2021 Year-End Tax Planning Guide for Individuals & Businesses
In this Guide
- Individual Tax Planning Highlights
- Business Tax Planning Highlights
- State & Local Taxes
- Download the 2021 Tax Planning Guide
Since the U.S. entered 2021, individuals and business owners have had to swiftly navigate the rapidly changing tax law environment. Various versions of tax and spending measures have all been negotiated and debated by members of Congress and the White House, including passed legislation like the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the Consolidated Appropriations Act (CAA), the American Rescue Plan Act (ARPA), and the Infrastructure Investment and Jobs Act (IIJA). At the time of this publication, the House has voted on the Build Back Better Act, and the Senate is working through its version of the bill.
As 2021 heads to a close, tax increases are expected, but the timing and content of changes will not become certain until final legislation has passed. The information below supports individuals and businesses in their year-end tax planning and is based on tax proposals as presented in the November 3, 2021 version of the Build Back Better Act. Our strategies are intended to potentially increase your after-tax cash flow and help you achieve your individual and business objectives but are subject to change with final legislation.
When tax planning, it is important to know your estimated adjusted gross income (AGI) and tax bracket. Many deductions are linked (or limited) to AGI; estimating this figure is an important start to this process.
2021 Federal Income Tax Rate Brackets
A “tax bracket’ is a range of income that applies to these tax rates.
For example: For 2021, married taxpayers who file a joint return with taxable income of $475,000 are in the 35% tax bracket.
Tax brackets are indexed for inflation, but if income grows faster than inflation, taxpayers may find themselves in a higher tax bracket. In this case, opportunities of tax benefits increase (as do the repercussions of forgoing such opportunities).
Individuals’ Tax Planning Highlights
While not exhaustive, here are several tax strategies to consider and key insights on 2021 tax legislation:
Underpaid 2021 Estimated Tax Liability
There may be enough time to change your income tax withholding by changing your withholding elections on Form W-4.
Consider: adjusting your withholding election and/or paying a fourth quarter estimated tax payment by January 15, 2022.
“Bunching” Itemized Deductions
For 2021, the standard deduction is $25,100 for married filing jointly and surviving spouses, $18,800 for head of household, and $12,550 for all other taxpayers. Taxpayers should consider “bunching” itemized deductions in 2021 and taking the standard deduction in 2022.
Consider: paying deductible items in 2021 such as medical bills, state estimated tax payments, and mortgage interest that are due in January 2022.
Consider: doubling up on charitable contributions every other year. The 2021 charitable deduction threshold is 100% of AGI in 2021 (up from 60%). If you are not itemizing deductions in 2021, there is an allowable $300 ($600 married filing jointly) above the line deduction for cash charitable contributions made in 2021.
Accelerating Expenses in 2021
Consider accelerating expenses into the 2021 tax year to reduce taxes by doing some of the following:
- Paying 2022 tuition in 2021
- Funding a 529 College Savings Plan
- Maxing out 401(k) contributions ($19,500 maximum annual contribution limit with a $6,500 catch up limit for taxpayers over the age of 50)
- Making charitable contributions by the end of 2021 using a credit card, if the bill will not have to be paid until 2022.
Backdoor ROTH Contributions
The current version of the Build Back Better Act would prohibit all taxpayers from funding ROTH IRAs or designated ROTH accounts with after-tax contributions starting in 2022, and high-income taxpayers from converting retirement accounts attributable to pre-tax or deductible contributions to ROTHs starting in 2032. In addition, the ability to convert non-deductible IRAs to ROTH IRAs would be eliminated.
Proposed Change to Deduction for State & Local Taxes
The Tax Cuts and Jobs Act (TCJA) introduced a $10,000 limit on deductions of state and local taxes paid during the year ($5,000 for married individuals filing separately).
The latest version of the Build Back Better Act would extend the TCJA SALT deduction limitation through 2031 and increase the deduction limitation amount to $72,500 ($32,250 for estates, trusts and married individuals filing separately). An amendment currently on the table proposes increasing the deduction limitation amount to $80,000 ($40,000 for estates, trusts and married individuals filing separately). The proposal would be effective for taxable years beginning after December 31, 2020, therefore applying to the 2021 calendar year.
Qualified Charitable Distributions (QCD)
Taxpayers 70 ½ years and older can take advantage of donating up to $100,000 tax free to one or more charities directly from a traditional IRA. This distribution counts as a Required Minimum Distribution (RMD) for taxpayers who have reached the age of 72 years and older. These must be made by December 31st in order to qualify for the charitable contribution deduction in 2021.
Capital Gains & Short-term Losses
Consider: selling short-term investments at a loss to offset ordinary income. Review mutual fund capital gain distributions and find assets to sell at a loss to offset the mutual fund capital gain distributions. Free up suspended losses by triggering passive gains.
If you anticipate being in a higher tax bracket in 2022…
Consider: selling long-term capital gain property in 2021. Long-term capital gains are taxed at capital gain rates of 0%, 15% or 20%, depending on your tax bracket.
