Here we are again! We are almost at the end of the year and Congress is debating and tweaking a bill that would significantly change tax law. If implemented, these changes would have important implications for future tax years and there is planning that would need to be executed now for certain taxpayers. In this case, the year is 2021, and the bill is the 2,135 page Build Back Better Act (BBBA). The effective dates of the various tax measures are mostly for years starting after December 31, 2021.
If the Build Back Better Act becomes law, the key items that we would need to look at include:
- Under BBBA, application of the 3.8% Net Investment Income Tax (NIIT) would be expanded to include the net income from flow-through and foreign entities. This would reduce the tax efficiency of having a profitable Subchapter S Corporation and taking only a minimal salary.
- BBBA contains a provision to add an income tax surcharge on high income individuals, estates and trusts starting in 2022. Only a handful of U.S. individuals would be affected as it would kick in at a modified adjusted gross income (MAGI) of $10million for joint returns. However, the threshold is only $200,000 for estates and trusts. MAGI is computed after adding back interest expense. It would make sense for estates and trusts to distribute the excess income to the beneficiaries or to charities.
- On the positive side for many of our clients, the most current iteration of BBBA raises the State and Local Income Tax (SALT) cap to $80,000 through 2030. This would clearly change the decision for many taxpayers to itemize deductions instead of taking the standard deduction.
- The exclusion of gain from the disposition of Qualified Small Business Stock would be only 50% instead of a full exclusion.
- The legislation includes multiple changes to corporate taxation and makes adjustments to the Global Intangible Low-Taxes Income (GILTI) regime that taxes foreign company income in the hands of U.S. persons. If this legislation passes, we will provide more information on this topic at that time.
Although a version of the Build Back Better Act of 2021 did pass the House of Representatives on November 19th, some changes and compromises may be necessary to pass the legislation through the evenly divided U.S. Senate. For now, let’s concentrate on what is actual current law and we will update you if and when it passes the Senate.
Remember that we are in a period covered by the Tax Cuts and Jobs Act of 2017 (TCJA). This act expanded the reporting and taxation of foreign income permanently but also introduced a series of changes that will expire or phase-out at the end of 2025.
The Gift and Estate Tax Exemption
The amount in your estate that can be passed on to your heirs without estate tax was doubled under the TCJA but will return to pre-TCJA levels in 2026 unless Congress enacts legislation to change the exemption amount. A significant reduction of the Estate Tax Exemption and an end to the step-up in basis of assets to Fair Market Value at date of death were provisions in the original BBBA but both have been removed from the version currently under consideration. This is great news as it is very difficult to plan your estate not knowing what the exemption amount is and whether assets will receive a step-up in basis. It’s a huge relief to all of us that the step-up in basis of a decedent’s assets to the asset’s Fair Market Value at date of death, or the Alternate Valuation Date six months later, is still in place.
Estate Tax Exemption
- 2021 – $11,700,000 each decedent
- 2022 – $12,060,000 each decedent
A properly structured estate plan can protect over $24 million for a U.S. citizen couple who both pass away in 2022. Remember that the unused exemption of the first decedent is portable to the second U.S. citizen spouse, and adds to their exemption amount, no matter how long they survive the first spouse. This is called the Decedent Spouse Unused Exemption (DSUE). Portability to the surviving spouse is elected on the timely filed estate tax return for the first to die. You may think that this will never apply to you, but a winning lottery ticket could change that calculation in an instant.
More good news is that a provision in the original bill that would have included certain types of grantor trusts in a decedent’s estate is also off the table now.
Gifts and Donations
The annual gift exclusion is rising from $15,000 for gifts made in 2021 to $16,000 in 2022. What this means is that you may make a gift of up to $15,000 this year / $16,000 next year or any amount directly to an educational institution or to a medical provider without eating away at your lifetime gift and estate tax exemption. For gifts made above these annual amounts, you may still have to file a gift tax return, but gifting can be a great strategy for passing wealth on while the Gift and Estate Tax Exemption is so high. Charitable donations don’t eat into your exemption either. The annual exclusion for gifts made during 2021 to a spouse who is not a U.S. citizen is $159,000. For gifts made in 2022 to non-citizen spouses, the exclusion will be $164,000.
Speaking of charity, if you make donations but not enough to itemize deductions, you can still take a deduction from taxable income in addition to the standard deduction. For 2020, the additional deduction was $300 on a joint return. On your 2021, joint filers can take an additional deduction for up to $600 of charitable donations. Keep your dated donation receipts.
Don’t forget that when you donate appreciated assets, you can deduct its market value without paying tax on the appreciation. In a sense you are donating both your cost in the property and the right for the charity to sell the property and realize the gain. Generally, donations are limited to 60% of your Adjusted Gross Income. Donations of appreciated assets have lower percent of AGI limits in certain circumstances. Some planning will be required.
