Year-End Tax Planning

Topics in this Update

  • Charitable Contribution Strategies

  • Roth IRA Conversion from a Traditional IRA

  • Federal Tax Deduction for State and Local Taxes

  • Qualified Opportunity Funds

  • Other Year-End Tax Planning

Year-end tax planning this year is more traditional than the past few years when tax increases were expected or very possible. For now, the myriad of tax increases proposed just a few months back has shrunk to only a few tax increases that primarily apply only to publicly-traded corporations and very wealthy individuals. However, there is always a chance of a major tax change as long as Congress is in session.

Charitable Contribution Strategies

Charitable contribution strategies to reduce taxes include:

  • Donating appreciated assets that have been held for more than one year such as stock, land or art. You can deduct the value of the property, up to 30% of your adjusted gross income (AGI), without paying tax on the appreciation. Check with us about appraisal requirements for contributions of appreciated property other than publicly-traded securities.

  • Donations can be “bunched” to possibly increase your deductions. If your itemized deductions (Form 1040 Schedule A) are less than your standard deduction, you may be able to itemize every other year by doubling up on tax deductible donations every other year. Then, in the other years you can claim the standard deduction. The standard deductions for 2021 are $12,550 for single filers ($14,250 if over age 65) and $25,100 for married filing jointly (plus $1,350 for each spouse over age 65)

  • Make donations by credit card for a deduction this year even if the credit card bill is paid next year.

  • Qualified Charitable Distributions (QCD) of up to $100,000 a year can be made from a traditional IRA if you are over age 70½. A QCD may be used to satisfy required minimum distribution requirements and can effectively produce a deduction for a charitable contribution even if you cannot itemize and must use the standard deduction. A QCD reduces adjusted gross income (AGI) which could result in larger tax deductions (e.g. medical costs), lower other taxes (e.g. net investment income tax), and reduced Medicare premiums.

  • Prepay multiple years of donations by donating to a donor advised fund (DAF) such as the North Carolina Community Foundation. See https://www.nccommunityfoundation.org/ for more details.

  • Donations of cash to qualified charities can offset up to 100% of your AGI for 2021 only.

Roth IRA Conversion from a Traditional IRA

Roth IRA Conversions from traditional IRAs continue to be popular due to Covid-19 negatively affecting income for many taxpayers, including early retirements, plus the huge increase in government spending is thought to increase the likelihood of higher tax rates in the future. A conversion of a traditional IRA to a Roth IRA is a fully taxable event.

The current tax rates, combined with the qualified business income tax deduction, are possibly the lowest we will see for some time. Since the primary consideration in deciding whether to convert to a Roth from a regular IRA is whether your current tax rate is less than your future income tax rates, the time to convert may be in 2021. Since it can be difficult to estimate your future tax rate with much certainty due to ever changing tax laws and changes in your personal tax situation you not may want to now go "all in" but to convert only part of an IRA.

Also, a great time to consider a conversion to a Roth IRA is if you retire before starting required minimum distributions and your taxable income is lower than usual.

In either case above it may not be worthwhile to convert to a Roth IRA unless you have funds outside the IRA to pay taxes on the conversion.

Federal Tax Deduction for State and Local Taxes

Federal Deduction for State and Local Taxes will become much more of a consideration for individuals if the cap on this itemized deduction is raised from $10,000 to $80,000 this year as proposed in the Build Back Better Act. If the cap if increased this year, individuals that can itemize their deductions may want to pay any property taxes and fourth quarter state estimated taxes by year end. If not increased this year, it could be better to pay the taxes in 2022.

Qualified Opportunity Funds

An Investment in a Qualified Opportunity Fund (QOF) can defer and permanently reduce taxes on a gain from the sale of investments, real estate, and certain business assets. An amount equal to the taxable gain must be invested in a QOF during a certain period after the gain is realized. To be eligible for a 10% permanent reduction of taxable gain, the investment generally must be made by December 31, 2021. The gain can then be deferred until December 31, 2026 when it would be taxed. This may not be a good strategy if capital gains rates increase.

Other Year-End Tax Planning Strategies

Review your realized capital gains and losses to consider whether to sell additional securities by year-end to minimize tax on gains and maximize the tax benefit of losses. Be careful not to buy the same or a very similar security within 30 days before or after a sale of a security at a loss. A “wash sale” loss cannot be deducted.

Cash method businesses should consider paying their bills by year end and prepaying certain expenses for up to one year to capture deductions this year if you do not expect your tax rate to increase next year.

Businesses can place equipment purchases in service by year end to take maximum advantage of 100 percent bonus depreciation plus Section 179 expensing up to $1,040,000 for equipment and certain real property. The 179 deduction begins to phase out if purchases are over $2,590,000 of eligible property.

If you own an interest in a pass-through entity such as an S corporation, LLC or partnership that may report a loss this year, check your tax basis and hours of participation. Be sure you have sufficient tax basis to allow for a deduction of the loss and review your participation in the activity to document that you satisfy the passive activity rules. Also, if you expect "qualified business income" from a pass-through entity, see if it is subject to one of the limitations based on W-2 wages or taxable income and plan accordingly.

Avoid underpayment penalties by reviewing estimated taxes paid and tax withholding on your wages or retirement plan distributions, then adjust if necessary to avoid or reduce a penalty for underpayment of taxes.

Maximize retirement plan contributions for maximum tax deductions for 401(k), SIMPLE, SEP or regular IRA. These contributions by employers can be made after year-end but generally by next April 15. Employee 401(k) deferrals have to be made by year end to reduce this year’s taxes.

Take retirement plan required minimum distribution (RMD) if you will be over 72 years of age by year end. Note this does not apply to a Roth IRA. You can also withhold taxes from the RMD instead of paying quarterly taxes.

Make gifts to children and grandchildren of up to $15,000 each ($30,000 for married couples who elect to “split gifts”) if you think your assets could be subject to estate tax or if you want to shift income to your children. Direct payments of tuition and medical expenses to qualified institutions on behalf of donees are not counted against the annual $15,000 limit.

Please contact us with any questions or if you would like to meet to discuss your taxes.

This update represents a general checklist and should not be relied upon without a professional analysis of your specific situation. Any tax information contained in this update was not intended to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or state tax law provisions.

Alex Lehmann