The Ultimate 2021 Guide to Year-End Tax Planning as an Advisor

Though it may seem that we’ve just put last tax season to rest, the time is now to make final contributions and adjustments to optimize your client’s 2021 taxes. As there is never a dull moment in the tax world, 2021 offers a few unique (and temporary) items to be aware of. Let's review everything you need to think about as we wrap up 2021 and prepare for the upcoming tax season.

Start with the Basics

Eye on the “Prize”

The tax code is riddled with thresholds and keeping a close eye on where everything falls in any given year can help you strategize with your clients to make sure that no savings get left behind.

Every year the IRS adjusts the brackets, credits to prevent unaccounted for bracket creep due to inflation. Prior to the 2017 Tax Cut and Jobs Act, the IRS used the Consumer Price Index (CPI) for any adjustments to income thresholds, but they now use the Chained Consumer Price Index (C-CPI). For 2021 the adjusted marginal tax rates and their respective filing status thresholds are:

Income Projection

We always recommend that taxpayers do a projection of their income for the year. With only a handful of weeks to go in the year, this is approachable for the W-2 wage earner and self-employed alike. Evaluating where your clients may land at year's end versus last year or the next can help to determine what strategies to employ in the final weeks of 2021.

Our anecdotal evidence seems to indicate that financial situations in 2021 have run the gamut. Some taxpayers report astronomical income that has us recommending accelerating deductions. Meanwhile, others have experienced lower-income years which leaves the silver lining of accelerating income to fill lower than usual marginal buckets. Regardless of where taxpayers land there is often an opportunity for optimization.

A quick income projection can often save taxpayers from the angst of underpayment penalties. For 2021, the Federal Safe Harbor Rules are:

• 100% of 2020 tax liability (110% for those with AGI greater than $150K) OR
• 90% of final 2021 tax liability

While it’s likely too late to adjust withholding for W-2 employees, taxpayers can make fourth-quarter estimates, which are due January 18, 2022 (being mindful that estimated payments are not applied evenly throughout the year as W2 withholdings are).

Easy Wins: HSAs, IRAs, and Other Retirement Contributions

With a little agility (and a great financial advisor, YOU) in their corner, taxpayers can make final strategic moves for 2021 to adjust income (and consequently AGI) to tweeze out the financial silver linings of 2021. The big thing to keep in mind is that deadlines vary.

• Roth Conversion Deadline: December 31, 2021
• Solo 401ks must be opened by December 31, 2021 (funding can take place up until April 18, 2022, or extension, if applicable)
• IRA/HSA contribution deadline: April 18, 2022

You know the drill by now—the first place to start when we’re looking to reduce gross income is with tax-advantaged HSA and retirement contributions. Get your clients to fill those buckets!

If they’re not already doing so, max out pre-tax employer-sponsored retirement plans (401k, 403b, 457) - $19,500 limit in 2021 ($26,000 if age 50 or older). This bucket can offer double the fun for taxpayers with access to the 403b and 457 allowing the possibility of up to $39,000 ushered off.

Perhaps you’ve had a banner year? For the self-employed, the Solo 401k offers the largest maximum tax deferment advantages. You, the employee, contribute up to $19,500 ($26,000 if age 50 or older) + employer contributions (also “you”, you rockstar) up to 25% of your gross compensation up to a max of $58,000 ($64,500 if age 50 or older).

We both know it’s not always feasible (mentally, financially, behaviorally)  to make this shift, but as we’ll discuss later, last-minute increases in contributions have the potential to have a big impact this year, especially for families.

A note from the XYTS Magic 8-Ball: In previous years, when taxpayers weren’t quite sure about eligibility for a Roth IRA contribution we might just suggest they wait until tax season to make any determination and either make their contribution or execute a Backdoor Roth, but with looming proposed legislation you may consider executing a backdoor Roth before the end of the year.

Pedal to the Metal: Accelerating Deductions or Income

It may seem like we’ve been living in some sort of odd-ball alternative universe, but for those who experienced what you expect to be an unusually high-income year, the time is now to accelerate deductions to reduce taxable income. It’s important to be strategic here and ensure that any accelerated methods used will exceed the standard deductions of $12,550 for single filers ($25,100 for MFJ). The options to do so are abundant and offer something for nearly everyone.