Standard vs Itemized Deductions
The standard deduction, like many other tax numbers, is indexed for the cost of living. In addition to the amounts below, you can take the additional charitable donation deduction mentioned above.
|Head of Household
|Married Filing Jointly
Add $1,400 to each amount above if the taxpayer and/spouse is over 65 years of age or blind, or add $1,750 if you are a Single filer.
Itemized deductions are generally:
- medical insurance and expenses above a threshold
- mortgage and investment interest
- property and state income taxes (subject to the SALT cap)
- charitable donations.
It is often a good strategy to maximize donations and/or medical expenses every other year so that itemizing gives a better result instead of spreading those expenses evenly over every year and only taking the standard deduction. Prepaying mortgage interest, or making donations before December 31st can help utilize or increase itemized deductions.
Personal Tax Rates
The top tax rate is still 37%, not the 39% that was batted around in Congress. What is new is that it kicks in at $628,301 for Married Filing Jointly (MFJ) in 2021 and will apply to income greater than $647,850 for 2022. For Single filers, the top bracket kicks in at $523,601 for 2021 and will apply to income greater than $539,900 for 2022. For Head of Household filers, the top rate applies to incomes greater than $523,600 in 2021 and $539,900 for 2022.
Trust Tax Rates
The top tax rate of 37% kicks in at a measly $13,050 for 2021 and $13,450 for 2022. It’s still tax-inefficient to have high taxable income in a non-grantor trust or estate.
Timing Your Taxes
Taxes withheld at source are deemed to be withheld evenly throughout the year. If you think you are going to owe tax and you are a little short on your estimated payments, you might want to have more taxes withheld from your December paycheck or IRA distribution. Why pay non-deductible penalties on late or insufficient estimated payments!
IRAs and RMDs
What is new for 2021?
- The maximum contribution to a traditional or a Roth IRA is still $6,000 plus $1,000 if you are more than 49 years old and need to catch up. As before, even this low level of contribution is phased out depending on your family adjusted gross income (AGI) and whether one or both of you have access to a retirement plan at work.
- The maximum contribution to a 401(k) in 2022 will be $20,500 / $27,000 if you were born before 1973.
- A SEP-IRA is a Simplified Employee Plan. The employer makes the contribution. This is a favorite plan for the self-employed business owner because it has a relatively high maximum contribution. All employees of the business must be included in the plan. The maximum amount that can be contributed to the plan for 2021 is the lesser of 25% of compensation and $58,000. In 2022, that will rise to $61,000. The SEP contribution limit for a self-employed individual is 25% of their self-employment earnings after deducting the deductible part of their self-employment tax and the deduction for contributions to their own SEP-IRA. This effectively changes the 25% to 20%. Since this is an IRA, RMDs are required to be taken when a certain age is attained.
- Unlike 2020, you cannot waive your 2021 Required Minimum Distribution (RMD) from your traditional IRA. If you are 72 or older, you must take your RMD by the end of the year unless this is your first time, in which case you have the option of deferring both the withdrawal and the income pick-up until April 1, 2022.
- If you have multiple IRA accounts, you can take the RMD from any or all of them. If you have multiple 401(k)s and similar plans, the RMD must be taken from each account.
- Are you delaying retirement and working past 71? You may be able to delay taking RMDs from your 401(k) until you retire as long as you don’t own any more than 5% of the company.
Qualified Charitable Distributions (QCDs)
These may be made directly to a qualified charity from your traditional IRA to satisfy some or all of your RMD. The maximum amount that your IRA may distribute as a QCD is $100,000 per year per taxpayer. QCDs are not taxable to the IRA holder and do not add to your Adjusted Gross Income. This is important because a higher AGI may trigger the Net Investment Income Tax and a Medicare premium surcharge. Be diligent though. Have the custodian make the donations directly from the IRA. Do not handle the money yourself.
Foreign Earned Income Exclusion (FEIE)
The (FEIE) continues to be indexed upwards from $108,700 in 2021 to $112,000 in 2022. Depending on your situation, it may be better to forgo the FEIE and use foreign tax credits instead to shelter you from U.S. taxes. This allows you to stockpile more foreign tax credits for future use. Keep in mind that the source country tax is what it is, and you are going to be paying that foreign tax regardless. The decision to take the FEIE, or not, is entirely a question of U.S. tax strategy.
Alternative Minimum Taxes (AMT)
The AMT is still an issue for many taxpayers. Even though the annual exemptions are ticking up with inflation, no one is happy about paying AMT unless it is the only tax you are paying on stock options. Then it can be tolerated as long as there is not the potential of double taxation involving a foreign country. AMT is usually triggered by Net Operating Losses, Tax Exempt Income (like some categories of stock options), AMT depreciation on large assets and other preference items.
