Proposed Tax Changes and Planning Opportunities
Although most taxpayers and small business owners strive to implement tax planning strategies throughout the year, there are often issues that need to be considered leading up to year-end. Such a situation is what Democrats in Washington have been debating in the details of their proposed tax plan. The proposal is projected to raise more than $2 trillion in new revenue primarily from businesses and high-income individuals.
As originally proposed, this would be one of the largest tax hikes on high-income individuals in decades. Now is the time for individuals to pause and review their individual situations to make sure they’ve maximized their tax planning. Following are some tax planning strategies to consider before the end of 2021:
- Taxpayers should reimburse themselves for business expenses they paid personally by year-end. These expenses include meals, business travel, automobiles and supplies. Entertainment expenses generally are not deductible, although there are many exceptions.
- As their plan permits, individuals should adjust their 401(k) plan deferral contributions, if necessary, before year-end to ensure they reach the maximum statutory limits for the year. For 2021, the 401(k) maximum limits remain at $19,500 for those under 50 or $26,000 for those over 50 by year-end.
- It’s not too late to consider adding a Defined Benefit Plan for 2021 or modifying the funding of an existing plan for the 2021 tax year. For taxpayers who have maximized their 401(k) plan, this is a good way to save more into a tax deferred account. If the paperwork is submitted by early December, most advisors will continue to set these up if it makes financial sense. In order to be effective for the calendar year, the plan documents must be signed, and accounts opened, by year-end. For those with existing Defined Benefit Plans, consider funding only the normal target and save excess funding for future years.
- Charitable contribution and donation goals should be funded by year-end. Last year’s CARES Act enhanced tax incentives for making charitable contributions for the 2020 tax year, and the Consolidated Appropriations Act of 2021 extended many of these provisions into 2021. One way to get a tax deduction for charitable contributions would be to claim an above-the-line deduction of up to $300 for charitable contributions made by individuals, $600 for married taxpayers filing jointly. Another major benefit extended through 2021 is that individuals can claim an unlimited itemized deduction for a charitable contribution, which is normally limited to 50 percent of adjusted gross income (AGI). In the case of corporations, the usual 10-percent-of-AGI limitation is increased to 25 percent. Individuals who are required to take IRA minimum distributions should make charitable contributions directly from their IRA to reduce gross income and ensure the best possible tax deduction.
- Seniors should ensure they have taken their required minimum distributions (RMDs) by year-end, if applicable. Last year’s SECURE Act delayed the age at which individuals are required to take minimum distributions to age 72.
- Taxpayers should verify that they have sufficient taxes paid in by Dec. 31, 2021, in order to avoid paying any penalties or interest. This is referred to as “safe harbor” and it can be done either through payroll tax withholdings or with a fourth quarter estimated tax payment, no later than Jan. 15, 2022. Any additional state taxes due should be paid by year-end as these may be taken as a deduction, up to the SALT limit, on federal tax returns.
- Individuals who operate their business as an S corporation and pay for their health insurance through the business must report the premiums paid on their Form W-2. While these premiums are not considered wages for employment taxes, it must be reported here in order to be deducted by the S corporation and on the shareholder’s personal return.
Any tax reform proposal will likely not be finalized until later in November or December leaving little time to maximize tax planning opportunities. Keeping in mind the possibility of tax reform and some of the ideas stated above can ease the implementation process once the final details of tax reform become known.
Darren W. M. Thomas
Darren Thomas, J.D., CPA, EA, is a senior tax manager at Traphagen CPAs & Wealth Advisors. He is a member of the NJCPA and can be reached at firstname.lastname@example.org.