Tax planning in the wake of Build Back Better – Financial Planning

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Now that the back and forth over the Build Better Act has ceased, tax planners can formulate concrete tax-planning strategies to reduce the 2022 tax bill for our clients. There are several ways to reduce taxable income, which is particularly effective if the reduction in income will lower the taxpayer’s marginal rate or reduce adjusted gross income (AGI) to qualify the taxpayer for deductions they weren’t eligible for with a higher AGI.

Deferring income into future years and accelerating deductions into the current year are the keys to reducing taxable income. Here are some opportunities to look out for, which may vary depending on your client’s circumstances:

Defer income

Most salaried individuals can’t control when they receive payments from their employers, but business owners may be able to defer the recognition of income or revenue into next year, depending on their accounting practices.

Recognize ordinary and capital losses

The recent market volatility has certainly created some stress, but it has also provided opportunities for tax planning. Capital losses can be harvested to offset taxable income. However, be careful to avoid the wash sale rules if the client wants to repurchase securities. Now may be a particularly ripe opportunity to harvest losses on cryptocurrencies, which are not yet subject to the wash sale rules, but will likely become should a version of the Build Back Better Act pass in 2022.

Maximize tax-advantaged retirement annual contributions 

Encourage your client to maximize annual tax-advantaged contributions to pension plans, 401(k)s and IRAs.

Make charitable contributions

Charitable contributions are a tried-and-true method of reducing taxable income, particularly into the ever-popular donor-advised funds. Retirees can make tax-free qualified charitable distributions of up to $100,000 from their IRAs that count toward the RMD requirement if they are at least 70½.

Fund education

State income taxes can be reduced through contributions to 529s, depending on the state.

Maximize QBI deductions and contributions to SEP-IRAs, Solo 401(k)s or cash balance plans

Small business owners can take advantage of even more strategies to reduce taxable income. Reducing taxable income below or into the phaseout range for the qualified business income (QBI) deduction will allow the business owner to take a deduction for business income.

Acquiring or improving property that qualifies for Section 179, or bonus depreciation and/or increasing wages, bonuses and payroll will reduce business income — and may allow for a deduction beyond the phaseout range for qualified businesses. Small business owners can also maximize contributions to SEP-IRAs, Solo 401(k)s, or cash balance plans, or if they do not have one, explore creating one before the required deadlines.

If your client expects to be in a higher marginal bracket next year, they may benefit from implementing the opposite strategies — accelerating income into 2022 and deferring deductions into next year — to take advantage of their lower current marginal rate. This situation could arise if the client moved to a higher-paying position or a spouse returned to work after taking parental leave.

A closer look is also warranted for high net worth clients that pay the alternative minimum tax (AMT). Many of the strategies above can help decrease the exposure to AMT, such as tax-advantaged retirement contributions and contributions to FSAs and HSAs. However, avoid strategies that may increase exposure to AMT, such as prepaying state and local taxes (SALT).

Lastly, it’s always a good idea to discuss more creative options with your client. With more and more employers allowing remote work, many individuals are moving to areas with a lower cost of living and/or states with no income tax like Florida, Texas, Wyoming and Nevada.

In addition, all clients should consider whether switching to a high-deductible health care plan makes sense for their families. High deductible plans offer a tax-advantaged HSA fund, and employers often contribute funds toward the employee’s HSA account, making the program less risky for employees who fear unexpectedly high medical costs.

Assistant Professor of Business Planning, American College of Financial Services