2021 Tax Planning Letter
To Our Clients and Friends:
As we approach the end of 2021, it is time to finalize and implement tax planning strategies for the current year and to consider tax planning strategies for future years. Impacting multi-year tax planning is the Build Back Better Act (BBBA), or the reconciliation bill, that is currently being negotiated in Congress. Our team at Simon Lever is closely following this bill as it moves through Congress and can assist you in understanding its potential impact as we work with you on tax planning.
With the pandemic continuing through 2021, there has been additional legislation, stimulus money, and an ever-increasing myriad of regulatory impacts to individuals and businesses alike. Our team has worked diligently to stay current on all new legislation and developments in Washington. The tax code itself has been altered in ways that allow for some different tax planning strategies, and some traditional strategies continue to apply.
With the changes mentioned above, our goal for this letter is to provide you with currently known tax planning strategies. The information enclosed in this letter should be used as a reference guide – to remind and prompt questions of your Simon Lever advisor. It is not a substitute for direct conversations and the personal service you expect from Simon Lever.
Thank you for including us in your quest to achieve your goals. Our purpose remains unchanged – to maximize your success by delivering expert financial and business advice every step of the way.
Information & Opportunities
- Economic Impact Payments
- Child Tax Credit
- Virtual Currency
- Home Office Deduction
- Exclusion of Gain on Sale of Personal Residence
- Maximize Retirement Plans
- Harvest Capital Losses
- Maximize Contributions to a Health Savings Account (HSA)
- Standard Deduction versus Itemized Deductions
- Make Charitable Gifts of Appreciated Assets
- Post-High School Education
- Estate Planning
- Required Retirement Distributions
- Managing Your AGI
For Business Owners and Owners of Rental Real Estate
- Paycheck Protection Program (PPP) Loan Proceeds
- Qualified Business Income Deduction (QBID)
- Prepaying Expenses
- Equipment and Asset Purchases
- Evaluate Inventory for Damaged or Obsolete Items
- Basis of Accounting
- State Sales and Income Tax
- Real Estate/Property Ownership
- Net Operating Losses (NOLs)
- Tax Credits
- Limit Self-Employment Income
- Meals and Entertainment Expenses
- Build Back Better Act
Information and Opportunities for Individuals
Economic Impact Payments
A third round of Economic Impact Payments was authorized by the American Rescue Plan Act (ARPA) of 2021. Payments of $1,400 per eligible individual plus $1,400 for each qualifying child were distributed in March 2021, or throughout the year as 2020 tax returns were filed. These payments are not taxable but were an advance payment of a credit that will be reconciled on your 2021 individual tax return. The income phaseout amounts changed for this third round of payments. Payments begin to phaseout for individuals with adjusted gross income (AGI) of more than $75,000 (single) and $150,000 (MFJ) and are fully phased out at $80,000 (single) and $160,000 (MFJ). In addition, the definition of qualifying dependents was expanded to include all qualifying dependents claimed on a tax return, which includes college students or older relatives that are qualifying dependents. This payment will be reconciled on your 2021 tax return therefore we recommend you retain documentation of the amount you received during 2021.
Child Tax Credit
The ARPA that was enacted in March 2021 included increases to the child tax credit for taxpayers with certain income thresholds. The credit is being increased from $2,000 to $3,600 per child ages 5 and under and to $3,000 per child ages 6-17. These increases will begin phasing out for AGI above $75,000 (single) and $150,000 (MFJ). The credit will not be reduced below $2,000 per child until AGI exceeds $400,000.
The Act also included provisions for advance payments of the child tax credit, which started in July 2021 and continue through December 2021. The monthly advance of the child tax credit is not considered taxable income to you, but the advance payments will be reconciled on your 2021 income tax return. If the credit on the return reconciles higher than what was projected in the advance payment calculation, you will receive additional credit on your 2021 tax return. If the credit on the return reconciles lower, then you will be required to return a portion of the payment on your 2021 tax return. Please retain documentation of how much you received in advance child tax payments so it can be reconciled on your 2021 tax return.
