The year is nearly over, and as we head into the final month of 2021 it can be helpful to review some year-end tax tips for your personal and family finances. The following guidelines may help you either increase the amount of your income tax return, increase possible deductions, or decrease/eliminate certain taxes.
Marriage, kids, and family strategies
If you are thinking of getting married or divorced, you need to consider December 31, 2021, in your tax planning. You’ll also need to consider the zero-taxes planning strategy if you give money to family or friends (other than your children, who are subject to the kiddie tax). And if you have paid your children who are under 18 for work they’ve done for your business, have you paid them in the right way?
If so, you’ll want to consider the following five strategies as we come to the end of 2021.
- Put your children on your payroll
If you have a child under the age of 18 and you operate your business as a Schedule C sole proprietor or as a spousal partnership, you should think about putting that child on your payroll for two reasons:
- Neither you nor your child would pay payroll taxes on the child’s income.
- With a traditional IRA, the child can avoid all federal income taxes on up to $18,550 in income.
If you operate your business as a corporation, you can still benefit by employing the child even though both your corporation and your child will be subject to payroll taxes.
- Finalize your divorce after December 31
The marriage rule works like this: you are considered married for the entire year if you are married on December 31.
Although lawmakers have made many changes to eliminate the differences between married and single taxpayers, in most cases the joint return will work to your advantage. Filing jointly instead of separately often means you will get a larger tax refund or have lower tax liability. You may also qualify for other tax benefits and have a higher standard deduction than you would filing separately.
Warning on alimony! The Tax Cuts and Jobs Act (TCJA) changed the tax treatment of alimony payments under divorce and separate maintenance agreements executed after December 31, 2018:
- Under the old rules, the payor deducts alimony payments, and the recipient includes the payments in income.
- Under the new rules, which apply to all agreements executed after December 31, 2018, the payor gets no tax deduction, and the recipient does not recognize income.
- Stay “single” to increase mortgage deductions
Two single people can deduct more mortgage interest than a married couple.
If you own a home with someone other than a spouse, and you bought it on or before December 15, 2017, you can each individually deduct mortgage interest on up to $1 million of a qualifying mortgage.
For example, if you and your unmarried partner live together and own the home together, the mortgage ceiling on deductions for the two of you is $2 million. If you get married, the ceiling drops to $1 million.
If you bought your house after December 15, 2017, then the reduced $750,000 mortgage limit from the TCJA applies. In that case, for two single people, the maximum deduction for mortgage interest is based on a ceiling of $1.5 million.
- Get married on or before December 31
Remember, if you are married on December 31, you are married for the entire year.
If you are thinking of getting married in 2022, you might want to rethink that plan for the same reasons that apply in a divorce (as described above). The IRS could make big savings available to you for the 2021 tax year if you get married on or before December 31, 2021.
You have to run the numbers in your tax return both ways to know the tax benefits and detriments for your particular case. But if the numbers work out, a quick trip to the courthouse could save you thousands.
- Make use of the zero percent tax bracket
People used to apply this strategy to their college students, but today, this strategy does not work with college students because the kiddie tax now applies to students up to age 24.
However, this strategy is a good one, so ask yourself this question: Do I give money to my parents or other loved ones to make their lives more comfortable?
If the answer is yes, is your loved one in the zero percent capital gains tax bracket? This capital gains tax bracket applies to a single person with less than $40,400 in taxable income and to a married couple with less than $80,800 in taxable income.
If the parent or other loved one falls within this bracket, you can get extra bang for your buck by giving this person appreciated stock rather than cash.
Example: You give Aunt Millie shares of stock with a fair market value of $20,000, for which you paid $2,000. Aunt Millie sells the stock and pays zero capital gains taxes. She now has $20,000 in after-tax cash to spend, which should take care of things for a while.
Had you sold the stock, you would have paid taxes of $4,284 in your tax bracket (23.8 percent x $18,000 gain).
Of course, $5,000 of the $20,000 you gifted goes against your $11.7 million estate tax exemption if you are single. But if you’re married and you made the gift together, you each have a $15,000 gift-tax exclusion, for a total of $30,000, and you have no gift-tax concerns other than the requirement to file a gift-tax return that shows you split the gift.
