With year-end approaching, its time to start thinking about moves that may help lower your tax bill. Once again, this year’s planning is challenging due to the uncertainty surrounding pending legislation that could increase top rates on both ordinary income and capital gains starting next year. The standard year-end approach of deferring income and accelerating deductions to minimize taxes will continue to produce the best results for all but the highest income taxpayers. If proposed tax increases do pass, the highest income taxpayers may find that the opposite strategies produce better results: pulling income into 2021 to be taxed at currently lower rates, and deferring deductible expenses until 2022, when they can be taken to offset what would be higher-taxed income. This uncertainty puts everyone in a difficult position as year-end approaches as we normally wouldn’t make major tax planning decisions based on government proposals. We have compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end.
• Depreciation rules for businesses. Businesses should consider purchasing assets and placing them in service prior to year-end. Between the new Section 179 limit of $1,050,000 and favorable rules regarding 100% bonus first year depreciation, most assets placed in service before the end of the year will be eligible to be fully expensed in 2021.
• Arizona Tax Credits. Contributions to charities that qualify for the various Arizona (“AZ”) Tax Credits (listed below) generate a dollar-for-dollar state tax credit. While these no longer qualify for the federal charitable deduction, taxpayers who itemize deductions and whose state and local taxes paid are less than $10,000 can still get the extra benefit of a federal itemized deduction in addition to the state tax credit. Either way these are still valuable tax planning tools. You can contribute to one or more of the following:
The public school tax credit for donations to qualifying public schools allows a maximum credit of $200 ($400 if married filing jointly (“MFJ”)).
The private school tax credit has two parts. The basic part allows a maximum credit of $611 ($1,221 if MFJ). Additionally, a ‘switcher’ credit of $608 ($1,214 if MFJ) is also allowed, bringing the combined total to $1,219 ($2,435 if MFJ). You can make both parts of your contribution to the same private certified school tuition organization.
The Charitable tax credit for donations to charities that assist the Working Poor allows a maximum credit of $400 ($800 if MFJ).
The Foster Care tax credit for donations to qualifying foster care organizations allows a maximum credit of $500 ($1,000 if MFJ).
Lists of qualifying organizations appear on the ADOR website https://azdor.gov/tax-credits.
For the school, charitable and foster care credits, qualifying contributions made between January 1, 2022 and April 15, 2022 can be used as a tax credit on either your 2021 or 2022 AZ income tax return.
The AZ Military Family Relief Fund tax credit. This popular credit of $200 ($400 if MFJ) is administered by the AZ Dept of Veterans’ Services. Annual donations to the fund are capped at $1 million. Unfortunately, the 2021 cap was reached earlier this year. If you’d like to take advantage of this credit for 2022, remember to donate early in 2022.
• Contributions to 529 College Savings Plans. AZ has substantially increased the deduction for 529 Plan contributions to $2,000 per beneficiary ($4,000 if MFJ) beginning in 2021. For example, a married couple contributing $4,000 to each of their five grandchildren’s 529 accounts can claim a $20,000 deduction on their AZ tax return. The old rule capped the total deduction at $2,000 ($4,000 if MFJ).
• Required minimum distributions (“RMDs”) are back for 2021. The RMDs that must be taken from IRAs and retirement plans were waived for 2020 but are once again required for 2021. If you were 72 or older in 2020 you must take your RMD during 2021. Those who turn 72 in 2021 have until April 1 of 2022 to take their first RMD but may want to take it by the end of 2021 to avoid having to double up on RMDs in 2022.
• Use IRA for charitable donations. If you are age 70½ or older by the end of 2021, have traditional IRAs, and particularly if you don’t itemize deductions, consider making charitable donations via qualified charitable distributions from your IRAs. These distributions are made directly to charities from your IRAs, the amount of the distribution is not included as taxable income and does not reduce your standard deduction. Plus the amount of the qualified charitable distribution counts towards your RMDs, resulting in tax savings.
• Charitable contribution ‘above the line’ deduction. This is a small change, but every dollar counts. The ‘above-the-line’ charitable deduction for those that do not itemize deductions was extended and modified for joint filers. For 2021 the maximum deduction remains $300 for single & head of household filers, but has increased to $600 for joint filers. Remember to keep track of your charitable contributions even if you claim the standard deduction.
• Unemployment benefits. One change that is not in the taxpayer’s favor is the taxation of unemployment compensation received in 2021. Unlike 2020, where the first $10,200 of unemployment benefits were not taxed for most taxpayers, benefits received in 2021 are fully taxable.
• Covid relief advance payments. During 2021, many taxpayers received advances from the IRS for the Covid Economic Stimulus payment (@$1,400 per person in the spring) and/or the new advanced child tax credit payment(s). Each of these payments will need to be reflected and reconciled on your 2021 tax return. Keeping good records of the payments you received will make it easier come tax time.
• Paycheck Protection Program (“PPP”) Loan Forgiveness. For businesses and self-employed taxpayers that received PPP loans, remember to be aware of your specific deadline to apply for forgiveness. You have 10 months from the end of your coverage period to apply. Work with your bank to obtain their forgiveness forms and documentation requirements. Details of the PPP loans are very complex and beyond the scope of this newsletter but if you have any questions or need assistance while applying for forgiveness, please give us a call.
The tax planning strategies mentioned in this letter are general suggestions that may not apply to every taxpayer. Please feel free to contact us to discuss your specific tax situation. By doing year-end tax planning now, we can take a proactive approach to reducing your taxes, rather than just being reactive.