Charitably minded: Have your clients front-load their charitable contributions for the upcoming year(s). It’s a boon for the organization of choice and reduces their tax liability. Win, win! As an alternative, you know we love a Donor Advised Fund, and your high-earning philanthropic clients might as well. Expanded benefits allow taxpayers to deduct cash contributions up to 100% of their AGI for 2021, and noncash contributions are deductible up to 50% of AGI (or 30% of AGI if donating long-term capital gain property).

Cash basis business owners: This is an easy win: prepay your bills prior to December 31, 2021.

The educationally minded: Mind the AGI thresholds, but consider pre-paying that tuition for 2022 and taking advantage of the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC). Check your state rules for income tax deductions on 529 plan contributions.

Harvest losses: “Harvest” unrealized capital losses to offset income. Remember, if capital losses exceed capital gains up to $3,000 can be used to offset ordinary income, and the rest are carried forward indefinitely. For clients that generally receive capital gains distributions (from taxable accounts), there is still time to harvest losses to offset these gains.

Prepay property taxes: Prepay your January mortgage payment (and deduct that extra interest). It may not be applicable to all taxpayers, but for those not subject to SALT limitations it may be worthwhile to prepay property taxes. As we promised this time last year, no one on the XYTS team is currently in possession of a crystal ball, but certainly, it’s worth noting that consideration of repealing the SALT limitation is on the table for 2022, which could present a completely different opportunity for those applicable taxpayers.

We don’t want to be unempathetic—for some, 2021 was just a never-ending curveball. Those taxpayers that find themselves in a lower-income year have the opportunity to make some power plays for the long game. Low-income years offer the opportunity to accelerate income for better positioning in the future.

Initiate Roth conversions: As has been much discussed in our industry as of late, the potential for the elimination of Roth conversions looms. Converting traditional funds to a Roth IRA now, especially given the opportunity to fill lower than usual tax brackets, could be a pivotal move for the future.

Harvest capital gains: Those taxpayers in the 10% and 12% marginal tax brackets should consider selling appreciated assets to take advantage of the 0% federal long-term capital gains rate.

Accelerate business income: It’s not always feasible in the world of self-employment, but for those operating cash basis businesses accelerating receipt of payments due might be beneficial. Particularly if you’re expecting next year to have much higher revenue.

Reach for the Roth(401k): For those with the option, there may still be time to change the final contributions of the year from traditional 401k contributions to Roth 401k.

Defer deductions: Charity, other itemized, business deductions, education expenses may be deferred to higher-income years. If you anticipate increased income and jumping brackets in 2022, any deduction your client may be considering in the final hours of 2021 may very likely be worth more in 2022.

2021 News & Exclusives

We’ve covered the ways your clients may use income arbitrage based on where they find themselves at the end of 2021, but let’s take a moment to look at some of the credits at stake for those dancing around various AGI thresholds. There are some unique opportunities this year, especially for families with young children.

Third Stimulus Payment

The American Rescue Plan Act of 2021 authorized the third (and currently, final) economic impact payment (EIP) as an advanced payment of this tax year’s Recovery Rebate Credit. The payments, $1,400 for an eligible individual and $1400 per qualifying dependent, were made to those eligible beginning in March of 2021. Eligibility was determined by whether or not individuals are:

• U.S. citizens or U.S. resident alien
• not a dependent of another taxpayer, and
• their adjusted gross income (AGI) is not more than:
• $150,000 if married and filing a joint return or if filing as a qualifying widow or widower
• $112,500 if filing as head of household or
• $75,000 for eligible individuals using other filing statuses

Phaseouts for this credit are sharper than the previous two EIPs. Complete phaseouts occurred for those with AGIs above:

• $160,000 if married and filing a joint return or if filing as a qualifying widow or widower
• $120,000 if filing as head of household
• $80,000 for eligible individuals using any other filing status

While many taxpayers have already received their payment based on previously filed 2019 or 2020 AGI income, those within proximity of the eligibility thresholds in 2021 may consider making out-of-the-ordinary contributions that would reduce AGI and maximize the $1400 per eligible individual.