Cryptocurrency has not only caught the attention of many investors in 2021, but Congress and the IRS also have the digital asset class in their sights. As the IRS aims to increase enforcement of virtual currency reporting, we want to provide you some important information regarding the taxation of transactions involving virtual currency: 1) please inform your Simon Lever advisor if you bought, sold, received, or exchanged any financial interest in virtual currency during the year; 2) virtual currency is treated as property and is generally subject to capital gain/loss treatment; 3) a taxpayer must recognize ordinary income when virtual currency is sold as inventory to customers or when it is received as payment for goods or services in a trade or business. Due to the variety and complexity in virtual currency transactions, please discuss these transactions further with your advisor.
Home Office Deduction
The Tax Cuts and Jobs Act (TCJA) suspended miscellaneous itemized deductions until 2025, which is where individuals historically claimed the deduction for unreimbursed employee expenses which includes the home office deduction. This means that unless you are a partner in a partnership or report income or loss on Schedule C, the home office deduction is not available to you on your federal tax return.
Exclusion of Gain on Sale of Personal Residence
If you sold your personal residence for a gain in 2021, you likely qualify for exclusion of that gain from your income. To claim the exclusion, you must have owned and lived in the home as your main residence for at least two years out of the prior five years. The amount of gain that can be excluded is $250,000 (single) or $500,000 (MFJ). If you did not sell your principal residence for $500,000 (MFJ) more than your basis in the residence, you will not have any gain to report.
Maximize Retirement Plans
If you have a 401(k) plan at work, it is just about time to tell your company how much you want to set aside on a tax-free basis for next year. In addition, if you have not maximized your contributions for this year, you still have some time to increase your retirement plan withholding before December 31. The amount you can contribute to a 401(k) plan is $19,500 for 2021, with an additional $6,500 contribution permitted if you are 50 years old by the end of the calendar year. Contribute as much as you can, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the maximum level required for the employer match. If your employer offers a ROTH option to the 401(k), you can utilize both the traditional and ROTH vehicles to control your taxable income.
Individual Retirement Accounts (IRAs) can also be utilized when available – both traditional and ROTH IRAs. One change brought about by the Setting Every Community Up for Retirement Enhancement Act (SECURE) was the removal of the maximum age limit of 70½ to make contributions to IRAs. High-income individuals covered by an employer’s retirement plan are limited in their ability to participate in deductible IRAs. For these individuals, there are strategies available that will enable them to utilize the tax-free earnings available to IRAs even though a tax-deductible contribution is not available. One strategy involves contributing to a non-deductible IRA and then converting this contribution to a ROTH IRA. IRS income limits restrict high-income investors from making ROTH contributions. However, there are no income restrictions on conversions. These investors can contribute through the back door by making a nondeductible traditional IRA contribution and then converting to a ROTH IRA. From a tax standpoint, this strategy works best if you do not have other traditional IRA assets, because otherwise part of the conversion could be subject to income tax. Due to the complexity of this strategy and consequences if the transaction is not properly executed, please contact us in advance for counsel and assistance on this issue. Note that this strategy may not be available going forward based on the outcome of the BBBA that Congress is currently drafting.
Harvest Capital Losses
There are several year-end investment strategies that can have an impact on your tax bill; perhaps the simplest is reviewing your securities portfolio for any losers that can be sold before year-end to offset gains you have already recognized this year or to get you to the $3,000 ($1,500 married filing separate) net capital loss that’s deductible each year. If your net loss for the year exceeds $3,000, the excess carries over indefinitely to future tax years. Be mindful, however, of the wash sale rules when you jettison losers – your loss is deferred if you purchase substantially identical stock or securities within the period beginning 30 days before and ending 30 days after the sale date.