For investors in the lowest two tax brackets who anticipate being in higher tax brackets in the future…
Consider: selling long-term capital gain property at 0% tax rate and then reinvesting the same property for a step up in basis. Watch out for any income-producing sales that may place you in a higher tax bracket in the current tax year.
Pulling Income Between Tax Years
Depending on a taxpayer’s situation, there may be reasons to either pull income into the current tax year or push it into the following tax year. If you believe that tax rates will increase or that you may enter a higher tax bracket in 2022, you may want to pull income into 2021.
Accelerating income can be accomplished by triggering long-term capital gains, taking taxable withdrawals from a traditional IRA (for taxpayers over the age of 59 ½), or converting traditional IRA’s to ROTH IRA’s. Conversely, if you anticipate being in a lower tax bracket in 2022, push these same income-producing transactions to the following tax year.
2021 Child Tax Credit Advance Payments
As a result of ARPA, the 2021 Child Tax Credit (CTC) was increased to $3,000 per qualifying child, and an additional amount of $600 is provided for kids under the age of six years. Qualifying taxpayers who filed a tax return in 2019 or 2020 (or applied for a stimulus check) are automatically receiving half of their estimated 2021 Child Tax Credit in advance through monthly installments between July and December 2021, unless they have opted-out through the Internal Revenue Service (IRS) website. These advances reduce the amount of CTC that could be offsetting your 2021 tax liability. The final 2021 CTC advance payment is not scheduled until December 15, 2021, and taxpayers still have an opportunity to opt-out by November 29, 2021 in order to potentially increase the amount of refundable CTC on your 2021 return.
Planning for Charitable Contributions
Taxpayers are permitted to take a deduction for qualifying cash contributions made in 2021 to the extent the contribution does not exceed the Taxpayer’s AGI. Any excess contributions carry forward for five years. Donations made to a non-operating private foundation or a donor advised fund (DAF) are not eligible for this deduction and remain limited to 30% and 60% of AGI respectively. The 100% AGI donation to qualifying charitable organizations expires in 2021; therefore, you should consider maximizing 2021 cash charitable contributions to qualified charities. Other tax planning opportunities are to create and fund a DAF, and to donate appreciated property to a qualified charity to avoid long-term capital gains tax.
Estate & Gift Taxes
The proposed Build Back Better Act does not include changes to estate and gift rules; however, the current exemptions are expected to sunset in 2025. For gifts made in 2021, the gift tax annual exclusion is $15,000 and for 2022 is $16,000. For 2021, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $11,700,000 per person. For 2022, the exemption is $12,060,000. All outright gifts to a spouse who is a U.S. citizen are free of federal gift tax. However, for 2021 and 2022, only the first $159,000 and $164,000, respectively, of gifts to a non-U.S. citizen spouse are excluded from the total amount of taxable gifts for the year.
Tax planning strategies may include:
- Making annual exclusion gifts
- Making larger gifts to the next generation
- Creating an estate plan in consideration of sunset provisions
Whether considering pulling income into 2021, or pushing into the following tax year, it is recommended that taxpayers consult with their trusted tax advisor before doing so.
Business Tax Planning Highlights
Change in Method of Accounting
A small business defined as a C-Corporation, in partnership with a C-Corporation partner, or that maintains inventory with average annual gross receipts of $26 million or less, is able to change to the cash method of accounting. Prior to the implementation of the Tax Cuts and Jobs Act (TCJA), C-Corporations were restricted to use the accrual method of accounting. If a small business wishes to utilize the cash method of accounting, they must file a timely Form 3115 Application for Change in Accounting.
Cash method of accounting allows taxpayers more flexibility in pushing/pulling income and deductible expenses between tax years for tax planning purposes. For example, income and expenses are recognized for tax purposes when received and paid, respectively. A change in accounting method is ideal for small business taxpayers who are currently on the accrual method of accounting and have significant accounts receivable that exceed accounts payable and accrued expenses at year-end. Use of the cash method is not beneficial for taxpayers that receive advanced payments.
Businesses that purchased either new or used machinery and equipment, or qualified investment property, may be able to take advantage of a 100% bonus depreciation deduction in the year of purchase. This deduction is permitted without any proration based on when an asset was placed in service during the tax year. As such, businesses should consider whether it makes sense to make any such purchases prior to year-end in order to maximize after-tax cash flow.
Section 179 Deduction
Partnerships, sole proprietors and S-Corporations may consider making expenditures that qualify for the business property expensing option under Section 179. For tax years beginning in 2021, the expensing limit is $1,050,000, and phases out for entities with qualifying asset purchases greater than $2,620,000. Section 179 is generally available for most depreciable property (other than buildings and off-the-shelf software), as well as certain interior improvements referred to as “qualified improvement property.”
