9 tax tips that could save you money now

Consider these ideas that could potentially reduce your tax bill or increase your refund

 

September 30, 2021 

AMONG THE KEY TAX TOPICS FOR 2021: Recent proposals from the House of Representatives for higher federal income tax rates, especially for corporations and affluent individuals. Also top of mind are increases in capital gains rates for certain high-income taxpayers and new limitations for high-income taxpayers on contributions to IRAs, as well as Roth IRA conversions. Though Congress has yet to enact the proposals, it’s not too early for taxpayers who believe they may be subject to higher taxes to prepare. Another important consideration this year is the phase-out of some tax breaks related to the Coronavirus Aid, Relief, and Economic Security Act (CARES ACT) that were in effect for 2020 only. Beyond those considerations are other time-tested tax approaches that could help your finances.

The ideas below are suggested by tax accountant Vinay Navani of WilkinGuttenplan. Discuss them with your personal tax professional to see whether they might make sense for you.

1. Consider how tax law changes could affect your finances

As a CPA and shareholder at WilkinGuttenplan, Mr. Navani is not affiliated with Merrill. Opinions provided are his, do not necessarily reflect those of Merrill and may be subject to change. Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

The House (like the current administration) has proposed raising the highest individual income tax rate from 37% to 39.6%—the rate in place before the Tax Cuts and Jobs Act of 2017.  The House proposal imposes an additional 3% surtax (effective after December 31, 2021) on taxpayers with incomes in excess of $5 million ($2.5 million for married filing separately).

Also significant, especially for investors, the House has proposed increasing the top tax rate on long-term capital gains from 20% to 25%.1 While that’s not as high as the administration’s proposal to nearly double the top tax on long-term capital gains, from 20% to 39.6%2, “What we're telling our clients now is that if there is any change, it's most likely going to be an increase in the capital gains rate,” Navani says.

Business owners thinking of selling their company, for example, may want to speed up their planning, he suggests. Likewise, couples considering selling a home in today’s hot housing market may want to move forward to be sure they can take advantage of the current ability to exclude $500,000 of gains when selling a home they’ve lived in for at least two of the last five years preceding the sale. Taxes alone shouldn’t drive major life decisions, especially since no changes are certain.

Still, if you’re planning on such moves, potential tax increases may be one more reason to act sooner rather than later.  Note, however, that the House, like the administration, has proposed making the capital gains rate increase retroactively effective to earlier this year.  Learn more about the proposed capital gains hike here.

2. Keep track of where you’ve worked remotely

Remote work, which for millions started as an emergency response to pandemic quarantining, is increasingly looking like the new normal for many. This creates potential state income tax complexities for those living in a different state from where their employer’s office is located or for those who spend time working remotely from locations other than their state of residence.

While rules vary from state to state, once you reach 183 days (more than half the year) in the state from which you’re working remotely, that state, if it taxes income, may consider you a resident and tax your total income. Depending on which states you are living or working in, those states may have relaxed that requirement for 2020 to help people adjust to a time of uncertainty; in 2021, some states are reverting to the traditional rules, Navani notes.

If you’re planning on certain moves, like selling your home, potential tax increases may be one more reason to act sooner rather than later.

And keep in mind that 183 days is not the universal threshold. Even if you haven’t passed half a year, some states expect partial income tax based on the number of days you worked there—though your home state may allow you a credit for whatever you owe to the temporary one, he says. To help avoid potential penalties, track your days spent working in different locations carefully and speak with your tax advisor about the latest rules in the states where you’re living, where you’re working remotely, and where the business is located, Navani suggests.

Also, note that working from home does not automatically qualify you for a tax deduction, Navani adds. In fact, the rules surrounding home office deductions are strict, so review these with your tax advisor as well.

3. Max out on your retirement plan

Thanks to the CARES Act, required minimum distributions (RMDs) for IRAs and 401(k)s and most other defined contribution plans were waived for 2020. That offered individuals an opportunity to keep more money invested for the future and may have resulted in lower income tax obligations for the year. Note that in 2021, the usual RMD rules apply, Navani says, so speak with your tax advisor about how your tax picture may change.

Working remotely out of state? Once you reach 183 days, your temporary state, if it taxes income, may tax your total income.

But there are still good incentives to invest longer, he adds. The SECURE Act of 2019 (for “Setting Every Community Up for Retirement Enhancement Act”) eliminated the 70½ age limit for contributing to a traditional IRA while raising the age for required minimum distributions (RMDs) from 70½ to 72.