Maximize Contributions to a Health Savings Account (HSA)
If you are enrolled in a high-deductible health plan, you may be eligible to make pre-tax or tax-deductible contributions to an HSA of up to $7,200 for family coverage or $3,600 for individual coverage. An additional $1,000 is permitted if you are 55 or older by the end of the year. Distributions from the HSA will be tax free if the funds are used to pay unreimbursed qualified medical expenses. Furthermore, there is no time limit on when you can use your contributions to cover expenses. The funds, if unused, can accumulate and the investment earnings are tax-free. Any withdrawals used for non-medical expenses will be subject to income tax as well as an additional 10% penalty.
Standard Deduction versus Itemized Deductions
For 2021, the standard deduction amounts (with a few exceptions) are $25,100 for joint filers and $12,550 for single taxpayers. Taxes continue to be deductible up to $10,000 per year which include all state and local income taxes as well as personal real estate taxes. Please note that the $10,000 cap for state and local taxes may change pending the outcome of the BBBA that is currently being drafted.
Since the TCJA, more of our clients are utilizing the standard deduction, rather than itemizing deductions by totaling the amounts paid for taxes, mortgage interest, and charitable contributions. In 2020, the Coronavirus Aid, Relief and Economic Security Act (CARES) made some changes to the charitable contribution rules. First, the income limitation for cash donations to public charities was removed, and individuals may now deduct contributions up to 100% of AGI. Noncash and appreciated stock contributions remain limited to 50% and 30% of AGI, respectively. The Consolidated Appropriations Act of 2021 (CAA) maintains the charitable contribution incentives originally enacted by the CARES Act.
New for 2021, the $300 deduction for charitable contributions is expanded to $600 for joint filers. However, the deduction will be a deduction from AGI, as compared to a deduction before AGI as it was in 2020. This means any taxpayer who is not itemizing in 2021 can still take a deduction for up to $300 (single) or $600 (MFJ) of charitable contributions.
Another strategy to mitigate the increase in the standard deduction and get a tax benefit for your charitable contributions is to “bunch” the larger charitable deductions into one year. This allows the standard deduction to be exceeded in one year and maximizes the tax benefit of your charitable giving. In the following year, the standard deduction would be utilized. This strategy works particularly well with charitable contributions (which are entirely discretionary) combined with a donor advised fund. This is because a taxpayer receives a charitable contribution when the funds are given to a donor advised fund, but the charity can receive the money disbursed from the donor advised fund in the year the taxpayer is utilizing the standard deduction. A word of caution; cash contributions to a donor advised fund are limited to 60% of AGI, not 100% as mentioned above because these are not considered public charities. Bunching can also be used to increase the tax benefit of significant medical expenses. Please contact your advisor for further details on this strategy.
Make Charitable Gifts of Appreciated Assets
IRS statistics indicate an inconsistency in charitable giving – 80% of charitable giving is done with cash, however total assets owned by donors are only 10% in cash, 90% in non-cash assets. Giving of non-cash assets can yield significant tax benefits. If you have appreciated stock (or mutual fund shares) that you have held more than a year and you plan to make significant charitable contributions before year-end, consider keeping your cash and donating the stock instead. You will avoid paying tax on the appreciation but will still be able to deduct the donated property’s full value. However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to the charity. If you give the stock to the charity, your charitable deduction will equal the stock’s current depressed value and no capital loss will be available. This strategy would apply to any asset that has appreciated in value (such as real estate) – although many times these types of assets, if donated, come with additional requirements – please contact your personal advisor for details and guidance.
Post-High School Education
The cost of post-high school education continues to increase. The use of 529 plans is an increasingly common way to help fund this cost. While contributions to 529 plans are not tax-deductible for federal income tax purposes, earnings grow tax-free and – if used to pay for the beneficiary’s college expenses – are never taxed. Contributions to a 529 plan are deductible for Pennsylvania tax purposes, resulting in a 3.07% tax deduction. Maximum PA tax-deductible contributions permitted to 529 plans equal $15,000 per individual for 2021.
As a reminder, 529 plans may also be used for up to $10,000 of educational expenses for beneficiaries enrolled at public or private school grades K-12.
There are education credits, including the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC) that are available when qualifying education expenses are paid. However, each credit has different limitations and requirements – please contact your advisor for details on these opportunities.