Stock Portfolio Strategies
When you take advantage of the tax code’s offset game, your stock market portfolio can represent a little gold mine of opportunities to reduce your 2021 income taxes.
The tax code contains the basic rules for this game, and once you know the rules, you can apply the correct strategies.
Here’s the basic strategy:
- Avoid the high taxes (up to 40.8 percent) on short-term capital gains and ordinary income.
- Lower the taxes to zero — or if you can’t do that, then lower them to 23.8 percent or less by making the profits subject to long-term capital gains.
Think of this: you are paying taxes at a 71.4 percent higher rate when you pay at 40.8 percent rather than the tax-favored 23.8 percent.
To avoid the higher rates, here are seven possible tax-planning strategies.
Strategy 1
Examine your portfolio for stocks that you want to unload and make sales where you offset short-term gains subject to a high tax rate such as 40.8 percent with long-term losses (up to 23.8 percent).
In other words, make the high taxes disappear by offsetting them with low-taxed losses, and pocket the difference.
Strategy 2
Use long-term losses to create the $3,000 deduction allowed against ordinary income.
Again, you are trying to use the 23.8 percent loss to kill a 40.8 percent rate of tax (or a zero percent loss to kill a 12 percent tax, if you are in the 12 percent or lower tax bracket).
Strategy 3
As an individual investor, avoid the wash-sale loss rule.
Under the wash-sale loss rule, if you sell a stock or other security and purchase substantially identical stock or securities within 30 days before or after the date of sale, you don’t recognize your loss on that sale. Instead, the code makes you add the loss amount to the basis of your new stock.
If you want to use the loss in 2021, then you’ll have to sell the stock and sit on your hands for more than 30 days before repurchasing that stock.
Strategy 4
If you have lots of capital losses or capital loss carryovers and the $3,000 allowance is looking extra tiny, sell additional stocks, rental properties, and other assets to create offsetting capital gains.
If you sell stocks to purge the capital losses, you can immediately repurchase the stock after you sell it — there’s no wash-sale “gain” rule.
Strategy 5
Do you give money to your parents to assist them with their retirement or living expenses? How about children (specifically, children not subject to the kiddie tax)?
If so, consider giving appreciated stock to your parents and your non-kiddie-tax children. If the parents or children are in lower tax brackets than you are, you get a bigger bang for your buck by gifting them stock, having them sell the stock, and then having them pay taxes on the stock sale at their lower tax rates.
Strategy 6
If you are going to donate to a charity, consider appreciated stock rather than cash, because a donation of appreciated stock gives you more tax benefit.
It works like this:
- Benefit 1: You deduct the fair market value of the stock as a charitable donation.
- Benefit 2: You don’t pay any of the taxes you would have had to pay if you sold the stock.
Example: You bought a publicly traded stock for $1,000, and it’s now worth $11,000. If you give it to a 501(c)(3) charity, the following happens:
- You get a tax deduction for $11,000.
- You pay no taxes on the $10,000 profit.
Two rules to know:
- Your deductions for donating appreciated stocks to 501(c)(3) organizations may not exceed 30 percent of your adjusted gross income.
- If your publicly traded stock donation exceeds the 30 percent, no problem. Tax law allows you to carry forward the excess until used, for up to five years.
Strategy 7
If you could sell a publicly traded stock at a loss, do not give that loss-deduction stock to a 501(c)(3) charity.
If you sell the stock, you have a tax loss that you can deduct. If you give the stock to a charity, you get no deduction for the loss — in other words, you miss out on that tax-reducing loss.
Planning ahead
2021 is quickly coming to a close, and some of these year-end strategies may be helpful for you and your family’s tax situation. As we move into 2022, Shaw & Associates has your back when it comes to planning ahead and setting you up with financial confidence and success from the beginning to the end. If you have any questions about year-end planning or tax strategies moving forward, please reach out to us at 970-223-0792 or visit our website to schedule an appointment.
