Tax planning for 2021 is just as complicated as it was for 2020 for many due to the following major factors:
- The impact on business profits, cash flow, and activity of the continued COVID-19 pandemic and the related government assistance programs, and
- The current uncertainty about future tax law changes in proposed legislation.
Discussions of all the “what-ifs” are beyond the scope of this article, and our planning ideas will focus on the short-term – reducing 2021 taxes. We recommend you consult your tax advisor if you believe your situation is particularly impacted by unusual circumstances.
Maximize pre-tax deductions – Determine if you are on track to have 2021 maximum amounts withheld from your paycheck for your retirement plan deferrals, HSA contributions, dependent care benefits, and other pre-tax options with your employer. If you are not going to maximize these, consider having additional amounts withheld from year-end bonuses, if possible. Also, consider increasing these amounts for 2022.
Capital gains and losses – If you have realized net capital gains during 2021, consider realizing capital losses before the end of the year to offset the gains. Remember that net long-term losses can be used to offset net short-term capital gains which otherwise would be taxed as ordinary income. Also, be aware of the “wash sale” rules if you are inclined to reinvest in a security you sell at a loss.
Bonus depreciation & Section 179 – Businesses should consider these tax breaks related to fixed asset acquisitions:
- Special “bonus depreciation” allowance. For 2021, 100% of the cost of qualifying property (includes used assets) is deductible if the property is placed in service by year end. This deduction can create or increase an existing business loss. Note: Because its requirements are much less restrictive, 100% bonus depreciation usually will make Section 179 not applicable.
- Section 179 depreciation deduction. In 2021, individuals and business entities can elect to deduct up to $1,050,000 of qualifying business property cost in the year the property is placed in service. The deduction is reduced dollar-for-dollar for qualifying property cost greater than $2,620,000. This deduction is available only to the extent of positive business taxable income.
Self-employed retirement plans – If you have self-employment income and don’t have a retirement plan in place to shelter any of it, you may qualify to use a Self-Employed Plan (SEP). A SEP contribution deduction is allowed for 2021, even if the SEP is created and funded at any time up to the due date, including extensions, of your 2021 income tax return in 2022. Depending on the amount of self-employment income, you could fund (and deduct) up to $58,000 for 2021.
Required minimum distributions (RMDs) – Individuals with traditional IRAs and most individuals with employer-sponsored qualified retirement plan accounts are required to take minimum annual distributions from the account upon reaching a certain age, most recently changed to 72.
Charitable contributions – Depending on your situation, it may be beneficial to accelerate planned 2022 charitable contributions into 2021 or to defer 2021 contributions into 2022 to bunch them into the same year for greater tax savings.
Due to the CARES Act, the deduction limit on cash charitable donations has increased from 60% to 100% of adjusted gross income for contributions made in 2021 (note that the contributions must be to public charities or churches, not private foundations or donor-advised funds to qualify for the increased percentage). Contributions of most non-cash assets remain limited to 30% of adjusted gross income. For taxpayers who do not itemize their deductions, up to $300 of charitable contributions are allowed to be deducted this year even without itemizing.
Annual gifting – You may give your children and others up to $15,000 each in 2021 without any gift tax consequences. This annual exclusion is calculated on a per donee basis and no carryover is allowed for the unused exclusion. Consider making year-end gifts to fully utilize this year’s annual exclusion.
Roth IRAs – With individual tax rates at the lowest levels in recent memory, consider conversion of IRAs to Roth IRAs. The current tax cost from a conversion done now may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings. Also, consider making a backdoor Roth IRA contribution, if your current income level is too high to make a direct Roth IRA contribution. A backdoor Roth IRA contribution consists of making a nondeductible IRA contribution followed by a conversion of the contributed funds to a Roth IRA. The rules regarding this are very particular so please consult with your tax advisor regarding this strategy.
HSAs & FSAs – Health Savings Accounts (HSAs) and Flexible Savings Accounts (FSAs) are two separate tools, each helping convert your dollars spent on medical expenses from post-tax into pre-tax, potentially saving you up to 42% of the cost. An HSA is a bank account set up to pay for medical expenses and must be paired with a high-deductible health plan. FSAs allow you to direct some of your wages into a pre-tax account, and your employer will reimburse you from the account for your documented medical expenses. Specific funding rules and limits apply to these accounts.
S Corporation and partnership losses – If your S Corporation will generate a tax loss this year, consider whether you have enough basis in the stock (or in loans you’ve made to the corporation) to take the full loss. If you don’t, additional investments should be considered. Similar considerations can arise in some situations with partnerships expecting tax losses.
Excess Business Loss – The Tax Cuts and Jobs Act (TCJA), passed in late 2017, introduced a limitation on business losses deductible by individuals and other non-corporate taxpayers (trusts and estates) against non-business income. Specifically, the TCJA disallowed net tax losses from active businesses in excess of $250,000 ($500,000 for joint filers), adjusted annually for inflation. For pass-through entities, this is calculated at the owner level, as tax-paying persons combine all business activities when determining overall net business income or loss. Disallowed losses are treated as net operating loss carryforwards to the following year. Under the TCJA, the excess business loss (EBL) limitation was effective for 2018 through 2025. The CARES Act retroactively postponed implementation of the EBL limitation until 2021. The EBL limitation for 2021, as adjusted for inflation, is $262,000 (or $524,000 for joint returns).