Federal student loan payment relief was in effect throughout 2020 and 2021. On
January 31, 2022, interest will begin accruing again and monthly payments will be due for federal student loans. If you paid federal or private student loan interest in 2021, the interest remains deductible up to $2,500 per year, subject to income limitations of $85,000 (single) and $170,000 (MFJ).
Estate planning is a critical component of any financial strategy. Our encouragement to each of you is to make sure your wills and estate plans are updated and accurately reflect your end-of-life desires. The lifetime estate tax exemption increased to $11,700,000 per individual for 2021. Please note the lifetime exemption reverts to $5 million, adjusted for inflation, on January 1, 2026 unless Congress acts, so a routine and regular review of your plans is necessary. Please consult your advisor to develop and maintain a plan to maximize your wealth and transfer property to your beneficiaries in the most tax-efficient way possible.
Required Retirement Distributions
Required minimum distributions (RMDs) are back for 2021. The CARES Act waived RMDs during 2020 for IRAs and most other retirement accounts, which include beneficiaries with inherited accounts. The tax law generally requires individuals with traditional retirement accounts to take withdrawals based on the size of their account and their age beginning with the year they reach age 72. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn.
If you plan on making additional charitable contributions this year and you have not yet received your 2021 required distribution from your traditional IRA, you might want to consider using your traditional IRA to do both. IRA owners and beneficiaries who have reached age 70½ are able to make cash donations totaling up to $100,000 to IRS-approved public charities directly out of their IRAs. Qualified Charitable Distributions (QCDs) equate to an immediate 100% federal income tax deduction without having to itemize your deductions. This is particularly true for taxpayers who are no longer itemizing deductions because of the new tax law. However, to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity. Once you receive the cash, the distribution is not a QCD and will not qualify for this tax break. A major change brought about by the SECURE Act was the elimination of the age limit for traditional IRA contributions. This opened the possibility of contributing to an IRA and then making a QCD, which is generally excluded from income in the same year, as discussed above. To prevent this, Congress included an anti-abuse provision that requires QCDs to be reduced by deductible IRA contributions made during a year in which and after the taxpayer turns 70½. Due to the complexity added with the SECURE Act related to these transactions, please contact your advisor to help develop your strategy.
There was another major change regarding retirement accounts and RMDs included in the SECURE Act. For 2020 and after, beneficiaries of IRAs may no longer stretch distributions and tax payments out over their single life expectancy. Beneficiaries are required to withdraw assets from an inherited account by the end of the 10th year following the death of the original account holder. Failure to distribute the entire IRA balance on time results in a 50% penalty of the remaining account balance. There is an exception for eligible designated beneficiaries, which include surviving spouses, minor children, disabled individuals, chronically ill individuals, and beneficiaries not more than 10 years younger than the account owner. These eligible designated beneficiaries can stretch the IRA over their single life expectancy.
Managing Your AGI
Many tax deductions, credits, and tax rates change depending upon your personal AGI – which means only taxpayers with AGI below certain levels benefit. Examples of deductions and credits subject to phase outs include education credits, charitable deductions, and passive rental losses. Managing your AGI can also help you avoid (or reduce the impact of) the 3.8% net investment income tax and utilize the 0% and 15% capital gains tax rates currently available to taxpayers with taxable income below certain dollar amounts. Unfortunately, the applicable AGI based limits differ for each of these categories of income and deduction. Managing your AGI can be challenging since it requires calculation and estimation of all items on your personal tax return. Please consult with your personal contact at Simon Lever to determine appropriate techniques to manage your AGI and maximize your personal tax attributes.
We encourage our clients to make their advisors aware of any changes in their personal tax circumstances that may affect their tax liability or compliance requirements before the end of the year. A sample of these types of changes are listed below:
- Marriage, divorce, or death of a spouse
- Birth of a child
- Retirement, drawing retirement funds or social security
- Purchase of real estate
- Child that turned 17 during the calendar year
- Children that married or moved out of the home
- Payment of college expenses
- Starting a business
- New job or employment status
Information and Opportunities for Business Owners and Owners of Rental Real Estate
Paycheck Protection Program (PPP) Loan Proceeds
The CAA clarified the tax treatment of forgiven PPP loans. The PPP loan proceeds that were forgiven are not taxable. Business expenses paid for with the forgiven PPP loan funds are deductible. PPP loan proceeds are included in a shareholder’s/partner’s basis in the year that they are forgiven.
