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Midyear tax planning for individuals

Keeping up with tax changes and navigating the complexity of tax law consistently rank as top challenges for tax professionals. But these challenges can lead to tax-saving opportunities for your individual tax clients – if you help them take advantage of the complex tax changes by planning now to minimize 2021 income taxes.

Implementing tried and true midyear planning ideas based on current law can help your clients save tax dollars. But the President’s tax plan may raise future tax rates for some taxpayers, so this is also a good time to estimate your clients’ 2021 income and be prepared to project how law changes may impact them.

With those thoughts in mind, here are some midyear planning ideas to consider and tax actions to take for your clients.

Adjust tax withholding and estimated payments 

To prevent unexpected tax bills next year, or waiting for refunds while cash is needed now, help your clients adjust their tax withholding or upcoming estimated payments. The IRS has a “Tax Withholding Estimator” to assist taxpayers in completing Form W-4. Your clients will need to provide their most recent paystub(s) (for both spouses if married filing a joint return), details of other sources of income, and a copy of their most recent tax return for an accurate tax projection. Also, check with your self-employed clients to make sure their income isn’t fluctuating, which could lead to an over or under payment situation.

Take advantage of low tax rates on investment income

Income from an investment held for more than a year is generally taxed at preferential capital gains rates. Those rates are 0%, 15%, and 20% for most investments. [Higher-income individuals may be subject to an additional 3.8% net investment income tax (NIIT).] The rate that applies is determined by taxable income. For example, the 0% rate applies if 2021 taxable income doesn’t exceed $80,800 (for joint filers), $54,100 (for heads of household), or $40,400 (for other individuals). The 20% rate doesn’t apply until taxable income exceeds $501,600 (for joint filers), $473,750 (for heads of household), $250,800 (for married filing separate), or $445,850 (for other individuals). If a client’s income hovers around these threshold amounts, the following actions may reduce taxable income to achieve a lower capital gains rate:

  • Make deductible IRA contributions
  • Reduce taxable wages by deferring bonuses
  • Reduce taxable wages by contributing to employer retirement plans
  • If age 70½ or older, consider making contributions to a qualified charity with a direct distribution from an IRA
  • For a cash-basis business owner, wait to send invoices and accelerate deductible expenses at year end

If a client’s income is too high to benefit from the 0% rate, recommend gifting investments (like appreciated stock or mutual fund shares) to children, grandchildren, or other loved ones who will be in the 0% or 15% capital gains tax bracket when the investment is sold (if held for more than a year). But keep in mind that there are gift tax consequences if a client transfers assets valued over $15,000 during 2021 to a single recipient. Also, children under age 18 and most children who are age 18, or age 19–23 who are full-time students, are subject to the Kiddie Tax rules, which may limit the opportunity to take advantage of the 0% capital gains rate. 

Manage investments with tax rates in mind

Under the President’s proposed tax plan, the tax rate on long-term gains would increase to 39.6% for taxpayers making over $1 million, which when combined with the NIIT, would yield a marginal rate on long-term gains of up to 43.4% (39.6% + 3.8%). Until we know for certain whether the capital gains rates will change, the best strategy is to be prepared. If rates increase for 2022, it might make sense for individuals to sell winners before year-end and hold losers until January. Be mindful of what is potentially on the horizon and have a plan in place to help your clients time their transactions to result in the best possible tax outcome. 

Bunch deductible expenditures to save taxes

For taxpayers with itemized deductions just under (or just over) the standard deduction amount, consider bunching state and local taxes into alternating years by paying two years’ worth of taxes in the same calendar year. However, the effect of the state and local tax limitation must be considered. While there is discussion in Congress of this limit being lifted, the deduction currently is limited to $10,000 ($5,000 if married filing separately).

In addition to bunching state and local taxes, consider advising clients to bunch charitable contributions, or to make donations to donor-advised funds. Also known as charitable gift funds or philanthropic funds, donor-advised funds allow donors to make a charitable contribution to a specific public charity or community foundation that uses the assets to establish a separate fund. Taxpayers can claim the charitable tax deduction in the year they fund the donor-advised fund and schedule grants over the next two years or other multi-year periods.

Use our roadmap for more individual tax-saving ideas

Reviewing a taxpayer’s 2020 Form 1040 provides a great opportunity to identify potential tax-saving ideas. The Tax Planning for Individuals Quickfinder Handbook includes a “Roadmap to Individual Tax Savings” that helps you use information included on a client’s 2020 Form 1040 to identify specific tax-saving ideas for 2021 and beyond. The Handbook also includes Client Handouts that you can use to provide your clients more information on selected tax topics.

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