Like much of the country, the financial services and tax communities have been focused on potential drastic changes to estate and income tax laws on the table in the Build Back Better bill. Alas, the Build Back Better bill was passed by the House on November 19th, but it did not include any estate tax provisions. Additionally, the Build Back Better bill included surcharges on high-income earners, expansion of the Net Investment Income Tax, and limitations on Qualified Small Business Stock exclusions. These provisions will not be broadly felt but could be consequential to many of our clients.
A surprising development in the bill that passed the House was a tax cut for high-income earners in high-tax states because the bill would increase the limit on federal deductible state and local taxes from the current $10,000 to $80,000. The provision is already getting squeezed from the left as a tax cut for the rich and from the right as a handout to those living in primarily blue-leaning high-tax states.
The Senate is currently hoping to vote on the bill the week of December 13th, and we will continue to monitor what is left standing after the fray. In the meantime, we have compiled a year-end tax and financial planning checklist as 2021 falls into history.
1. Should you pay your 2021 state income taxes before the end of the year?
With a potential increase in the federal deduction for state and local taxes to $80,000, many more taxpayers would be able to deduct the full amount of the state income taxes than they are today. Prior to the passing of the 2017 Tax Cuts and Jobs Act, which included the current $10,000 limitation, a popular tax planning strategy for many taxpayers was to remit their fourth-quarter estimated tax payments before December 31st rather than closer to the January 15th deadline. This resulted in a higher state tax deduction on their current year’s tax return. If the limitation does increase in the final Build Back Better bill, this strategy will be back on the table.
However, taxpayers need to be careful. We will not know until the second half of December if the limitation will be increased and whether it will apply to the 2021 tax year. While accelerating the deduction into 2021 (i.e., instead of waiting to take it until 2022) is the optimal outcome, a damaging result would be making the payment in 2021 when it is not a deduction and losing the opportunity to deduct it in 2022. GW & Wade will continue to monitor the bill as we seek to optimize tax planning opportunities like this for our clients.
2. Have You Received Advanced Child Tax Credits?
The American Rescue Plan, which passed in March 2021, allowed the IRS to make direct payments of an enhanced child tax credit to American families. As a result, many taxpayers have been receiving monthly payments from the government since July 2021 for as much as $360 per child. December 15th is currently the last scheduled payment. However, the Build Back Better plan may extend these payments.
With income limitations and phaseouts, these payments are not uniform for all taxpayers. Since these monthly payments are an advance on a 2021 tax credit, they will need to be reconciled on your 2021 income tax return to be filed in the spring of 2022. Now is the time to gather information on when and how much of these payments were received to calculate their impact on your 2021 tax return. This will also allow you to easily provide this information to your tax preparer in early 2022.
3. Time to Use those Flexible Spending Accounts
While flexible spending accounts (FSA) are a great opportunity for you to set aside tax-free money for medical expenses and child care costs, those savings can quickly be destroyed if the funds are lost at the end of the year.
While some employers allow a $500 carryover into the following plan year, the option is unique to each employer and is not mandatory. Be sure to check your balance and spend enough of your FSA balances before you lose it.
Additionally, if you are in the midst of open enrollment for your employee benefits, consider whether you will get a larger tax break for contributing to the dependent care FSA or availing yourself of the dependent care credit. Generally, the larger your income the more beneficial the FSA deduction is compared to the credit. If you have questions as to whether you should contribute to a dependent care FSA, please consult with your GW & Wade Counselor or your accountant.
4. Year-End Charitable Giving
For many individuals, the holidays are often when they consider supporting their favorite charities. Donating in a tax-efficient manner may allow you to contribute even more to those organizations you wish to support.
As a result of the current state and local tax federal deduction limitation of $10,000, many taxpayers are now taking the standard federal deduction ($12,000 individual, $24,000 joint) as opposed to itemizing. Here are some of the charitable deduction strategies to consider:
- Bunch multiple years of charitable donations in one year so that when combined with your other deductions, you have itemized deductions in excess of the standard deduction. Then, the following year, you could switch back to the standard deduction when you are not contributing as much to charity.
- Make qualified charitable distributions from your IRA in lieu of receiving your Required Minimum Distribution (RMD). You can transfer up to your RMD but no more than $100,000 from an IRA to a charity and the amount transferred will not be subject to income tax. It will also satisfy all or part of your annual RMD.