Qualified Business Income Deduction (QBID)
The QBID has the potential to reduce taxable income by 20% of company profits. For example, if a company reports $100,000 in qualified profits, only $80,000 will be reported as taxable income. This deduction is very complex to calculate, with many different factors including:
- personal taxable income and capital gains
- amount of wages paid, and cost of property owned by the business if certain thresholds are met
- separate rules for “service” businesses
- aggregation of entities
Rental property will qualify as a business and for this deduction under the following criteria:
- Separate books and records maintained
- Form 1099 must be issued to anyone the rental activity pays more than $600 for services provided
- 250 hours or more of services are performed per year
Self-rental (real estate leased to a company with common ownership) will qualify as a business. Triple net lease arrangements will generally not qualify for this deduction. This calculation will be a key and complex area in determining your 2021 tax liability.
Prepaying Expenses (when maximizing deductions is the strategy)
Certain types of expenses (including insurance, charitable contributions, and supplies) are eligible for a tax deduction when paid. This is an attractive tax deduction strategy particularly if cash discounts can be received and/or negotiated. Please keep in mind that expenses charged to a credit card are deductible in the year charged, not when payment is made on the card. Thus, charging expenses to your credit card before year-end enables you to increase your 2021 tax deductions even if you are temporarily short on cash.
Equipment and Asset Purchases (when maximizing deductions is the strategy)
Consider purchasing business assets prior to year-end. Current tax law expanded the bonus depreciation option to allow a first-year deduction of 100% of the cost of equipment. There is no dollar limit to this deduction (some restrictions apply). You can also expense up to $1.05 million of eligible equipment purchases each year (some restrictions apply). The remaining assets purchased will be subject to the normal depreciation rules. There are certain circumstances where it is more beneficial to expense equipment purchases rather than use bonus depreciation – your personal advisor will advise you if your circumstances meet these criteria. With these very favorable depreciation options you may want to consider accelerating purchases planned for the first quarter of 2022 into the 2021 calendar year to accelerate tax deductions. Be aware that there are certain limitations on vehicles related to depreciation. Please contact us before utilizing vehicle or other purchases to maximize tax deductions.
Evaluate Inventory for Damaged or Obsolete Items (when maximizing deductions is the strategy)
Inventory is normally valued for tax purposes at cost or the lower of cost or market value. Regardless of which of these methods is used, the end-of-the-year inventory should be reviewed to detect obsolete or damaged items. The carrying cost of any such items may be written down to the lesser of their probable selling price (net of selling expenses) or cost.
Basis of Accounting
Current tax law has made it significantly easier to report taxable income using the cash basis of accounting. Under the cash basis of accounting, income and expenses are reported only when cash is received or disbursed. Making the change from accrual basis to cash basis can result in a significant one-time deferral of income. The specific rules and analysis are complex and based on each company’s business model – your advisor is aware of this strategy and will be reviewing the applicability of this planning tool to your circumstances.
State Sales and Income Tax
In June 2018, the United States Supreme Court handed down a decision on sales tax that is having an impact on many business clients. The standard for when states can begin to assess sales tax is now based on an economic standard (how much business you execute) rather than requiring a physical presence in that state. The primary reason the standard was changed was to reduce the advantage provided to online sellers and to adjust the law for the current economic reality. As a further consequence to the Supreme Court decision, states have begun to pass laws pertaining to economic nexus to collect income tax rather than just sales tax. Unless stymied by the courts, our expectation is that states will continue to expand their reach to companies that do business within their state to increase revenue. As a result, we will be asking many more questions regarding destination sales and customers in states other than your “home” state than in prior years to ensure compliance and proper risk management. Please ask your advisor as you have questions on this law change.
