6 Tax Planning Opportunities Not to Miss Before Year-End

Summary: As we approach the end of 2021, there remains a lot of uncertainty in the markets- ranging from rising inflation to a new Omicron coronavirus variant.

To review actions towards what we can control, we summarize 6 tax-focused items to consider before year-end. Additionally, with new legislation[1] that may limit actions such as backdoor Roth contributions (#5 and #6 below) in 2022, investors may want to act quickly to evaluate these strategies.  

Please consult a financial / tax professional before considering these strategies.

1. New rules on unused Flexible Spending Accounts (FSA)

Due to a temporary pandemic relief change [2], unused FSA and dependent care FSA amounts may be carried forward from 2021 to 2022. Verify the specific policies with your employer and check if the plan opted into the changes. Note that rollover amounts may impact allowed 2022 contributions.

2. Tax-loss harvesting

Tax-loss harvesting involves selling investments at a loss to offset taxes incurred from realized gains and/or up to $3k of ordinary income in a given year. Unused losses can be carried forward indefinitely, so during bouts of market volatility this can be a useful tool to reduce investor’s tax bill each year.

After selling a position, investors should avoid the “wash sale rule”, which prevents the subsequent purchase of a ‘substantially similar’ security within 30 days of the sale.

Cryptocurrency investors may want to consider harvesting losses and repurchasing positions before year-end, as new legislation seeks to apply the wash sale rule to Cryptocurrency beginning in 2022 [3].

3. Bunch deductions

For those itemizing deductions, bunching them together in one year can help maximize the impact beyond what’s available through the standard deduction- $12.55k for single filers and $25.1k for married filing jointly in 2021.

Common itemized deductions include state and local taxes (or SALT), mortgage interest, charitable contributions, and unrealized medical expenses.

As per the recent version of the Build Back Better bill [4], there are talks of increasing the SALT cap from $10k to $80k through 2030, which could further benefit those living in high-income tax states like New York, California, and New Jersey.

4. Maximize your impact to charity

For 2021, the IRS [4] issued a notice that allowed up to $300 (single filers) / $600 (married filing jointly) of deductible cash contributions to qualified charities, even if filers claimed the standard deduction.

To further the benefits of charitable giving, consider donating appreciated securities instead of cash and utilizing a donor advised fund (DAFs):

• Donating appreciated securities removes embedded unrealized gains (and subsequent tax liability) from the donor’s balance sheet. The donor may then repurchase the same security if they choose, but at a higher cost basis to further enhance the tax benefits of this strategy.

• DAFs allow for a large donation in one tax year (therefore bunching deductions), with the option to distribute charitable proceeds over multiple years. Further, DAFs can accept and sell donated appreciated securities, and distribute proceeds to the chosen charity. This is helpful to get cash in the hands of smaller charities that may not have the infrastructure to accept securities outright.

5. Backdoor Roth

A Roth IRA is a retirement account where you pay taxes on contributions (up to $6k, or $7k for ages 50+) going in, and receive future withdrawals tax-free. These accounts can benefit investors that expect higher marginal tax rates during retirement.

While the current law prevents direct Roth IRA contributions for those with annual income greater than $140k (single filers) /$208k (married filing jointly), higher earners are able to contribute post-tax dollars into a Traditional IRA, and then convert them into a Roth IRA.

Care must be given to execute this correctly, as 1) the contribution, and subsequent conversion should be done before year-end, and 2) investors that execute this strategy with pre-tax dollars sitting in traditional IRA’s may incur additional taxes. Consider rolling pre-tax IRA balances into a 401k plan before executing the backdoor.

6. Mega backdoor Roth

A derivative of the Backdoor Roth IRA, this strategy rests on an IRS rule that allows employees to set aside as much as $58k/year ($64.5k for ages 50+) in their 401k plan. So for a < 50 year-old employee that maxes out their 401k of $19.5k/year, another $38.5k of after-tax contributions can be made, though any company match reduces that figure.

A drawback is that not every plan supports this strategy. The 401k plan would need to 1) accept post-tax contributions, and 2) allow in-service withdrawals into the Roth IRA.

References:

[1] Wall Street Journal, ‘A Popular Tax Trick for Savers, the Mega Back Door Roth IRA, Is Eliminated in House Bill’ (Nov 2021)

[2] New York Times, ‘Have an F.S.A.? You May Be Able to Carry Over More Money in 2022’(Oct 2021)

[3] Kiplinger, ‘Cryptocurrency and the Wash Sale Rule: A Tax Loophole That May Soon Go Away’ (Nov 2021)

[4] Wall Street Journal, ‘Tax Plan Inflames Democratic Debate in Senate Over Biden’s $2 Trillion Spending Bill’(Nov 2021)

[5] IRS.gov, ‘Year-end giving reminder: Special tax deduction helps most people give up to $600 to charity, even if they don’t itemize’ (Nov 2021)

Disclaimer:

The article is for informational purposes only and is not intended to be used as a general guide to investing or financial planning, or as a source of any specific recommendations, and makes no implied or express recommendations concerning the manner in which any individual’s investments or assets should or would be handled, as appropriate strategies depend upon each individual’s specific objectives. Opinions expressed in this article are current opinions, which are not reliable as fact, as of the date appearing in this article only and are subject to change. For a comprehensive review of your personal situation, please consult with a financial or tax advisor.