Tom Talks Taxes - December 20, 2021

Five easy ways to reduce taxable income for 2021 before year-end

December is “tax planning season” for many tax professionals - it is the time where we can make last-minute shifts in a client’s situation to have a better tax outcome for the entire year. Once the calendar passes into the next tax year, we are more limited in what we can do retroactively to help with the prior tax year.

For tax year 2021, managing a taxpayer’s adjusted gross income (AGI) and taxable income are more important that ever. Not only does the taxpayer reap savings equal to the marginal tax rate, but also many COVID-19 related tax provisions enacted for tax year 2021 begin to reduce their value within a narrow range of AGI:

• The 2021 recovery rebate credit phases out between $75,000 to $80,000 AGI for single/married filing separate and $150,000 to $160,000 AGI for married filing joint.

• The 2021 enhanced child tax credit amounts begin to phase out at $75,000 AGI for single/married filing separate and $150,000 AGI for married filing joint.

• The 2021 enhanced child and dependent care credit begins to phase out at $125,000 AGI for all filing statuses.

One tried-and-true method is contributing to retirement accounts; in addition, some retirement contributions can be made in 2022 and attributed to tax year 2021, depending on the type of account.

In addition to retirement, consider these five strategies:

1. Purchase business equipment (only if needed). If a taxpayer purchases a business asset and places it in service on or before December 31, 2021, then it’ll be generally eligible for 100% bonus depreciation provided it has a class life of 20 years or less. An asset is placed in service when it is “first placed in a condition or state of readiness and availability for a specifically assigned function” per Treas. Reg. §1.167(a)-11(e)(1)(i). It does not actually have to be used in the trade or business to meet the requirement.

2. Delay invoicing. For cash method taxpayers, income is recognized when actually or constructively received. A taxpayer can delay invoicing until after December 31, 2021, and thus receipt of the funds, if a last-minute increase in receipts would reduce or eliminate AGI-dependent tax benefits.

3. Pre-pay expenses. A cash method taxpayer can pre-pay up to 12 months of expenses and deduct them in the year paid or incurred under Treas. Reg. §1.263(a)-4(f). By doing this, the taxpayer is simply shifting expenses, not increasing overall deductions; however, in tax year 2021, since there are extra AGI-dependent deductions and credits, it may be much more beneficial to claim the expense in tax year 2021. As an example, rent can be pre-paid with a check mailed in tax year 2021 and received by the landlord in tax year 2022; in this case, the landlord will not be negatively impacted as he or she will recognize the same amount of income in tax year 2022 whether you pre-pay it or not.

4. Harvest capital losses. If a taxpayer has loss stock positions, then he or she can sell them on or before December 31, 2021 and use the losses against other capital gains, or up to $3,000 per year against non-capital gain income.

5. Charitable contributions. Charitable contributions, since they are deducted on Schedule A, don’t reduce AGI and only reduce taxable income if the taxpayer itemizes deductions. For tax year 2021 only, a taxpayer can take a charitable contribution deduction of $300 ($600 married filing joint) in addition to the standard deduction for most cash contributions; however, this deduction is not above-the-line and only reduces taxable income. There is one loophole to allow an above-the-line benefit for charitable contributions: a taxpayer over age 70.5 can make a qualified charitable distribution from a retirement account to a charity and exclude up to $100,000 of it from income. A qualified charitable distribution can also meet a taxpayer’s annual required minimum distribution requirement. This is an important AGI reduction strategy for older taxpayers who need to take funds from tax-deferred retirement assets but plan to make charitable contributions during the year. Use of a qualified charitable distribution can also reduce Social Security taxation if the taxpayer is in the appropriate income range.

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