax-Deductible Medical Expenses
If you have outstanding medical or dental bills, paying the balance before year-end may be beneficial. However only if you already meet the 7.5% of the AGI floor for deducting medical expenses. Think about adding the payments and if that would put you over the 7.5% threshold. Also consider if you are itemizing your deductions. You could pay expenses with a credit card, but only if any interest expenses you’d incur would be less than the tax savings.
Make Business Purchases
Consider reducing taxable income on last-minute business purchases. For example, purchases like office equipment, tools, machinery, and vehicles. Then write them off using the 100% bonus depreciation or Sec. 179 expensing. Just be sure to place the item(s) into business service by the end of the year. However, you must also consider the impact that expensing the items will have on your taxable income and the Sec. 199A 20% pass-through deduction. It may be appropriate to contact this office in advance of any last-minute business acquisition.
Silver Linings Fall Tax Planning Strategies
Divorced or Separated During the Year
A divorce or separation can have a significant impact on a couple’s tax filings. Carefully consider the effects of filing joint or separate returns. Also who claims the children, and the tax rules related to whether to take the standard deduction or itemize. In addition, consider how income and tax prepayments are allocated. It’s best to figure that all out in advance.
Disaster Loss Planning
2021 has had some significant declared disasters including Hurricane Ida and the wildfires in the West. Any losses incurred because of a federally declared disaster can be claimed on the current year’s tax return. Or, at the election of the taxpayer, they can be claimed on the prior year’s return (2020 for 2021 disasters). This generally provides quicker access to a tax refund. However, plan ahead! Be sure to claim any disaster loss on the year that will provide the greatest benefit. In addition, after insurance reimbursement is accounted for, the result may not be as expected. So take extra care to determine which year to claim a loss.
Fall Tax Planning For Gifting Giving Individuals
Increased Charitable Giving Opportunities
2021 is the final year that the normal 60% of AGI limit on cash contributions has been increased to 100%. This gives those folks the ability to increase normal charitable contributions and deduct them as an itemized deduction. The normal 5-year carryover applies to any excess over 100% of AGI.
Increased Charitable Giving Opportunities for Non-Itemizers
Non-itemizers are allowed to claim a deduction of up to $300 for cash charitable contributions made in 2021. That’s $600 on a joint return. Normally, only itemizers can deduct their charitable contributions. (Fun fact…did you know, currently about 90% of income tax return filers are not -itemizers?)
Take Advantage of Energy Credits
Two of the major green credits are the solar tax credit and the electric vehicle credit. The solar credit for 2021 is 26% of the cost of the installed solar system. Please not that the system must be complete and functional before year’s end to claim the credit in 2021. The credit is not refundable, and any excess has a limited carryover. The credit for electric vehicles must be determined from the IRS website. This is because credit begins to phase out once 200,000 of the vehicle type by manufacturer has been sold.
Insurance
Obtained your medical insurance through a government marketplace? Employing some of the strategies mentioned here could impact the amount of your allowable premium tax credit.
Income Tax
Consider the impact of some of these strategies on your state return, if you are not from Washington. If you live in a state that has an income tax, these strategies may not all be beneficial for you.
Ready to discuss how these strategies might provide you tax benefits based upon your tax circumstances? Excellent!
To schedule a tax planning appointment, please give the office a call at (360) 778-2901.
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