Good to Know
Year-end tax planning for 2021 depends in large part on proposed legislation, such as the “Build Back Better Act.” Without a reliable crystal ball, the ultimate passage of the Act and other legislation is hard to handicap. However, the passage of the Act could hit many upper-middle-income and high-income taxpayers squarely in their purse or wallet; here are just four-year end tax planning opportunities that could reduce the impact of proposed increases in tax rates next year:
- Accelerate income and defer deductions,
- Take capitals gains and harvest capital losses,
- Charitable gift timing, and
- Conversions to Roth IRAs.
Accelerate Income and Defer Deductions
The captioned strategy is heresy to conventional tax wisdom. Conventional wisdom encourages taxpayers to do the opposite: accelerate deductions and defer income (with few exceptions).1 The conventional goal is to reduce income taxes in the current year and defer as much tax as prudent into the next year. Conventional wisdom isn’t necessarily wrong, but it is most effective in conventional tax environments, i.e., tax rates remain about the same next year as in the current year.
These are certainly not conventional tax times. Potential tax changes for individual taxpayers in 2022 include not only increased income tax rates but an increase in long-term capital gain rates, a sharp reduction in the charitable itemized deduction, and the elimination of Roth IRA conversions for certain taxpayers.
Harvest Capital Losses
The current long-term capital gains rate is generally 20%, but rates could jump to 28% or more. Taking profits from winning stocks and offsetting those gains by selling the “losers” in the portfolio could be a tax opportunity, assuming that the strategy is appropriate from an investment perspective.
Caution! Remember the Wash Sale Rule. Capital losses will be disallowed in the year of the sale if a “substantially identical security” is purchased within a 61-day period; that period is defined as the 30 days before the sale, the day of the sale, and the 30 days after the sale. For those of you thinking call option, great idea! Sadly, the IRS has already slammed that door shut. The purchase of a call option on the same security sold at a loss is generally considered a “substantially identical security.”
Charitable Gift Timing
Contributions of cash in 2021 to a public charity such as the Juvenile Diabetes Research Foundation is an itemized deduction of up to 100% of the donor’s adjusted gross income (AGI). The 100% maximum deduction will sunset as of December 31, 2021, and fall to 60% thereafter unless changed by Congress.
Conversion to Roth IRAs
Discussions among the Administration and federal lawmakers include “Roth IRA Blocking.” Taxpayers with AGI in excess of an as-yet-undefined amount would be disqualified from converting a traditional IRA to a Roth IRA. Bottom line—if such a conversion makes sense under 2021 tax laws, there’s no guarantee it will also be available in 2022.
Tax planning in this unpredictable legislative environment is fraught with uncertainty. One thing is certain, however; upper-middle-income and high-income clients need an experienced tax professional to help navigate the best tax moves between now and the end of 2021.
1 As one example, managing the Alternative Minimum Tax.