Four End of Year Tax Mitigation Tips:
As we know, the House of Representatives already passed the Build Back Better (BBB) legislation. It contains a few tax increases and even some tax decreases, most starting next year. We still don’t know what changes, if any, the Senate will make, or even if BBB will get passed this year. But here are 5 strategies that you might want to consider before the end of 2021.
Standard Deduction vs Itemizing for 2021: We know that the standard deduction is currently $25,100 for married couples and $12,550 for single filers. If your itemized deductions are close to that amount, you may want to accelerate deductions into this year or push them off until next year. For instance, if you are married and normally have 25K in itemized deductions between the 10K SALT and 15K of Charitable and Mortgage interest, you would use the standard deduction instead of itemizing. You may want to consider making a larger charitable gift this year to plan for the next few years of charitable giving. Or, you may want to pay both halves of your property taxes before the end of the year. Thus, creating a large, itemized deduction in 2021, and then possibly use the standard deduction in 2022.
Accelerating Income: If you own a business and are expecting to be in a higher tax bracket next year, keep an eye on the newly proposed House of Representatives-passed 3.8% Net Investment Tax, which would apply to all business income in 2022. Currently it is only applied to Capital Gains. Accelerating business income into 2021 may be a good strategy. Luckily, tax rates are not scheduled to increase for another 4 years, as that provision was cut from the House version of BBB.
IRS Penalty Avoidance: If you are expecting more income in 2021 than in 2020, make sure you pay at least 110% of what you paid in 2020 to the IRS and your state. This strategy could avoid penalties and interest. If you are receiving a W-2, then boosting your withholding for December is an excellent way to accomplish this goal since federal withholding is deemed paid ratably throughout the year. Of course, if you paid the correct amount of taxes all year through payroll or quarterly estimates, then you should also avoid any late payment or penalties.
To Roth or Not to Roth. That Is the Question. 2021 may be the last year that high income taxpayers can convert to Roth. Actually, in the currently passed House bill, high income taxpayers have until 2028, but 2021 could end up in the Senate bill and final legislation if it passes. So, keep an eye on this. In any case, if you believe your income tax rate will be just 1% higher when you withdraw money from your IRA or retirement plans, you should definitely consider converting your IRA to a Roth IRA before it is too late and before it grows too much more. Just make sure you have the cash available to pay the taxes on your conversion as the entire conversion amount will be added to your income in 2021.
In addition, if you have very low income in 2021, then converting your IRA to a Roth and paying taxes at these historically low rates could be especially beneficial.
Finally, for those business owners in California and 18 other states, this one may be for you. The Trump tax cuts lowered the unlimited SALT exemption to $10,000/yr. The House version of BBB increases that to $80,000/yr starting in 2022. (This is a windfall for high income earners if passed.) Although, 19 states already passed legislation that allows you to pay some of your state taxes through your S-Corp, LLC or Partnership and take them as a tax deduction, like State taxes used to be. Some states, including CA, go into effect for 2021. Hopefully, you have already heard from your CPA or tax preparer about this new law if it applies to your business, as you need to be very deliberate on how you pay those State taxes, or you will lose this amazing benefit.
The above information should not be considered tax advice as you should always consult with your tax professional before making any tax decisions.