2021 has been yet another tough year for tax planning. Federal tax legislation in some form or another has been on the table since the Spring. As possible law changes appear and then are dismissed, it’s been a bit like trying to tango with an unwilling partner who’s actually waltzing. Taxpayers and their advisors have been contemplating, strategizing, and making moves that haven’t clearly had a payoff or were even unnecessary.
With the end of the year quickly approaching and the Build Back Better bill still stuck in the Senate, what should you do? Here, we’ll discuss tax provisions currently in the bill that could impact you, what moves you may want to make over the next few weeks, and general year-end tax planning.
With several changes up in the air, a few have been discussed over the last several months that are clearly out of the bill as of this writing. These include:
- An increase in capital gains tax rates
- An increase in ordinary income tax rates
- Taxing inherited unrealized capital gains
- Inclusion of assets of certain grantor trusts into a deceased’s estate
- Reduction in level at which the federal estate tax applies
- Reporting of taxpayer bank account activity to IRS
- The “Billionaires Income Tax” that would have essentially been an asset-based tax.
In short, a lot of the concerns that had folks running around most of the year making changes, are moot. At least for the moment. Could we, however, see some of these make a comeback in future legislation? Possibly. Certainly something to be keeping in mind for tax planning in the coming years. Tax rate changes are always on the table and the current estate tax threshold of around $11 million will drop back to its previous level of about $5 million in 2026 without any BBB influence.
Still In…For Now
There are still quite a number of tax law changes in the Build Back Better bill. Effective dates range from 2021 to 2032. Here are some of the changes that have a more immediate impact:
- Expansion of the child tax credit under the American Rescue Plan Act of March 2021 would be extended through 2022. This would include the continuation of advanced payments.
- The so-called SALT limit would be increased. For those of you who haven’t worked in tax for many years, SALT is the acronym for State and Local Taxes and refers to such taxes as income and property taxes. These taxes are generally available to be included with personal itemized deductions. Under the Tax Cuts and Jobs Act of 2017 (TCJA), the amount of total deductible SALT is $10,000 per year. Build Back Better would raise this to $80,000 starting 2021.
- Starting 2022, after-tax traditional IRA contributions would not be allowed to be converted to Roth IRAs.
- For those with over approximately $500,000 in income, BBB would bring active passthrough business income under the umbrella for which the 3.8% Net Investment Income tax is applicable starting in 2022.
- So-called wash sale rules would apply to digital currencies starting January 1, 2022. This would mean that the sale of a digital currency at a loss would not be tax deductible if that currency were subsequently repurchased within 30 days, which is the current tax treatment of publicly traded securities.
- The credit for electric vehicle purchases would be expanded. Beginning 2022, the EV credit under BBB would be up to $12,500 which is up from a current $7,500 maximum. The credit is subject to certain rules, such as income thresholds and location of assembly. Also included is a new, smaller credit for used
- A new 5% tax on folks with income over $10 million, and an additional 3% tax if over $25 million, would show up beginning 2022.
Tax Strategies to Consider under BBB as-is
With the above in mind, here are some possible action items for you in December:
- If you have realized capital gains you’re trying to offset AND are holding cryptocurrency that’s gone down in value, you could sell the crypto and buy it back fairly quickly. This would keep you in the same economic position while allowing you to create a loss to offset your gain. Keep in mind, though, that you do need some sort of non-tax purpose behind the sale. Also, good to consider is that you will be resetting your crypto tax basis to the new, lower amount which may mean a higher gain later on when you (re)sell it.
- Remember back in the old days when we pre-paid state income taxes before year end? That could work again. For example, if you plan to make a 4th quarter state estimated income tax payment in January 2022, you might pay it this month. This strategy could be effective if you will itemize your personal tax deductions and if your 2022 tax rate is expected to be the same or lower than your 2021 tax rate.
- If your custodian can make it happen before 2022, make your backdoor Roth IRA contribution now. If you normally make a non-deductible IRA contribution and then immediately convert to a Roth, do this now. Many folks do this in the year following as the tax return due date is the due date of executing this strategy. Assuming BBB passes as-is, the after-tax contribution and the conversion needs to be done now. Similarly, if you participate in your employer’s Mega Backdoor Roth, wrap up these contributions and conversions this month.
And some thoughts for 2022 if BBB passes in its current form:
- If the Net Investment Income application to S Corporation profits passes, consider your business’ tax structure. S Corporations are a popular strategy for higher income small businesses, but an additional 3.8% tax on profits adds additional cost to the structure.
- The $400K-$500K range is being targeted through various changes (not all listed in this article). Are there things you could be doing now to stay under this range such as shifting an employer bonus from one year to another?
- Although most of my client base is not in the $10 million+ category, this could certainly happen with a once-in-a-lifetime event such as a business sale. If this is, or could be, you, are there ways you could defer or spread some of this income over multiple years, e.g., installment sale treatment?
- BBB is definitely going after perceived abuses of Roth IRAs. If you’re interested in converting funds from your traditional IRA to a Roth, consider how you can accelerate those plans and start maximizing your conversions.
General Tax Strategies to Consider before Year End
Regardless of anything that happens with the Build Back Better legislation, here are some tried and true tax strategies to consider:
- Income timing. For business owners, those selling appreciated investments, and really anyone with some level of control over the timing of their taxable income:
- If you expect income to go up sharply in 2022 over 2021, you may want to accelerate income into 2021 and defer deductions into 2022. For example, if you’ll be in the 22% federal tax bracket in 2021 but could be in the top 37% bracket in 2022, moving income into 2021 may create a permanent tax savings by having income taxed at a lower rate. Referencing previous discussion in this article, one way to do this would be a Roth conversion if this is in line with your financial plan.
- If you expect 2022 taxable income to be at or lower than 2021 levels, pushing income into 2022 may make more sense. Even if you’ll be in the same tax bracket for both years, pushing income into 2022 makes it next year’s problem and lets you hold onto your cash a bit longer.
- Make sure you’re prepared to maximize 2021 HSA and/or IRA contributions by April 15th, 2022. (But see previous discussion if you’re anticipating a backdoor Roth IRA contribution.) For those receiving a W-2, make sure you’ve maximized your employer-sponsored retirement plans such as 401(k)s by December 31, 2021 – don’t forget catch up contributions.
- Charitable giving:
- Consider “bunching” multi-year contribution into one year to take advantage of itemized vs. standard personal deductions. You may want to consider establishing a donor-advised fund to accomplish this.
- For 2021 only, deductible cash charitable contributions are allowed up to 100% of Adjusted Gross Income – this limit is normally 60%.
- Also, for 2021 only, those who are taking the standard deduction, a $300 charitable contribution deduction will be allowed in addition to the standard deduction, so keep your receipts. This contribution amount is $600 if filing a joint return with your spouse.
- If you are over 70½ years old in 2021, you can make a Qualified Charitable Distribution of up to $100,000 from your IRA to a 501c3 charity. This is a nice way for folks who don’t itemize to fulfill philanthropic goals while also decreasing the balance in their IRAs on which Required Minimum Distributions are calculated beginning at age 72.
- Business owners should address any Qualified Business Income deduction limitations now.
- As mentioned previously, consider capital loss harvesting. For those in the lowest tax brackets, consider capital gain harvesting as a potentially tax-free way to reset the cost basis of certain holdings.
If you have questions about how the above information might apply to your particular situation, please don’t hesitate to reach out. If you have concerns about the continual stream of arbitrary and anxiety-creating federal tax legislation, write to your congressperson.