Real Estate/Property Ownership
Owners of buildings and real estate cannot deduct the cost of the asset in the year of purchase; but are required to deduct/depreciate the cost of the building over multiple years – 39 years for commercial property, 27.5 years for residential rental property, or 15 years for qualified improvement property (QIP). The addition of QIP is a correction from the TCJA; it created a category of property that is bonus eligible. These assets are typically non-structural, interior improvements to non-residential property. Owners of real estate can gain tremendous tax benefits by using a popular asset depreciation technique called cost segregation. Using this method, a real estate holding can be determined to consist not only of land and buildings but also tangible personal property and land improvements. The tax savings come from accelerated depreciation deductions available to personal property and land improvements. In addition, some qualifying assets can be depreciated using the bonus depreciation mentioned above. Care must be taken to adequately document (typically performed by an engineer or cost segregation study specialist) the portion of the building that qualifies for accelerated depreciation. Please contact us for further information on this tax savings opportunity.
Net Operating Losses (NOLs)
NOLs from years beginning after December 31, 2020 are not able to be carried back to previous years and instead are carried forward to subsequent tax years indefinitely until fully utilized (offset limited to 80% of the subsequent year’s taxable income). Farmers have an exception to this rule in which they can carry NOLs back two years and then forward indefinitely until fully utilized.
The Families First Coronavirus Response Act (FFCRA), CARES Act, and CAA created and expanded upon several payroll tax credits aimed to help employers and their employees during the pandemic. The Employer Retention Tax Credit (ERTC) provided some relief for employers who had to close or suspend operations and/or experienced a significant decline in gross receipts. The CARES Act also provided some employer payroll tax deferral opportunities. Some of the credits received do impact the calculation of taxable income. Our team at Simon Lever is here to assist you if you believe you may qualify for these programs or if you want to understand more about the tax impact of the credits.
The research and development tax credit was designed to serve as a stimulus to companies to incentivize them to develop new or improved methods, processes, and/or products. Because the program is a credit, it results in a dollar-for-dollar reduction in your tax liability. The credit is more applicable and available than generally believed. Good candidates for the credit include manufacturers, engineers, information technology companies, and companies applying for patents. The credit is complex to calculate and requires specific expertise and documentation. Please contact your tax advisor for further information.
Limit Self-Employment Income
If you are self-employed, consider changing the entity structure of your company to save Medicare and Social Security taxes from being levied on all your company profits. Various entity structures can be utilized to lower the effect of these two taxes, without affecting liability protection or causing major changes to your operations. Due to the intricacies associated with making any changes to your entity structure and to fully ensure all ramifications are considered, please contact us for guidance and direction on this issue.
Meals and Entertainment Expenses
Entertainment expenses are not deductible. Entertainment expenses include typical expenses such as taking a customer to a ballgame or a golf outing. However, the CAA allowed for business meals to be 100% deductible in 2021 and 2022, provided they were purchased from a restaurant. Note that tickets for an event that includes food, but the food is not itemized separately, will be considered entertainment and not deductible.
Build Back Better Act
The information provided in this letter is designed to assist in managing and planning for your 2021 taxes. Your personal tax strategy may change based upon the outcome of proposed tax reform currently in Congress. Tax policy has become an important part of the economic recovery efforts resulting from the ongoing COVID-19 pandemic. When planning for your 2021 taxes, the outcome of tax reform may present items to consider in your multi-year tax plan. Our team is committed to providing you and all our clients with up-to-date information to aid in making informed tax decisions regarding your tax management strategy.
The ideas discussed in this letter are a good way to get you started with year-end planning, but they are not substitutes for personalized professional assistance. Please do not hesitate to call us with questions or for additional strategies on managing your taxes. We would be happy to set up a planning meeting or assist you in any other way that we can. Please visit our website at www.simonlever.com for these updates and for relevant tax information such as the Social Security wage limit, maximum retirement plan contribution limits, etc. Thank you for the opportunity to serve you.