For Single filers, the 2021 AMT exemption amount of $73,600 started phase-out at $523,600. In 2022 the exemption amount will be $75,900 with phase-out starting at $539,900. The 2021 numbers for MFJ filers are $114,600 and $1,047,200. For 2022 the MFJ AMT exemption will be $118,000 starting to phase out at $1,079,800. As you can see, there is a marriage penalty (speaking about taxes only).
Advance Child Tax Credits (CTC)
The CTC is a hot topic these days. Although the CTC has been around for many years, it has been bulked up to deal with the shortage of child care situations during the pandemic. It is still calculated based on your income level and the age and number of children who are your eligible children. Since the summer of 2021, half of the anticipated CTC is now available as an advance payment paid monthly. The advance payment of CTC may be as much as $300 per month for each child under six years of age and $250 for those children aged 6 through 17. This advance CTC payment is only available to families where at least one spouse lives at least 6 months in their main home in the United States and filed a 2019 or 2020 tax return (even if it was just to get the credits). Eligible children must have a valid social security number. Be aware that if your income increases over what you expected when you applied, you may end up receiving more advance payments than you are entitled to and would have to repay some amount.
The Economic Impact Payments that you may have received in 2020 and in early 2021 are advance payments of a refundable tax credit and are not taxable income. These are also called Recovery Rebates. Please keep track of what you receive and when you receive it.
The American Rescue Plan Act of 2021 allowed for $10,200 of unemployment insurance received in 2020 to be exempt from tax, at least federally. That program was for 2020 only and unemployment payments are fully taxable for 2021. The IRS is still processing corrections and refunds for 2020 tax returns that were filed prior to the $10,200 exemption being announced and/or written into tax preparation software.
Business programs that are a response to the pandemic include PPP loans, Employee Retention Credits, Deferred Payroll Taxes, Paid Leave Credit and Family Sick and Medical Leave. These programs continued into 2021 but are not as generous as they were in 2020. Essentially, 2021 is the year where these programs wrap up and start to be settled. Repayments of the PPP loans are well under way. The first repayment of unforgiven loans was/is due approximately 16 months after you received your first loan payment. Be aware of deadlines and filing requirements. Many payroll reporting forms have changed and become much more complex. Form 941 is at least twice as long as it was previously to account for payroll that fits into each of the programs, from regular payroll to Extended FMLA wages.
If you have purchased personal protective equipment (PPE) to prevent the spread of the coronavirus, these are deductible medical expenses. If your business has purchased PPE for use in the business, those are deductible business expenses. Again, the purpose of the purchase must be to prevent or slow the spread of the coronavirus. The IRS advises that these costs can also be paid or reimbursed from your Flexible Spending Account, Medical Savings Account or Medical Reimbursement Account.
Working from home expenses for employees is a 2% itemized deduction (employee’s unreimbursed expenses) that was suspended for 2018 through 2025 due to the Tax Cuts and Jobs Act of 2017. This is the same legislation that suspended the deduction for investment management fees. Both deductions are scheduled to resume in 2026. The pandemic did not change these rules. Employers are allowed to provide some support for work-at-home activities if it helps employees to remain productive, and this is not a part of taxable income to the employee. If you are self-employed, you may deduct home office expenses related to your business use of your home, equipment, and supplies. The key test is that the area must be regularly and exclusively used for business. If the same desk and computer is used for business during the day and for personal activities at night, no deduction is available.
Your tax professionals are just as frustrated as you are with the crazy slow processing of returns and refunds and long response times from the IRS. The IRS continues to be understaffed and overwhelmed. At one point it was calculated that only 3% of the up to 1,500 calls per second to the IRS were connected to a real person. With the pandemic, the number of calls to the IRS has increased exponentially as new support programs came into being and taxpayers need more help navigating them. All this while IRS computers are spitting out ominous notices. We are trying to do as much as possible online, but if your return hasn’t been touched yet, the online system won’t have any information either. This is our collective opportunity to be kind when we finally get through to an agent.
And now for some good news…. Congress has not changed the taxation of capital gains. They had suggested taxing capital gains at 25% or taxing all capital gains whether long-term or short-term at the highest marginal rate to the extent that your income was over a million dollars. Neither of these proposals are in the current iteration of the Build Back Better Act. For now, we continue to manage your gains and losses based on economic advantages and income smoothing instead of trying to pull gains forward into 2021.
There are a lot of programs and credits that we haven’t touched on in this communication as they don’t affect as many of our clients and there is just too much to cover. If you are looking for information on Opportunity Zones, adoption credits, EITC, QBID, taxes on expatriation, or any number of other topics, we will try to answer your questions in other blogs. We probably won’t write an article about the tax on imported arrow shafts unless someone specifically requests it. (I know – so obscure!)
If you have any questions regarding any of the topics that we have covered in this newsletter please reach out to us! The Private Wealth Managers at Cardinal Point are part of a robust team of cross-border investment, planning and tax professionals.