December 7, 2021

Tax Planning Strategies for Individuals Before the End of 2021

Give yourself a holiday treat by having your taxes figured out before the end of 2021.

While 2021 might almost be over and everyone is making the transition to their holiday mode, prepping your taxes is probably the last thing on your mind.

But if you’re looking into finally experiencing a stress-free tax season for the next year that doesn’t involve headaches and/or sleepless nights, we truly believe there is no time better than now. Before the holiday season truly kicks in, use some of this time to do some tax planning and take advantage of certain tax provisions that may apply to you.

Opportunities for Individuals

1.    Minimize Your Surtax on Unearned Income

Higher-income earners must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).

As year-end nears, a taxpayer's approach to minimizing or eliminating the 3.8% surtax will depend on his/her estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, seeing if they can reduce MAGI other than NII, or consider ways to minimize both NII and other types of MAGI.

2.    Withholding to Account for Your Estimated Tax

The 0.9% additional Medicare tax may also require higher-income earners to take year-end actions. This applies to individuals whose total wages received with respect to their employment and self-employment income exceeds a threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case).

When that happens, employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Therefore, self-employed persons must take this into account when figuring out their estimated tax figure.

This is because there could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he or she would owe the additional Medicare tax. However, there would be no withholding by either employer for the additional Medicare tax since wages from each employer do not exceed the stipulated $200,000.

3.    Tax Rates for Long-term Capital Gain

Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer's taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the maximum zero rate amount (e.g., $80,800 for a married couple).

If the 0% rate applies to long-term capital gains you have taken earlier this year, try not to sell assets yielding a capital loss as you will not be able to yield a benefit within the same year. And if you hold long-term appreciated-in-value assets, consider selling enough assets to generate long-term capital gains sheltered by the 0% rate.

4.    Harvesting Your Tax Losses

If you have stocks or other capital assets in a loss position, consider “harvesting of tax losses”. What that means is recognizing capital losses to the extent of recognized capital gains plus $3000 ($1,500 for married individuals who file separate returns).

5.    Postpone Your Income & Accelerate Deductions

Postpone income until 2022 and accelerate deductions into 2021 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2021 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest.

Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. However, do note that in some cases, it may pay to accelerate income into 2021. This includes people who will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or expects to be in a higher tax bracket next year.

6.    Investing Into a Roth IRA

If you believe a Roth IRA is better than a traditional IRA, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA in 2021 if eligible to do so. But please keep in mind that such a conversion will increase your AGI for 2021 and possibly reduce tax breaks geared to AGI (or modified AGI).

7.    Be Aware of Standard Deduction Amounts When Itemizing

Many taxpayers won't be able to itemize because of the high basic standard deduction amounts that apply for 2021 ($25,100 for joint filers, $12,550 for singles and for marrieds filing separately, $18,800 for heads of household) and because many itemized deductions have been reduced or abolished.

Currently, no more than $10,000 of state and local taxes may be deducted; miscellaneous itemized deductions (e.g., tax preparation fees and unreimbursed employee expenses) are not deductible; and personal casualty and theft losses are deductible only if they're attributable to a federally declared disaster and only to the extent the $100-per-casualty and 10%-of-AGI limits are met.

You can still itemize medical expenses but only to the extent they exceed 10% of your adjusted gross income, allowing you to claim up to $10,000 in state and local taxes, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt. However, payments of those items won't save taxes if they don't cumulatively exceed the standard deduction amount that applies to your filing status.

Some taxpayers may be able to work around these deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year.

8.    Use Your Credit Card to Pay Your Taxes 

Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2021 deductions even if you don't pay your credit card bill until after the end of the year.

9.    Take Your RMDs from your IRA or 401(k) Plan

RMDs from IRAs must begin by April 1 of the year following the year you reach age 72. That start date also applies to company plans, but non-5% company owners who continue working may defer (if the plan permits) RMDs until April 1 following the year they retire.

Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Thus, if you turn age 72 in 2021, you can delay the first required distribution to 2022. But if you do so, you will have to take a double distribution in 2022 for the amount required in both 2021 and 2022.

Therefore, you should think twice before delaying 2021 distributions to 2022, as bunching income into 2022 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2022 if you will be in a substantially lower bracket that year.

10.  Donate to a Charitable Cause

If you are age 72 or older by the end of 2021, have traditional IRAs, and can’t itemize your deductions, consider making 2021 charitable donations via qualified charitable distributions from your IRAs.

Such distributions are made directly to charities from your IRAs and the contribution amount is neither included in your gross income nor deductible on Schedule A, Form 1040. This amount of qualified charitable distribution reduces the amount of your required minimum distribution, which can result in tax savings.

11.  Make a Full Year’s Worth of Deductibles

If you become eligible in December of 2021 to make health savings account (HSA) contributions, you can make a full year's worth of deductible HSA contributions for 2021. The maximum individual contribution limit is $3,600 and family $7,200 for 2021.

12.  Shelter Your Gifts from Tax Inclusion

Make gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2021 to each of an unlimited number of individuals. Such transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

If you’re interested in reading more about tax planning strategies before the end of the year that apply for businesses and business owners, you can click here.