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Tax Man: Methods to Decrease Your Tax Invoice 2021 – and align future tax financial savings

With the end of the year fast approaching, it's time to consider measures that will cut your tax bill in 2021 and hopefully position you for tax savings in the years to come. This column is part one of my two-part list of suggested year-end strategies.

But first we have to deal with the great uncertainties regarding the future of your personal tax situation. Here goes.

What you should know about planned tax increases

In May, the Treasury Department published its General Statement on the Biden Government's Proposed Revenue for Fiscal Year 2022, also known as the “Green Paper”. The document contains fairly detailed information about President Joe Biden's proposed tax changes that would be included in the so-called American Jobs Plan and the so-called American Families Plan.

Individuals could see federal income tax increases under these proposals. At this point in time, it is too early to say which, if any, proposed changes will actually become a reality. So this issue is a moving target. Not all of the proposed changes in the Green Paper are listed below, but I will briefly summarize the changes that I think will be of most interest to individuals, including those who own small businesses. I also included some changes proposed by the House Democrats.

Higher maximum individual tariff

Beginning in 2022, the Biden Plan would raise the highest individual federal income tax rate on ordinary income and short-term net capital gains to 39.6%, the maximum rate that was in effect prior to the TCJA. This proposed rate increase would affect singles with taxable income above approximately $ 450,000, married couples enrolled together with taxable income above approximately $ 510,000, and householders with taxable income above approximately $ 480,000.

Under the separate plan proposed by the House Democrats, the maximum federal rate for normal income and short-term net capital gains would be increased to 39.6%, with that top tier starting at $ 400,000 for individuals and $ 450,000 for married couples. The House Democratic proposal would also impose a new 3% surcharge for individuals and married couples with an Adjusted Gross Income (AGI) above $ 5 million. After taking into account the 3% surcharge, the new maximum effective rate on ordinary income and short-term net capital gains would be 42.6% (39.6% + 3%) or 39.6% + 3% + 3.8% compared to the current maximum effective rate of “only” 37% or 40.8% when applying the 3.8% NIIT (37% + 3.8%).

Higher maximum rate for long-term profits and dividends

For gains recognized after an unspecified date in 2021, high-income individuals would pay a maximum rate of 39.6% on long-term net capital gains. After adding the NIIT of 3.8%, the maximum effective rate would be 43.4% (39.6% + 3.8%) compared to the current maximum effective rate of "only" 23.8% (20% + 3, 8th%). The same maximum rate increase would apply to qualifying dividends received after that date. However, this proposed retrospective tax rate increase would only apply to taxpayers whose AGI is above $ 1 million, or above $ 500,000 if the separate marriage status is used. Taxpayers would only be subject to the higher maximum rate if the adjusted gross income (AGI) exceeds the applicable threshold.

For example, a co-registered married couple with an AGI of $ 1.2 million, including long-term net capital gain of $ 300,000, would apparently hit the 39.6% / 43.4% maximum on just the last $ 200,000 – Pay dollars of long-term net capital gain.

Under a separate plan proposed by the House Democrats, the maximum federal rate for long-term net capital gains and qualified dividends would be retrospectively increased to 25% with effect from a date later this September. After taking into account the new 3% surcharge and the NIIT of 3.8%, the new maximum effective rate would be 31.8% (25% + 3% + 3.8%) compared to the current maximum effective rate of “only “23.8% (20% +.). 3.8%).

All pass-through income could be subject to NIIT or SE tax

Under applicable law, singles and householders with an AGI greater than $ 200,000 and married co-filing couples with an AGI greater than $ 250,000 are potentially subject to the NIIT of 3.8% on all or part of their income from capital gains, interest, dividends , Royalties and passive income activities. Income from self-employment (SE) is not subject to the NIIT. The proposed changes would be aimed at S shareholders, limited partners and LLC members whose shares of passed-through income are currently not subject to NIIT or SE tax.

Under a proposed change, all income not subject to SE tax would be subject to NIIT for taxpayers with an AGI above $ 400,000. According to another proposed change, income passed on to S shareholders, limited partners and LLC members who have a significant interest in the company's business would be subject to SE tax if the passed-on income exceeded certain thresholds. With these proposed changes, affected onward income would be effectively subject to either NIIT or SE tax for tax years beginning after 2021.

The House Democrats' separate plan would only impose an additional 3.8% tax on the income of transit companies.

Restriction of real estate § 1031 similar exchange

The Trump administration's Tax Cuts and Jobs Act restricted the ability to defer profits on property exchanges using Section 1031-like exchanges. Biden's tax plan would limit the amount of profit that can be deferred in Section 1031 Exchanges to $ 500,000 per year, or $ 1 million for married couples filing together. This change would take effect for exchanges completed after 2021.

Other proposed changes that have been published

In addition to the more "official" proposed changes summarized above, several other proposed changes have been proposed at various times, including in the area code information published by the Biden campaign. These other proposed changes include the following.

