Year-end tax-planning tips for 2021

Consider these tips on how you might be able to reduce your 2021 tax bill.

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Key takeaways

  • Don't let the uncertainty in Congress distract you from important year-end tax-planning opportunities.
  • You may be able to do several things that could potentially help reduce your taxable income, maximize your charitable deductions, and reduce exposure to future taxes.
  • Before making any decisions, be sure to consult with your tax advisor about what best suits your present circumstances and long-term strategy.

For some time now, all eyes have been focused on Washington as legislators continue to debate the specifics of the Build Back Better Act, which is still pending in Congress. At present, it appears that many of the provisions that would have had the biggest impact on individuals—increases to the individual and capital gains tax rates, changes to grantor trust rules, and an accelerated reduction of the gift and estate tax exclusion—are no longer on the table. But given how fluid negotiations have been so far, it's important to remember that the bill could still change and that the timeline to passage and implementation is still unclear.

That said, with the end of 2021 fast approaching, you shouldn't let the uncertainty in Congress distract you from the traditional, year-end housekeeping that could help lower your taxable income, maximize your charitable deductions, and reduce exposure to future taxes.

Lowering your taxable income

The end of the year is a great time to take stock of what opportunities are available to you and how you can use them to your advantage. Here are some ways you might be able to hang on to more of your hard-earned money:

  • Tax-loss harvesting. Investment losses can be used to offset any gains you've realized in 2021, or up to $3,000 of income on a joint tax return. Consider selling depreciated securities that no longer fit your strategy, have poor prospects for future growth, or can be replaced with similar investments that play a similar role in your portfolio.
  • Contributing to tax-advantaged accounts. Contributions to a 401(k), 403(b), or a health savings account* could potentially lower your taxable income for 2021 and increase the assets you have available for future retirement and medical expenses. It's good practice to review your contributions before year-end to ensure you're taking full advantage of the limits for these accounts.

Maximizing your charitable deductions

If you're like me, your mailbox is probably filling up with letters from the charities you support asking for additional end-of-year contributions. Giving is inherently rewarding, but you may also want to consider ways to give tax-efficiently. Here are some tax-efficient giving strategies based on current law:

  • Bunching charitable contributions. It may be wise to take 2 years' worth of charitable contributions in 2021 so you can itemize deductions versus splitting them over 2 years and taking the standard deduction each year.
  • Donating appreciated assets. If you donate an asset held for longer than one year to a qualified public charity, you may be able to deduct the fair market value of the asset without paying capital gains on a sale.
  • Making cash contributions. If you are itemizing deductions, remember that up to 100% of your adjusted gross income (AGI) can be deducted for cash contributions made to qualified public charities in 2021. If you own a C corporation, up to 25% of taxable income can be deducted for cash contributions. This was a provision of the CARES Act and is expected to expire this year. Be aware: Donor-advised funds are not considered qualified public charities.
  • Universal deduction. If you do not itemize deductions in 2021, you may deduct up to $300 ($600 for married couples filing jointly) for cash contributions to qualified public charities.

Reducing exposure to future taxes

Year-end planning isn't just about the here and now. There are several things you can do before the end of 2021 that could help reduce the impact of future taxes and provide added benefit to your beneficiaries or favorite causes:

  • Annual exclusion gifts. You can make gifts up to $15,000 to as many beneficiaries as you like, which can help reduce your estate's value without using any of your lifetime gift and estate tax exemption.
  • Qualified charitable distributions. If you are age 70½ or older and have an IRA, you may want to consider making direct transfers of up to $100,000 from your IRA to eligible charities. This could potentially reduce the amount of current or future required minimum distributions. Additionally, a direct transfer does not increase your AGI, meaning it will not adversely affect your itemized deductions, Medicare premiums, or Social Security benefits.
  • Accelerating business income or deferring business expenses. If you think corporate or individual rates (for pass-through entities) might increase in 2022, consider accelerating any business income in 2021. You may also want to put off large expenses until future years when they can be used to offset potentially higher tax bills.
  • IRA or 401(k) distributions. This may be worth considering if you have relatively low income in 2021, especially if you believe that tax rates will rise in the coming years.
  • Roth IRA conversions ahead of the proposed December 31 deadline. While it's still far from certain, proposed legislation in Washington would eliminate the ability to convert after-tax assets to a Roth IRA. If this was something you were considering, time may be of the essence. Before you decide, however, understand that you will need to have other liquid assets available to pay the associated income tax due as a result of the conversion.

Keep a long-term perspective

While we can never predict the future with certainty, it's never a bad thing to be educated on the possibilities of different outcomes. By understanding these possibilities, we can build enough flexibility into our plans to ensure that we're able to stay focused on our long-term goals and objectives. Before you determine your next step, consult with your tax advisor and work together to identify the best approach for your specific situation.

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