Changes to the Child Tax Credit

Under the American Rescue Plan, for 2021, the maximum child tax credit increased from $2000 per qualifying child to $3,000 for each qualifying child age 6-17 and $3600 per qualifying child under 6 for eligible families. In addition to the increase in the amount for certain taxpayers, the credit is fully refundable for 2021. Beginning in July, eligible families began seeing deposits of half their estimated 2021 credit amount to be paid over the final six months of 2021. The remainder of the credit will be claimed when they file their 2021 tax return. Your clients may have seen monthly payments up to:

• $300 per qualifying child ages five and under on December 31, 2021 (50% of $3600/6)
• $250 per qualifying child between the ages of 6 and 17 on December 31, 2021 (50% of $3000/6)

Fully Enhanced Child Tax Credit: Eligible families with Adjusted Gross Income (AGI)  up to $112,500 (HOH) and $150,000 (MFJ) will have likely seen advanced payments in the full amount depending on the age of the qualifying child.

First Phase-Out: Eligible families with AGIs between $75,000(S)/$112,500 (HOH)/$150,000(MFJ) and $200,000(S/HOH)/$400,000(MFJ) were still eligible to receive the credit (and advanced payments) but with a reduction in value of $50 per $1000 increase in AGI until reduced to the unenhanced amount of $2000/child. These families may have received monthly payments between $166 and $300 per child, depending on the age of the child and AGI.

Second Phase-Out: Eligible families with AGI exceeding $200,000(S/HOH)/$400,000(MFJ) saw no distinguishable difference in credit eligibility. The second phase out reduces the unenhanced child tax credit by $50 per $1000 increase in AGI until reduced to zero.

These payments were an estimated advance of a credit for the taxpayer's 2021 return. The estimated part of this is important. They were based on the taxpayer’s 2020 return, if processed by June 28th, or their 2019 return, if not. Taxpayers that experienced a jump in income for 2021 may find themselves needing to repay all or a portion of their advanced payments. Likewise, a change in filing status and the number of dependents for 2021 or loss of income will impact the final credit. This generates another possibility for optimization for those filers within proximity to thresholds. An additional word of caution here: Accurate record keeping and reporting will prevent delays in the processing of their returns. We recommend taxpayers include a transcript of received pre-payments with their standard tax documents this year.

Child and Dependent Care Credit

For families, the changes to the child and dependent care credit for 2021 via the American Rescue plan offers yet another opportunity to maximize credits.

It’s yet to be determined if the changes will continue under the proposed American Families Plan, but the turbocharged credit offers much benefit to families this year.

Student Loan Forgiveness

The American Rescue Plan also changed the game for those receiving discharge of student loans beginning January 1, 2021 (until January 1, 2026). Temporarily suspended are the days where forgiveness of the debt would result in the issuance of a 1099-C for the taxpayer. For now, the amounts forgiven will not have to be included in the gross income of the taxpayer.

Charitable Donations: Non-Itemizers

In 2020, the CARES Act provided single and MFJ filers an “above-the-line” adjustment of up to $300 for cash gifts to eligible charities. This gave taxpayers an opportunity to shave a little off their AGI, and as we’ve established, nearly everything goes back to AGI thresholds. According to current drafts the 2021 benefit falls “below-the-line” and won’t have the same impact for non-itemizing taxpayers when it comes to AGI, but it will impact taxable income.

Repayment of Deferred Social Security

This doesn’t exactly fall into the “puppies and rainbows” category we’ve been covering, but it does warrant a warning. Those individuals, generally self-employed and household employers, who opted to defer half of their Social Security taxes in 2020 through the CARES Act, face a December 31, 2021 deadline to repay the deferred portion. These repayments need to be made as a separate payment and denoted “deferral payment” to be correctly applied.

As you close out the year with the clients you serve, it’s a worthy endeavor to examine where they stand as they approach tax season. As we know, personal finance is personal, and running projections can guide you to the best solutions for 2021 (and beyond). If you’re looking for a trusted tax partner to meet you and your clients’ needs this tax season, look no further than the team of experts at XY Tax Solutions. Get in touch here.

About the Author

Rachel Black is a Tax Specialist on Team XYTS. She pulls from her depth of tax expertise as a CPA candidate with over a decade of experience in small business operations and client relationships to heroically handle all things taxes for XYTS clients. Rachel gets a thrill from working with clients to demystify data collection and taxation. When she's not proudly expressing herself as a tax nerd, Rachel loves coffee and tromping through the trees with her three girls.