Year-End Tax Planning for Individuals

As we near the end of another turbulent year, it’s time to discuss the steps you need to take to reduce your tax burden for 2021 (and beyond). Unlike other years, 2021 presents many unique moving parts to the tax puzzle and will require strategic planning to favorably position you for the future.

This article will provide a high-level summary of the upcoming changes for your consideration.

California AB 150 SALT Workaround

In 2018, the TCJA significantly reduced the amount of state and local taxes (SALT) taxpayers could deduct, imposing a $10,000 cap on the federal income tax deduction, and sending some indirect tax rates well over 50%.

In July 2021, California Assembly Bill 150 was passed, which established a SALT workaround for qualifying passthrough entities. This bill allows partnerships and S corporations to elect to pay a 9.3% tax on taxable income.  A state tax credit would be passed through to owners on their California income tax return, which would be used to reduce their state tax liability. This credit cannot reduce state tax liability below the California tentative minimum tax. In addition, an election to pay the entity level tax reduces the passthrough owner’s federal net income, which effectively reduces their overall federal taxable income as well.

Owners of qualified passthrough entities who incur a personal state tax liability in excess of $10,000 in state and local taxes may consider incorporating this elective tax as a strategy to reduce their individual tax liability. This opportunity also helps owners who take the standard deduction, as they will get advantage of the state tax deduction against federal taxable income as well.

Individuals, estates, and trusts are eligible to receive this credit and carry forward any excess credit amount for up to five years. The election to pay this tax through the passthrough entity is an annual election, and should be considered each year the entity is eligible.

Keep in mind: the elective tax needs to be paid on a timely-filed tax return, without regard to any extensions. For taxable years after January 1, 2022 and before January 1, 2026, there are two payments required: the first is due on or before June 15^th of the elective year, and the second will be due on or before the due date of the original return.

Finally, the most recent draft of the Build Back Better Bill on November 3, 2021 included an expansion of the SALT cap to $72,500.  Should this expansion be included in final legislation, the use of this workaround may not be needed for some taxpayers. 

Re-Established Required Minimum Distributions (RMDs) from Retirement Accounts

RMDs are back for 2021. Last year, legislation stemming from COVID allowed seniors to skip their RMDs without having to pay a penalty. However, the temporary suspension only applied for 2020. This year, RMDs must be taken by taxpayers who are at least 72 years old by December 31, 2021, unless the taxpayer celebrated their 72^nd birthday this year, then they can defer payment until April 1, 2022.

Taxpayers who are looking to reduce their tax liability this year can also use qualified charitable distributions (QCD) to count towards RMDs as well. Taxpayers can contribute up to $100,000 to a qualified charity directly from their retirement accounts (excluding Roth IRAs) to reduce overall AGI.

Repayment of Deferred Social Security Tax

Self-employed individuals who opted to defer a portion of their Social Security taxes in 2020 are now required to repay half of the amount owed by December 31, 2021. The remaining balance is due by December 31, 2022. It’s important to make a separate tax payment noting that the amount should be applied to previously deferred Social Security tax.

Extension of Charitable Giving Benefits

A number of tax provisions have been expanded in 2021 to incentivize charitable giving during a time when nonprofits need it most.

Taxpayers who take the standard deduction are eligible to deduct $300 (single filers) or $600 (joint filers) on top of the standard deduction when they make a cash contribution to a qualified charity.

For those who itemize, donors are now able to deduct up to 100% of their AGI for cash contributions to qualified charities. Under previous law, the deductibility amount was limited to 60% of the taxpayer’s AGI. Please note that this expansion of charitable deductions is set to expire at the end of 2021.  Any unused charitable donations will carry forward to future years.

Donor advised funds and private foundations are excluded from the above expanded charitable giving benefits.

Child Tax Credit

The 2021 Child Tax Credit increased for families claiming the credit to up to $3,000 for each qualifying child ages 6-17 and up to $3,600 for each child under the age of 6. Under previous law, taxpayers received a child tax credit in the amount of $2,000 for qualifying children under age 17.

In addition, the IRS began distributing advanced monthly payments in July so that qualifying families could receive an immediate benefit. Payments will continue through December and the remaining 50% of the child tax credit will be claimed on 2021 returns.

Advance payments are based on either 2019 or 2020 tax returns, depending on which return was on file with the IRS at the time of distribution. If you believe that your monthly child tax credit payments will exceed the amount you qualify to claim on your 2021 return, you may consider making an adjustment or opting out before year end by visiting the IRS’ Child Tax Credit Portal. Otherwise, overpayments will need to be repaid by April 15, 2022.

Increased Lifetime Estate and Gift Tax Exemption Amount

The window of opportunity may be closing for taxpayers who seek to apply some or all of their lifetime estate and gift exemption amount. Currently, the federal estate and gift tax exclusion amount is $11.7 million per taxpayer (more than double since 2017 and ten times the amount in 2008).

While still in negotiations, the current administration has proposed tax changes for 2022 that could alter the gift tax amounts and limit the option to use some trusts as effective estate planning techniques. While this language was in the initial drafts, the November 3, 2021 version did not include any changes to estate taxation.

We recommend working closely with your estate planning attorney as legislation develops.

Continued Low Capital Gains and Qualified Dividend Rates

When considering how to lower your capital gains taxes you may benefit from using tax-advantaged retirement plan accounts, harvesting tax losses and gains, reinvesting in a Qualified Opportunity Fund to defer and minimize taxes, and closely monitoring mutual fund distributions prior to year-end. Proposed changes to the capital gains rates have also dropped off of the November 3, 2021 draft legislation. Until negotiations are complete, changes are still possible.

It’s Time for a Plan

This article only scratches the surface on year-end tax planning strategies as a result of the surmountable tax changes enacted over recent years and the potential changes that may lie ahead. With the right guidance and foresight, we can help you set the course for greater financial success. Please contact me at bforeman@bpw.com or (805) 963-7811 to schedule a year-end planning meeting. For updates, visit our Tax Guide with more information.