This is the time to assess your tax outlook for 2021. By developing a comprehensive year-end plan, you can maximize the tax breaks currently on the books and avoid potential pitfalls. Be aware that the concepts discussed in this article are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with a tax professional.

Charitable Donations

There were plenty of worthy causes for individuals to donate to in 2021, including disaster aid relief. Besides helping out victims, itemizers are eligible for generous tax breaks.

TAX TACTIC: Step up your charitable giving at the end of the year. Then you can reap the tax rewards on your 2021 return. This includes amounts charged to your credit card in 2021 that you do not actually pay until 2022.

Under the CARES Act, and then extended through 2021 by the CAA, the annual deduction limit for monetary donations is equal to 100% of your adjusted gross income (AGI). Theoretically, you can eliminate your entire tax liability through charitable donations.

Conversely, if you donate appreciated property held longer than one year (i.e., long-term capital gain property), you can generally deduct an amount equal to the property’s fair market value (FMV). But the deduction for short-term capital gain property is limited to your initial cost. In addition, your annual deduction for property donations generally cannot exceed 30% of your AGI.

Tip: If you do not itemize deductions, you can still write off up to $300 of your monetary charitable donations. The maximum has been doubled to $600 for joint filers in 2021.

Child Tax Credit

ARPA provides several key enhancements to the Child Tax Credit (CTC) for the 2021 tax year.

TAX TACTIC: Take full advantage of the latest rules for the CTC. Notably, ARPA includes the following changes that may benefit your family.

• The maximum credit increases from $2,000 to $3,000 for a qualifying child ($3,600 for qualifying children under age six).
• The definition of a qualifying child expands to include children under age 18 at the end of the year (up from age 17).
• The credit is fully refundable. Previously, only $1,400 was refundable.
• Although the credit begins to phase out at lower income levels, taxpayers adversely affected by these new ranges can elect to claim the $2,000 credit under the prior rules.

Finally, the IRS began making advance payments of the CTC during the second half of the year. But you may choose not to receive advance payments (or you can stop now).

Tip: Do not forget that the advance payments will be reflected on your 2021 return. This may result in a smaller tax refund than you were expecting.

Home Improvements

Previously, you could generally deduct mortgage interest on loans that qualified as either “acquisition debt” or “home equity debt,” within generous limits. But the Tax Cuts and Jobs Act (TCJA) revised the rules, beginning in 2018. Notably, it eliminated the current deduction for home equity debt.

TAX TACTIC: When appropriate and allowable, convert nondeductible home equity debt into deductible acquisition debt. This may be accomplished by using home equity loan proceeds to pay for home improvements.

For 2021, you can still deduct mortgage interest on the first $750,000 of new acquisition debt, defined as debt used to buy, build or substantially improve a qualified home. (The prior threshold of $1 million is “grandfathered” for certain older loans.) The deduction for home equity loans, up to the first $100,000 of debt, is suspended for 2018 through 2025.

Thus, if you take out a new home equity loan to make a substantial home improvement, it qualifies as acquisition debt. The interest is deductible within the usual tax law limits.

Tip: If you were planning to use personal funds for a home improvement and a home equity loan for another purpose—say, a child’s education—you might switch things around.

Alternative Minimum Tax

The alternative minimum tax (AMT) is a complex calculation made parallel to your regular tax calculation. It features several technical adjustments, inclusion of “tax preference items” and subtraction of an exemption amount (subject to a phase-out based on your income). After comparing AMT liability to regular tax liability, you effectively pay the higher of the two.

TAX TACTIC: Have your AMT status assessed. Depending on the results, you may want to shift certain income items to 2022 to reduce AMT liability for 2021. For instance, you might postpone the exercise of incentive stock options (ISOs) that count as tax preference items.

Fortunately, the AMT now affects fewer taxpayers, because the TCJA boosted the AMT exemption amounts (and the thresholds for the phase-out), unlike the minor annual “patches” authorized by Congress in prior years. The chart below shows the exemptions since 2017, including a significant boost in 2018.

Tip: The two AMT rates for single and joint filers for 2021 are 26% on AMT income up to $199,900 ($99,950 if married and filing separately) and 28% on AMT income above this threshold. Note that the top AMT rate is still lower than the top ordinary income tax rate of 37%.

Medical Deduction

The tax law allows you to deduct qualified medical and dental expenses above 7.5% of AGI. This threshold was recently lowered from 10% of AGI. What’s more, the latest change is permanent.

To qualify for a deduction, the expense must be for the diagnosis, cure, mitigation, treatment or prevention of disease or payments for treatments affecting any structure or function of the body. However, any costs that are incurred to improve your general health or well-being, or expenses for cosmetic purposes, are nondeductible.

TAX TACTIC: If you expect to itemize deductions and are near or above the AGI limit for 2021, accelerate non-emergency expenses into this year, when possible. For instance, you might move a physical exam or dental cleaning scheduled for January to December. The extra expenses are deductible on your 2021 return.

Note that you can include expenses you pay on behalf of a family member—such as a child or elderly parent—if you provide more than half of that person’s support.

Tip: The medical deduction is not available for expenses covered by health insurance or other reimbursements.

Miscellaneous

• Take advantage of the enhanced dependent care credit. Under ARPA, the maximum credit for a taxpayer with an AGI of $125,000 or less is $4,000 for one child and $8,000 for two or more children. The maximum is $1,600 or $3,200, respectively, if your AGI exceeds $183,000.
• Pay a child’s college tuition for the upcoming semester. The amount paid in 2021 may qualify for one of two higher education credits, subject to phase-outs based on modified adjusted gross income (MAGI). Note: The alternative tuition-and-fees deduction expired after 2020.
• Avoid an estimated tax penalty by qualifying for a safe-harbor exception. Generally, a penalty will not be imposed if you pay during the year 90% of your current tax liability or 100% of the prior year’s tax liability (110% if your AGI exceeded $150,000).
• If you are in the market for a new car, consider the tax benefits of the electric vehicle credit. The maximum credit for a qualified vehicle is $7,500. Be aware, however, that credits are no longer available for vehicles produced by certain manufacturers.
• Empty out your flexible spending accounts (FSAs) for healthcare or dependent care expenses if you will have to forfeit unused funds under the “use-it-or-lose it” rule. However, due to recent changes, your employer’s plan may provide a carryover to next year of up to $550 of funds or a 2½-month grace period or both.
• If you own property damaged in a federal disaster area in 2021, you may qualify for quick casualty loss relief by filing an amended 2020 return. The TCJA suspended the deduction for casualty losses for 2018 through 2025, but retained a current deduction for disaster-area losses.

Conclusion

This year-end tax-planning article is based on the prevailing federal tax laws, rules and regulations. Of course, it is subject to change, especially if additional tax legislation is enacted by Congress before the end of the year.

You may be interested in the other year-end articles:

• Click here for the 2021 Year-End Business Tax Planning article
• Click here for the 2021 Year-End Financial Tax Planning article

Finally, remember that this article is intended to serve only as a general guideline. Your personal circumstances will likely require careful examination. We would be glad to schedule a meeting with you to assist with all your tax-planning needs.