As 2021 draws to a close, you are no doubt looking for strategic ways to minimize your tax burden. It’s been a rollercoaster of a year, with complicated new provisions, credits, and policy changes that arose out of the pandemic. Though the Build Back Better plan has yet to be finalized, it contains several provisions that will heavily impact taxes for individuals and businesses alike. It will do you good to plan ahead of time.
Dive deep into our tax planning tips for 2021 to help you strategize for major deductions and reduce your tax burden. For your convenience, we have divided these tips into two sections—Individual and Business—so feel free to skip around to whatever section is relevant for you.
Above-the-Line Charitable Contribution Deduction– For 2021, taxpayers who don’t itemize can take advantage of a $300 above-the-line deduction for cash contributions to qualified charitable organizations ($600 for married filing jointly).
Increased Limit for Cash Contributions– The adjusted gross income (AGI) limit for cash contributions made to qualified charities has been increased to 100 percent through 2021. Donations to donor-advised funds and private foundations are not eligible for the increase. Further analysis should be made when donating both cash and noncash contributions, such as stock, or if the taxpayer is in a lower tax bracket or doesn’t otherwise itemize.
Required Minimum Distributions (RMD)– RMDs have resumed for the 2021 tax year and must be taken by December 31 unless the taxpayer turned age 72 during the year which defers the start date to April 1. Taxpayers at least age 70 and a half should consider making qualified charitable distributions (QCD)—of up to $100,000 per year—directly from a non-Roth IRA to a qualified charity to reduce AGI. QCDs count toward RMDs.
Child Tax Credit (CTC)– For eligible taxpayers in 2021, the CTC was increased and became fully refundable. The credit was increased by $1,600 for children under age 6 and by $1,000 for those ages 6 to 17. The increase starts to phase out for joint filers and qualifying widow(er)s with AGI of more than $150,000 ($112,500 head of household, $75,000 for all other taxpayers). The phaseout for the increase is calculated separately from the phaseout for the base $2,000 per child credit.
To allow families an immediate benefit, six advanced monthly payments of the credit started in July. The advanced payments are based on either the 2019 or 2020 tax return. The payments do not exceed more than 50 percent of the projected CTC and are up to $300 per month for each qualifying child under age 6 and up to $250 per month for children ages 6 to 17. There are certain tax situations where it’s more beneficial for the taxpayer to opt out of the advanced payments.
Qualified Medical Expenses– Personal protective equipment (PPE) purchased to prevent the spread of COVID-19 qualifies as medical expenses starting periods beginning on or after January 1, 2020. Items such as masks and hand sanitizer are now eligible to be paid, or reimbursed, under medical expense accounts such as FSAs, HRAs, HSAs, and MSAs. If a medical expense account is not used, and the items are not reimbursed by insurance, the costs can be included as a deductible medical expense. Deductible medical expenses must exceed 7.5 percent of the taxpayer’s AGI and the taxpayer must itemize to receive a benefit. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) signed into law in March 2020 also made over-the-counter medications and menstrual care products qualified medical expenses.
Repayment of Deferred Social Security Tax– Self-employed individuals and household employers who deferred half of their Social Security taxes for the 2020 tax year must repay half by December 31, 2021. The remainder is due by December 31, 2022. The repayment should be made with a separate tax payment and noted that it’s for “deferred Social Security tax” to be correctly applied.
Net Operating Losses (NOL)– For most taxpayers, NOLs can only offset 80 percent of taxable income in a tax year. Any remaining NOL is carried forward indefinitely. There is an exception for farm losses, which are eligible for a two-year carryback. NOLs arising in tax years prior to January 1, 2018, were limited to a 20-year carryforward, so taxpayers having NOLs from these years will need to track them separately. The CARES Act temporarily changed the NOL carryback rules for tax years 2018, 2019, and 2020.
Excess Business Losses– Noncorporate taxpayers can deduct a net trade or business loss up to a maximum of $262,000 ($524,000 for joint returns) in 2021. Business gains and losses reported on Form 4797 may be included in the loss calculation. However, W-2 wages are not considered business income in calculating the excess business loss. Any excess loss becomes an NOL and is carried forward to future tax years.
Employee Retention Credit (ERC)- The ERC was first enacted with the passage of the Coronavirus Aid, Relief, and Economic Security Act in 2020. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 extended the ERC to apply to wages paid from January 1, 2021, through June 30, 2021, and the American Rescue Plan Act of 2021 further extended the ERC to apply to wages paid from July 1, 2021, through December 31, 2021. There were a number of modifications to the ERC that will apply to wages paid in 2021, including which businesses are eligible for the credit as well as the amount of the credit.
To qualify for the credit for tax year 2021, you must meet the definition of an eligible employer. Eligible employers can claim a credit equal to 70 percent of qualified wages up to a maximum of $10,000 of wages per employee per quarter. This means the maximum credit for any one employee could total $28,000 for calendar-year 2021. However, the bipartisan infrastructure bill currently awaiting a vote in the House includes a provision that would end the credit for most taxpayers as of September 30, 2021, which would reduce the maximum 2021 credit per employee to $21,000. The credit is claimed on payroll tax Form 941. In addition, the amount of wages you are allowed to deduct on your 2021 income tax return is reduced by the amount of the 2021 credit claimed.
Net Operating Losses– The changes to net operating losses over the last few years have been numerous. In general, for tax years beginning after December 31, 2020, businesses that incur a net operating loss will only be allowed to carry the loss forward to be used in future tax years. While these losses will be carried forward indefinitely, they can only be used to offset 80 percent of taxable income.
Research & Development Costs– For tax years beginning after December 31, 2021, research and development costs must be capitalized and amortized. Research and development costs incurred in the U.S. will have an amortization period of five years, while those costs incurred outside the U.S. will have an amortization period of 15 years. This tax treatment is different from the way businesses currently account for these costs, as businesses can either deduct these costs or choose to capitalize and amortize these costs. Note, there is a provision in the budget reconciliation bill that would delay the effective date of the R&D capitalization and amortization requirement to taxable years beginning after December 31, 2025.
Business Interest Expense Limitation– The passage of the Tax Cuts and Jobs Act applicable for tax years beginning after December 31, 2017, created a new provision for the potential business interest expense limitation. For each tax year, businesses are required to compute their adjusted taxable income to determine their eligibility to deduct business interest expense paid during the year.
The deductible business interest expense was limited to 30 percent of the computed adjusted taxable income, and the computation for adjusted taxable income included an addback for depreciation, depletion, and amortization. For tax years beginning after December 31, 2021, the addback for depreciation, depletion, and amortization will no longer be included in the computation of adjusted taxable income. This change in the computation of adjusted taxable income may result in businesses having more interest expense disallowed for tax purposes.
To get started on your tax planning, get in touch with our Accounting & Tax team today.