- Make a large donation to a donor-advised fund (DAF)1. The donation will be entirely tax-deductible in the year contributed (subject to adjusted gross income (AGI) limitations), but once your DAF is funded, you can authorize grants in any amounts over a time frame of your choosing (e.g., over multiple years). Read more about our DAF tips on our blog, The Who, When, What and How of Charitable Giving.
The CARES Act did make two changes related to charitable giving for 2020 and 2021. Taxpayers utilizing the standard deduction can now claim an above-the-line deduction of up to $300 to qualified charities (not including DAFs and private foundations). Also, the limit on cash contributions to qualified public charities increased from 60% of AGI to 100%.
5. Tax Loss Harvesting
To help minimize any previously realized capital gains, consider selling stocks, bonds, or other funds that have declined in value since you purchased them.
For example, selling a security with a $10,000 loss could save you up to $2,380 in federal taxes plus another few hundred in state income taxes. You can even keep your market exposure by immediately investing in an ETF or mutual fund within a similar sector. Just be careful of the IRS's wash sale rule, as your new investment cannot be substantially identical to your original investment.
6. Annual Gifts
With the lifetime estate tax exemption of $11.58 million sunsetting in 2026 (and potentially on the chopping block every year), taxpayers with substantial estates are concerned that their estates will be subject to estate taxes. One option to minimize this concern is to avail yourself of the annual gift exclusion of $15,000. You can gift up to $15,000 to as many friends and family members as you wish. If you are married, you and your spouse can double the gifts to $30,000 per year. For those looking forward to 2022, the annual gift tax exclusion will be increasing to $16,000 per donor/donee.
7. Double-Check Your Tax Withholding Rates
If you have had significant changes to your life over the past year, then now is time to double-check your tax withholdings. Marriage, divorce, purchasing a new home, and welcoming a new child are just some of the life-altering events that can also impact your tax return.
Keep in mind that if you have too much withheld and end up with a tax refund, that is akin to giving the government an interest-free loan. On the other hand, you don’t want to withhold too little and get an unwanted surprise (and potential penalties) come April 2022. In lieu of that, you can review your most recent paystub to see what percentage of your income is being withheld from your yearly earnings and compare that with your 2020 effective tax rate. Then, you can account for any recent changes in your life. The easiest way to assess your withholdings is to provide a recent paystub to your GW & Wade Counselor.
8. Make (or Defer) Large Purchases of Business Assets
Accelerating large purchases of business assets into 2021 will allow you to immediately benefit from the tax deduction they will provide. However, you should also consider your expected income level next year. If you are anticipating earning much more income in 2022, deferring the purchase can provide even more tax savings.
9. Review Your Insurance Policies
Are you now running a small business out of your home? Have you added a swimming pool to your house? If your life has changed recently, you may wish to consider adding an insurance rider or an umbrella policy to give yourself extra protection in case of an injury or accident.
Also, you should keep in mind that purchases of highly unique or expensive items will generally not be covered by your homeowner's insurance. So, you may wish to add an insurance rider for fine art, jewelry, or collectibles.
10. Reconfirm Suitability of your Estate Documents
As you reconnect with your family members over the holidays, you may wish to take this opportunity to tell them your latest estate and legacy goals. Also, you should consider the extent that your life has changed recently and whether your estate planning documents and other important financial documents are up-to-date.
Here are five key questions that you should ask yourself:
- Is the personal representative of your will still available and capable?
- Has your health changed, potentially escalating the need to update your living will with new end-of-life medical care requests or revisiting your business succession plan?
- Are your beneficiaries current? For example, is your ex-spouse still listed as a beneficiary, or has another relationship soured in some way?
- If you have children, are the guardians assigned to raise your children in the event of your death still emotionally and physically capable?
- Is the trustee assigned to manage the money for your children still capable?
If you have questions about your financial situation please contact us. Perhaps you have recently experienced a significant life event, or retirement is on the horizon? No matter your circumstances, we welcome the opportunity to provide you with sound financial advice, strategic tax planning, and help achieve your lifetime goals.
We hope you have a safe, healthy, and joyous holiday season.
1Donor-advised funds (DAF): a charitable giving vehicle administered by a public charity that manages charitable donations for organizations, families, or individuals; an alternative to direct giving or creating a private foundation. Provides administrative convenience and cost savings to donors, by conducting grantmaking through the fund.
Investment advisory services offered through GW & Wade, LLC.
The information provided above is the opinion of the author, general in nature and is not intended to represent specific investment or professional advice. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship. Diversification and asset allocation do not ensure a profit or guarantee against loss. Past market performance is not a guarantee of future results.
Tax laws referenced and specific rates are subject to change.
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