Higher social security contributions for people with higher incomes

For 2021, social security tax of 12.4% is the first $ 142,800 in wages and / or net income from self-employment. Employees pay 6.2% through withheld paychecks and employers pay the remaining 6.2%. The self-employed pay the entire 12.4% out of their own pocket via the self-employed tax (SE). For 2021, social security tax of 12.4% will be abolished once wages and / or SE net income exceed the cap of US $ 142,800. For 2021 and beyond, the social security tax cap will be adjusted annually for inflation.

A change introduced would reintroduce 12.4% social security tax on wages and SE net income over $ 400,000. This is what is known as the donut hole approach to increasing social security tax. Over the years, the donut hole would gradually close as the bottom of the hole is adjusted for inflation while the top of the $ 400,000 hole remains static.

Eliminate investment property breaks

In addition to the proposed restrictions on exchanges of a similar nature under Section 1031, other changes introduced for investment property would: (1) remove the $ 25,000 exemption from the passive loss rules for rental property losses of middle-income people (2) rules, which allow faster depreciation on certain properties; and (3) eliminate the deduction of Qualified Business Income (QBI) for net rental income.

Specific tax steps at the end of the year that must be taken into account

After you've considered all of this, here are some year-end tax planning ideas to consider.

Play the standard trigger

The Tax Cuts and Jobs Act (TCJA) has nearly doubled the standard withholding amounts. For 2021, the basic standard deduction amounts are:

$ 12,550 if you are single or applying for separate married status.

$ 25,100 if you and your spouse file together.

$ 18,800 if you are a head of household.

Slightly higher standard deductions are possible for people aged 65 and over or for blind people.

Here is the plan. If your total line item deduction for that year is close to your standard deduction amount, consider making enough additional item allowance before the end of the year to exceed the standard deduction. These expenses will lower this year's tax burden. Next year your standard deduction will be higher thanks to an inflation adjustment, and you can claim the higher allowance if you don't list.

The easiest deductible cost for the prepayment is included in the house payment due on January 1st. If you speed up that payment this year, you will get a detailed mortgage loan interest discount of 13 months in 2021. Although the TCJA sets new limits on these deductions, arguably they are not affected. But ask your tax advisor to be on the safe side.

Next on the prepayment menu are state and local income and property taxes due early next year. Prepaid these bills before the end of the year can cut your 2021 federal income tax bill because your individual deductions are so much higher. However, the TCJA has lowered the maximum amount you can deduct for state and local taxes to $ 10,000 or $ 5,000 if you are using separate status for marriage. So beware of this limitation.

Warning: The state and local tax prepayment exercise can be a bad idea if you owe the dreaded Alternative Minimum Tax (AMT) for that year. This is because state and local income and wealth tax write-offs are completely prohibited under AMT rules. Therefore, if you are in the AMT zone, prepaying these expenses may bring little or no tax-saving benefit. Fortunately, the changes in the TCJA have put millions of taxpayers out of AMT danger, but not all. Ask your tax advisor whether you are clear about this year or not.

Consider making larger charitable donations this year and smaller donations next year to compensate. This could cause your individual deductions to exceed your standard deduction that year.

Finally, consider expediting elective medical procedures, dental treatments, and vision care expenses. You can deduct medical expenses insofar as they exceed 7.5% of your AGI when you break this down.

Carefully manage profits and losses in taxable investment accounts

When holding investments in taxable brokerage accounts, you should consider the tax benefit of selling valued securities that have been held for more than 12 months. Assuming no retroactive change to the contrary, the federal income tax rate on long-term net capital gains recognized this year is “only” 15% for most people, although it can reach the maximum rate of 20% at high income levels. The 3.8% NIIT add-on can bite even with high income levels. So the true maximum rate for high income individuals is 23.8%: the advertised maximum rate of 20% plus 3.8% for the non-advertised NIIT.

If you have capital losses or loss carryforwards from previous years this year, the sale of winners until the end of the year does not result in a tax burden. In particular, hedging short-term net capital gains against capital losses is a tax-intelligent move, as otherwise short-term net gains are taxed at your higher ordinary income rate of up to 37%, plus a further 3.8% if the NIIT bites. Ouch.

What if you have some loser investments that you want to unload? Biting the bullet and taking the resulting capital losses this year would protect capital gains, including highly taxed short-term gains, from other sales this year.

If selling some losers resulted in your capital losses in 2021 exceeding your capital gains in 2021, the result would be a net capital loss for the year. No problem. This net capital loss can be used to protect up to $ 3,000 of 2021 income from salaries, bonuses, self-employment income, interest income, royalties, and whatever ($ 1,500 if you use separate marriage status ). Any excess net capital loss is carried forward to the next year and beyond.

In fact, a capital loss carryforward could turn out to be really good business. The carryover can be used to protect both short-term gains and long-term gains that will be recognized in the next year and beyond. This can give you additional investment flexibility during these years as you don't have to hold valued securities for more than a year to receive a lower tax rate. You pay 0% to the extent that you can protect profits with your loss carryforward. In the event of future tax rate increases, loss carryforwards could prove to be very valuable in future years.

The bottom line

With all of the federal income tax hike proposals floating around, nothing is certain about taxes, including year-end tax planning strategies that will prove to be working. But I think what we're saying here is good advice all in all. In the meantime, please refer to the second part of our menu of tax planning strategies for individuals at the end of the year. Coming soon.

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