The end of the year always brings possible last-minute tax changes, which is especially true for 2021. New legislation may mean major changes starting in 2022, but other proposed bills, such as new capital gains and qualified dividend tax rates, may take effect retroactively.
These possibilities make it difficult to plan with certainty. Specific provisions under consideration include those discussed here. Note that, if passed, these provisions are likely to be subject to certain exclusions and dollar limits:
- Increasing the top ordinary income tax rate from 37% to 39.6%, which was the rate prior to the passage of the Tax Cuts and Jobs Act of 2017.
- Increasing the long-term capital gains and qualified dividend rate from 20% to 39.6% for taxpayers with annual adjusted gross income of more than $1 million.
- Changing the capital gains tax to:
- Tax capital gains when assets are gifted or transferred to people at death.
- Tax capital gains when assets are transferred to or from an irrevocable trust or partnership.
- Tax capital gains on unrealized appreciation of assets held in trust if capital gains have not been paid on a property for 90 years (e.g., property in a generation-skipping trust).
- Tax carried interests as ordinary income instead of capital gains.
- If taxable income is greater than $400,000, subjecting pass-through income to either the 3.8% Medicare tax or the 15.3% self-employment tax.
- Repealing the Section 1031 like-kind exchange rules for real estate so that investors cannot defer taxes by rolling profits from the sale of a property into their next purchased property.
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Although we have not yet seen a final draft of the proposed legislation, these are changes that should be considered as part of 2021 year-end tax planning. In addition, at least two other tax topics still might be included in the final bill: (1) a change in the $10,000 state and local income tax and (2) an increase in the estate and gift tax rate. However, the $11.7 million allowance is scheduled to sunset on December 31, 2025, unless it is extended.
Debate around all these provisions is ongoing, but prudent taxpayers should become familiar with how they can change business and estate plans going forward.
Here are six proactive measures that can result in lower taxes should these changes in the tax code be enacted:
- Transfer any appreciated assets you were planning to transfer by the end of 2021. Waiting until 2022 may expose these gifts to a capital gains tax. This is a good idea even for transfers to a spouse, revocable trust, not for profit, small business or family farm because we do not yet know whether transfers to any or all of these entities will be excluded from taxation.
- Review any estate tax planning strategies involving irrevocable trusts or partnerships to assess whether a capital gains tax may be triggered on appreciated assets to be contributed or distributed in the future.
- Consider selling investment real estate and buying new property in 2021. This may help avoid triggering taxes if the Section 1031 exchange rules change.
- Maximize contributions to retirement plans. Be aware that backdoor Roth IRAs may be eliminated in 2022.
- Cash out any carried interest positions.
- If you are thinking about selling a business in 2022, consider doing so in 2021 instead, before there is a change in the capital gains rate. The proposed capital gains rate is nearly double the current rate, which means you would nearly double the amount of tax paid on the sale.
Keep in mind that the situation is changing rapidly, and your best bet is to keep in close touch with an accountant or CPA.