Goodbye 2021 – Oops, What Did I Forget?

All those year-end tax-planning issues! You only have a few more days to wrap up your tax savings. What do you need to know before saying goodbye to 2021?

Ongoing political discourse and budget proposals have made financial planning in 2021 more challenging and stressful for individuals as well as professional advisors. Early versions of the Build Back Better (BBB) Act called for reducing the estate tax exemption to pre-Tax Cuts & Jobs Act (TCJA) levels. The BBB draft legislation also included proposals for changes to top marginal tax rates; capital gain rate increases; eradication of the benefits of grantor trusts; and Roth conversion restrictions.

These proposals sent financial planners and attorneys scrambling to devise and incorporate strategies ahead of the proposed legislative changes. However, as of this writing, nothing has been finalized and likely won’t be before the end of the year (and possibly not at all). So, how do you make final year-end financial decisions, while planning for an unknown future?

What We Know

First, let’s tackle what we know. The IRS kept the ability to deduct up to 100% of your AGI for any qualified cash charitable donations for 2021. Thus, any donations will ultimately reduce your taxable income on a dollar-for-dollar basis, if you itemize deductions.

If you plan to have sizable charitable donations and think you fall in a lower than normal tax bracket, recognizing additional income through Roth conversions could be advisable. Every dollar of income you recognize would be offset by each dollar you gift. However, be cautious! If you are dependent upon AGI (adjusted gross income) for credits, deductions, or Medicare premiums, additional income recognition could impact eligibility and costs.

Income tax rates and brackets have already been established for 2022, and any retroactive changes during the year are doubtful. So, the adage of taking deductions now while deferring income may warrant consideration. One way to accomplish this is by maximizing your retirement account contributions. If you participate in an employer-sponsored retirement plan, any pre-tax contributions will help reduce your taxable income for the year. Deferring up to the IRS’s established limits should be considered.

Contributions to a traditional IRA will also help accomplish postponing the recognition of income by allowing you to deduct contributions on your tax return, assuming you meet certain eligibility parameters (though you have until the tax filing deadline to complete these contributions). IRA contributions limits are $6,000 in 2021 ($7,000 if over 50 years old).

Contrary to the points above, income recognition isn’t always a bad strategy. For example, if 2021 looks like a lower-income year, you might consider selling appreciated, non-qualified positions that you’ve held for at least one-year to recognize capital gains. For 2021, if your taxable income is below $80,800 (married, filing jointly), you will pay 0% on your capital gains. This number is reduced to $40,400 for single filers.

What We Don’t Know

Now, for items of uncertainty. We do not know the near-term landscape for the estate tax exemption, but it stands to sunset at year-end 2025. If you have visions of lowering your taxable estate before future legislation (i.e., locking in your gift transfers), consider making gifts above and beyond the annual gift limit of $15,000 ($30,000 between you and your spouse in 2021) to family/friends. You will need to file a gift tax return, and though you will tap into your lifetime exemption limit ($11.7M in 2021; $12.02M in 2022), no tax will be due until you exceed the lifetime limit.

There had been calls for eliminating the allowance for after-tax, backdoor Roth conversions, though that seems unlikely for now. For those high-income earners who cannot contribute directly to Roth IRAs, ensure you have made your non-deductible contributions and subsequent conversions before the end of the year to ensure the activity is reported for 2021.

Final Year-End Thoughts

Beyond the scope of the more complex strategies are those that are a bit more basic but require annual attention.

If you are of the required minimum distribution age, ensure you have completed your IRA withdrawals by year-end. Consider making qualified charitable donations (QCDs) if you do not need the income. QCDs made up to $100,000 are not included as income and will satisfy the RMD requirement. Any RMD amount not taken is subject to a 50% penalty.

If you have an HSA, review your medical spending and determine if the amount contributed to your HSA is adequate. If you have the means, try to contribute the maximum allowable amount for 2021 ($3,600 for single coverage; $7,200 for family coverage; $1,000 catch-up for those over age 55).

Lastly, review your W4. If you feel you have withheld too little or too much in taxes for the year, this is an opportunity to make adjustments to get your withholdings more in line with what’s sufficient for your situation.

Summary

When it comes to tax law and estate planning regulations, Congress is, if nothing else, unpredictable. Rules that seemed almost certain for implementation months ago were stripped from the bill and it is possible that items off the table now could creep back into future legislation.

While the BBB bill appears to be dead in its current state, another bill will soon follow, offering up its own set of planning challenges. It is highly advisable to have consistent, thorough reviews with your financial advisor and accountant to ensure future legislation can be successfully managed. With mid-term elections less than a year away, expect to see additional proposals and subsequent bills brought to Congress in hopes of passage before next November.

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