The allowable amount of the Section 179 deduction is calculated at the individual level. Taxpayers are required to aggregate qualified purchases from all partnerships, sole proprietorships, and S-Corporations on their individual return in order to determine the amount of Section 179 deduction allowable for the current tax year. Any unused portion of the Section 179 deduction is carried forward indefinitely at the individual level.
Employee Retention Credit (ERC)
The ERC is a refundable payroll tax credit that can be claimed by employers who pay qualified wages to qualifying employees. This refundable tax credit was designed to help thousands of businesses retain workers and grow businesses in these unprecedented times. Changes were made with legislation to allow qualified businesses that took a Paycheck Protection Program (PPP) loan to also be eligible for the ERC. Originally, qualifying wages during 2021 would be considered in the calculation of the ERC. However, the recently passed IIJA terminated the ERC three months early, making wages paid after September 31, 2021 ineligible for the credit. Despite that, a business can still take advantage of this credit for wages paid for a majority of the year, despite having previously taken a PPP loan.
State & Local Taxes
Businesses should monitor the tax rules in the states in which they operate or make sales. Taxpayers that cross state borders—even virtually—should review state nexus and other policies to understand their compliance obligations, identify ways to minimize their state tax liabilities, and eliminate any state tax exposure.
Following are some of the state-specific areas taxpayers should consider when planning for their tax liabilities in 2021 and 2022:
- Does the state conform to federal tax rules (including recent federal legislation) or decouple from them? Not all states follow federal tax rules. (Note that states also do not necessarily follow the federal treatment of PPP loans.)
- Has the business claimed all state net operating loss/es (NOL) and state tax credit carrybacks and carryforwards? Most states apply their own NOL/credit computation and carryback/forward provisions. Has the business considered how these differ from federal and the effect on its state-taxable income and deductions?
- Has a state adopted economic nexus for income tax purposes, enacted NOL deduction suspensions or limitations, increased rates or suspended or eliminated some tax credit and incentive programs to deal with lack of revenues due to COVID-19 economic issues?
- The majority of states now impose single-sales factor apportionment formulas and require market-based sourcing for sales of services and licenses/sales of intangibles using disparate sourcing methodologies. Has the business recently examined whether its multistate apportionment of income is consistent with, or the effect of this trend?
- Consider the state and local tax treatment of merger, acquisition and disposition transactions, and do not forget that internal reorganizations of existing structures also have state tax impacts. There are many state-specific considerations when analyzing the tax effects of transactions.
- Is the business claiming all available state and local tax credits (e.g., for research activities, employment or investment)?
- For businesses selling remotely and that have been protected by P.L. 86-272 from state income taxes in the past, how is the business responding to changing state interpretations of those protections with respect to businesses engaged in internet-based activities?
- Has the business considered the state tax impacts of its mobile workforce? Most states that provided temporary nexus and/or withholding relief relating to teleworking employees lifted those orders during 2021.
- Has the state introduced (or is it considering introducing) a tax on digital services? The definition of digital services can potentially be very broad and fact-specific. Taxpayers should understand the various state proposals and plan for potential impacts.
- Remote retailers, marketplace sellers, and marketplace facilitators (i.e., marketplace providers) should be sure they are operating in compliance with state sales and use tax laws and marketplace facilitator rules.
- Assessed property tax values typically lag behind market values. Consider challenging your property tax assessment.
Whatever pivots your business adopts, tax strategy needs to be a crucial part of the plan to move forward. Evolving your tax approach alongside business strategy will help prevent unforeseen costs and maximize potential savings.
State Pass-through Entity Elections
The TCJA introduced a $10,000 limit for individuals with respect to federal itemized deductions for state and local taxes paid during the year ($5,000 for married individuals filing separately). At least 20 states have enacted potential workarounds to this deduction limitation for owners of pass-through entities, by allowing a pass-through entity to make an election (PTE tax election) to be taxed at the entity level. PTE tax elections present state and federal tax issues for partners and shareholders. Before making an election, care needs to be exercised to avoid state tax traps, especially for nonresident owners, that could exceed any federal tax savings. Note that the Build Back Better Act proposes to increase the state and local tax deduction limitation for individuals to $80,000 ($40,000 for married individuals filing separately) retroactive to taxable years beginning after December 31, 2020. In addition, the Senate has begun working on a proposal that would completely lift the deduction cap subject to income limitations.
Find the Strategy that Suits Your Needs
The items mentioned in this guide are only a few strategies that both individuals and businesses can employ as part of their year-end tax planning process in order to place themselves in the most advantageous position. However, many of these strategies can be complex and have other unforeseen tax ramifications that are not always apparent.
Every individual and business has different circumstances that impact their income tax situation and related tax planning. As such, we recommend that you consult with your trusted tax advisor prior to taking any action, in order to see what year-end tax planning strategies best suit your individual needs. If you don’t have a tax advisor and need help, please give us a call. It would be our pleasure to assist you, and help you navigate these complex and rapidly changing tax laws.