Regardless of your age, you may want to increase contributions to your 401(k)s, IRA or other retirement plan to reach the maximum contribution amount, he suggests—and if you’ll be age 50 or older during the calendar year, consider “catch-up” contributions. You generally have until the end of the tax year to contribute to a 401(k) plan and until April 15 of the following year to contribute to an IRA for the previous tax year. Certain high-income taxpayers may have an additional incentive to contribute to their IRA accounts now.

The House tax proposals, if enacted, would prohibit any additional contributions to traditional or Roth IRAs for a taxable year if the total value of the taxpayer’s IRA and defined contribution retirement accounts exceeds $10 million as of the close of the preceding taxable year.  The limit on contributions would only apply to single taxpayers (or taxpayers married filing separately) with taxable income over $400,000 (or over $450,000 for married taxpayers filing jointly, or over $425,000 for heads of households). The applicable provisions of the House proposal would be effective for tax years beginning after 2021.

4. Consider converting your traditional IRA to a Roth IRA

Under existing tax law, anyone can convert all or a portion of their assets in a traditional IRA to a Roth IRA. (The deadline for doing so is December 31.) Why might this move make sense now? Unlike with a traditional IRA, qualified distributions of converted amounts from a Roth IRA aren’t generally subject to federal income taxes, as long as at least five years have passed since the first of the year of your first Roth IRA contribution or conversion and you are age 59½ or older. However, you’re required to pay income taxes on the amount of your deductible contributions as well as any associated earnings when you convert from your traditional IRA to a Roth IRA—or, if you don't convert, when you retire and take withdrawals from your traditional IRA.

Depending upon your situation, this year could be an advantageous time to convert from a traditional IRA to a Roth IRA.

The House tax proposal prohibits all nondeductible IRA contributions from being converted to Roth regardless of income level, effective for tax years beginning after 2021. Note that the House tax proposal includes additional limitations for high-income taxpayers. Under the proposal, single taxpayers (or taxpayers married filing separately) with taxable income over $400,000 (or over $450,000 for married taxpayers filing jointly, or over $425,000 for heads of households) would no longer be permitted to convert any IRA contributions, whether deductible or nondeductible, to Roth, effective for tax years beginning after 2031. 

Depending upon your particular situation, and your views on potential tax increases, it could be beneficial to convert from a traditional IRA to a Roth IRA and pay taxes now, rather than holding the funds in the traditional IRA and paying taxes upon distribution at a later date. Consult with your tax advisor to see which might suit your circumstances better.

5. Use stock losses to offset capital gains

Now may be a good time to consider selling some underperforming investments, generating a capital loss before the end of the year—which could help offset the capital gains you realize from selling better-performing stocks. You may generally deduct up to $3,000 ($1,500 if married and filing separately) of capital losses in excess of capital gains per year from your ordinary income.

If your net capital losses exceed the yearly limit of $3,000 ($1,500 if married and filing a separate return), you can carry over the unused losses to the following year. Some investors who sell stocks or other assets at a loss to offset gains may decide to reinvest in those assets or ones very similar. But be sure not to invest in those assets or ones very similar for at least 30 days before or after the sale, Navani cautions, to avoid “wash sale” rules preventing you from claiming those losses on your taxes.

6. Look for tax-aware investing strategies

If your modified adjusted gross income is at least $200,000 ($250,000 for married couples filing jointly or qualifying widow or widower with a child, $125,000 for married filing separately), you're subject to a 3.8% Net Investment Income Tax on either your net investment income or the amount your modified adjusted gross income exceeds the statutory threshold amount, whichever is less. (Your tax advisor will understand.)

Putting a portion of your income into investments not generally subject to federal income taxes, such as tax-free municipal bonds, may not affect your tax picture this year, but could potentially ease your tax burden down the road, when these investments start generating income.

7. Fund a 529 education savings plan

By putting money into a 529 education savings plan account, you may be able to give a tax-free gift to a beneficiary of any age. (To find out more about contribution limits, see our Contribution Limits and Tax Reference Guide.) You may also be able to contribute up to five years’ worth of the annual gift exclusion per beneficiary in one year, subject to certain conditions. 529 accounts may be used to pay for qualified higher education expenses of the beneficiary—say, for instance, a child or grandchild—at an eligible educational institution. You’re allowed to pay up to $10,000 of qualified primary or secondary school tuition expenses annually from all 529 accounts for a beneficiary.

