There are dozens of ways you might be able to reduce your tax liabilities. Here are a few of them:
General tax planning strategies
General tax planning strategies for individuals include accelerating or deferring income and deductions, as well as careful consideration of timing-related tax planning strategies with regard to investments, charitable gifts and retirement planning. For example, consider using one or more of the following strategies:
Yearend bonus. If you anticipate an increase in taxable income in 2021 and are expecting a bonus at year-end, try to get it before Dec. 31.
Contractual bonuses are different in that they are typically not paid out until the first quarter of the following year. Therefore, any taxes owed on a contractual bonus would not be due until you file your 2022 tax return in 2023.
Charitable deductions. Bunching charitable deductions every other year is also a good strategy if it enables the taxpayer to get over the higher standard deduction threshold under the Tax Cuts and Jobs Act of 2017 (TCJA). Another option is to put money into a donor-advised fund that enables donors to make a charitable contribution and receive an immediate tax deduction. A public charity manages the fund on behalf of the donor, who then recommends how to distribute the money over time.
Stock options. If your company grants stock options, you may want to exercise the option or sell stock acquired by exercising an option this year. Use this strategy if you think your tax bracket will be higher in 2022. Generally, exercising this option is a taxable event.
Invoices. If you’re self-employed, send invoices or bills to clients or customers this year to be paid in full by the end of December. However, make sure you keep an eye on estimated tax requirements. If you anticipate a lower income next year, consider deferring sending invoices to next year.
Withholding. If you know you have a set amount of income coming in this year that is not covered by withholding taxes, there is still time to increase your withholding before the end of the year and avoid or reduce any estimated tax penalty that might otherwise be due.
Avoid the penalty by covering the extra tax in your final estimated tax payment and computing the penalty using the annualized income method.
Alternative minimum tax
The alternative minimum tax (AMT) applies to high-income taxpayers who take advantage of deductions and credits to reduce their taxable income. The AMT ensures that those taxpayers pay at least a minimum amount of tax; that was made permanent under the American Taxpayer Relief Act (ATRA) of 2012. Furthermore, the exemption amounts increased significantly under the TCJA. As such, not as many taxpayers are affected as were in previous years. In 2021, the phaseout threshold increased to $523,600 ($1,047,200 for married filing jointly). Both the exemption and threshold amounts are indexed for inflation.
AMT exemption amounts for 2021 are:
- $73,600 for single and head of household filers.
- $114,600 for married people filing jointly and for qualifying widows or widowers.
- $57,300 for married people filing separately.
Investment gains and losses
Investment decisions are often more about managing capital gains than about minimizing taxes. For example, taxpayers below threshold amounts in 2021 might want to take gains, whereas taxpayers above threshold amounts might want to take losses. Tax-loss harvesting — offsetting capital gains with losses — may be a good strategy to use if you have an unusually high income or significant losses this year.
Fluctuations in the stock market are commonplace. Don’t assume that a down market means investment losses. If you’ve held the stock for a long time your cost basis may be low.
This column is for information only and is not advice. Taxes are complicated and mistakes can be costly. Consider consulting professionals regarding tax matters.
Norm Grill, CPA, is managing partner of Grill & Partners, LLC, certified public accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien, 203-254-3880.