In addition, 529 accounts may be used to cover certain expenses for certified apprenticeship programs, and to repay principal or interest on qualified education loans, either for the beneficiary or the beneficiary’s sibling, up to a lifetime maximum of $10,000 per individual. Withdrawals for these qualified purposes are free from federal income tax. (Some states don’t follow all the federal tax rules, so it’s important to determine if any of these withdrawals would trigger state income tax.) If the beneficiary receives a refund from an eligible educational institution, you may generally re-contribute the refunded amount to the beneficiary’s 529 account within 60 days without adverse federal income tax consequences.

8. Cover healthcare costs related to the pandemic and beyond

If you took distributions from a retirement account last year to help get through pandemic-related challenges, now may be a good time for a conversation with your tax advisor, Navani says. The CARES Act enabled those with a spouse or a dependent diagnosed with the coronavirus or who had experienced certain adverse financial consequences due to the coronavirus to take distributions during 2020 of up to $100,000 from eligible retirement plans (if permitted by the plan) without paying the usual 10 percent additional federal tax for distributions before age 59½.

Moreover, the Act stated that for tax purposes, the income generated from those distributions could be included in your gross income ratably over three years. And, if you repay the distribution to your plan or IRA within three years, you can undo the tax consequences of the distribution. Your tax advisor can help ensure you maintain retirement savings momentum while keeping your tax obligation as low as possible.

Beyond the pandemic, both health savings accounts (HSAs) and flexible spending accounts (FSAs) could allow you to sock away tax deductible or pretax contributions to pay for certain medical expenses your insurance doesn’t cover. (For more on HSA contribution and plan limits, see our Contribution Limits and Tax Reference Guide.)

9. Give to your favorite charity—or your family

If you regularly give to charities, consider putting several years’ worth of gifts into a donor-advised fund (DAF) for a single year, Navani suggests. “Then you can spread out the giving from the DAF over the next several years.”

Also this feature of the 2020 CARES Act remains in place in 2021: taxpayers who itemize can deduct cash charitable contributions made to certain qualifying charities (not including DAFs) of as much as 100 percent of their adjusted gross income, up from 60 percent prior to the Act. While very few taxpayers can afford that level of generosity, Navani notes, this provision could work to the benefit of, say, a retired person with significant assets and modest living expenses.

When it comes to giving to loved ones, the lifetime federal gift and estate tax exemption has more than doubled since 2017, to $11.7 million for individuals in 2021 ($23.4 million for married couples3), meaning that far fewer estates owe estate tax. But changes could be in store, Navani notes. The current high estate gift and estate tax exemptions will, at the end of 2025, revert to 2017 levels (approximately $6 million for individuals, $12 million for couples) without Congressional action. And the House has proposed accelerating that reversion to the end of 2021.4 Speak with your tax advisor about whether such changes could affect your estate plans, Navani says.

You can give as many family members as you like up to $15,000 per year ($30,000 from a married couple electing to split gifts) each without being subject to federal gift tax. Generally, once the gift is made, your estate will not pay estate taxes on it, and it will not be considered taxable income for the recipient. However, also remember that the donor’s income tax basis carries over to the gift’s recipient, subject to a few qualifications—which means that in some cases, waiting to give could make sense.

These limits change on an annual basis, so please visit irs.gov for the latest information.

A private wealth advisor can help you get started.

Our advisors can help you follow your passions, build a legacy and have a positive impact on others.

1The Wall Street Journal, “What’s in the Democrats’ Tax Plan? Increases in Capital Gains and Corporate Tax Rates,” Sept. 14, 2021, https://www.wsj.com/articles/whats-in-the-democratic-tax-proposal-11631567727

2The New York Times, “Biden Banks on $3.6 Trillion Tax Hike on the Rich and Corporations,” May 28, 2021, https://www.nytimes.com/2021/05/28/us/politics/tax-rising-on-rich-corporations.html

3IRS, “Estate Tax,” https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax

4The Wall Street Journal, “Estate Taxes Are Easy to Avoid. House Democrats Want to Change That,” Sept. 14, 2021, https://www.wsj.com/articles/estate-taxes-are-easy-to-avoid-house-democrats-want-to-change-that-11631633676