Consider Accelerating Income: End of the Year Tax Planning
Physicians need a end of the year tax plan in 2021. What are you going to do now in the face of major proposed changes to the tax code? What is your 2021 end of the year tax plan?
It is true: there is a lot of uncertainty about future tax laws as several proposals are in play that will affect high income earners. What do we know right now? To tersely summarize the main idea for end of the year tax planning for physicians: accelerate income.
Let’s find out what it means to accelerate income, and consider why we might do so in 2021.
Possible Tax Changes and End of the year Tax Planning
There are many possible changes in the tax code that might go into effect next year. Here are some of the main concerns for high-income physicians when considering end of the year tax planning:
Changes in the Backdoor Roth
It looks like both the backdoor Roth and the mega backdoor Roth are on the chopping block. This will make it more difficult for high income earners to get money in Roth. Big picture: congress wants to limit your ability to have tax-free accounts in the future. The near future.
Future Exclusions of Roth Conversions Depending on Income
If you make enough income in the 2032, you may not be able to do Roth conversions. Yes, 2032. The cut offs are 400k single and 450k married filing joint, but the amount of the conversion may be included in that income! Note that this isn’t tax-inflated, so this number will look quite a bit smaller 10 years from now, especially when you have to include the Roth conversion into that number. Are the next 10 years the last, best time to consider a series of partial Roth conversions to control your taxes in retirement?
Future Growth Assumptions
You might assume lower stock and bond returns, and expect higher inflation in the near future. This has significant implications for retirement planning. Of course some people have been predicting this for the last 5-7 years. Predictions, especially about the future, are quite difficult.
Super-Sized Retirement Accounts
Look for new “RMDs” on retirement accounts more than $10M. If you have that much in retirement accounts, then you should worry now and google it.
Estate Planning (MAJOR CHANGES!)
Change in Lifetime Exemption Amount
Current tax law may decrease the unified credit exemption for gift and estate tax from $11.8M down to ~$6M per person. This was scheduled to happen in 2026 (when TCJA expires) but may be accelerated to next year. This is why SLATs have been so popular this year, but are on the chopping block since they are grantor trusts (see below).
Other Game Changers
For folks with net worth less than $5m-10m, estate issues may not be significant currently. But look out in the future.
If your net worth is north of that amount, then there are major game changers that will affect estate planning. If you haven’t done estate planning by now, then you won’t get it done this year as lawyers will be booked by these last-minute SLATs and FLPs etc. At this point, see what actually makes it through and pivot in the future. I hear a lot of folks did unnecessary planning year end 2012, but that is part of the way estate planning works.
You may want to decelerate giving this year (accelerate income!) as you might get a larger tax write off (if you itemize rather than taking the standard deduction) next year.
Remember, each person can get a $300 above the line deduction for cash donations this year. Claim this deduction in 2021! This applies even if you take the standard deduction.
Also because of the CARES act, you get a 100% of AGI deduction for cash (instead of 60%) this year only.
If you need to recognize capital gains despite a high income, this year might be the time to do so! Again, accelerate income.
Next year (or now, if made retroactive), long term capital gains rates might increase from 20 to 25% (or 23.8 to 28.8% including NIIT). The increase in long term capital gains rate is actually backdated to September, so if you sell at this point, you still might be stuck paying the higher rate. But who knows if the backdate will stick, and the increase might start in 2022 instead. If you need to recognize long term capital gains soon and your income will be above 400/450k, consider doing so in 2021.
Tax Planning if Lower Income
If you have lower income in 2021, there is tax reform with the goal of providing a safety net for child credits, as well as expansions to ACA premium tax credit and earned investment credits. Caregiver credits of $4000 phases out above 75k. If you have lower income (for a physician, anyway), there is much tax planning to consider which is not included here.
Income Tax – The Headline Issue
Changes to the income tax brackets are headline issues for high-income earners. The top rate goes to 39.6% and the top capital gains rate 25% when your income is above 400/450k. Yes, the marriage penalty is back!
In effect, the 33% tax bracket is unchanged, but for married filing joint couples, the 35% tax bracket is tiny, and above 450k, you will now pay 39.6% rather than 37%. So a higher tax bracket starting at a lower taxable income!
Income tax is the headline issues for individuals. If you have business income, be prepared to spend time with your CPA in January/February before tax season kicks into full gear. NIIT will now be included for business income >500k, and S-Corp earning also subject to NIIT (so, should you even bother with an S-Corp?). Moreover, the 199A deduction is also caped income >500k. Thus, if your business income is areound or above 500k, there are big changes in store for you next year!
If you are going for Real Estate Professional Status, business losses are caped at 500k as well.
C-Corps will have progressive taxes depending on income. That won’t affect most doctors!
Finally, there is a surtax above 5M of income. You don’t think that will affect you? Well, do you have an estate or a trust? This surtax kicks in at only 100k for estates and trusts, so trusts that retain income or inherit pre-tax accounts such as IRAs or 401ks will be manhandled.
Wash Sale Rules Apply to Cryptocurrencies
And you will have to affirmatively note if you have had disposal of any virtual assets on your 1040 (as has been the case since 2019).
EV Tax Credits
If you want to buy an EV, wait til next year when there might be a Tax Credit for buying an electric vehicle.
Any $600 transaction through your bank will need to be reported. Yes, the IRS will be watching you. If this passes, expect to hear a lot more about it.
Self-directed IRAs will only be able to own publicly traded securities. This might phase in over 2 years but could up-end a lot of folks self-directed IRAs (and 401ks and eQRPs).
The capital gains exclusion for Qualified Small Business Stock (QSBS) might be severely limited. If you invest in private equity, pay attention to this one.
And who knows if SALT deduction issues may still come up, or the AMT for the matter.
Summary: End of Year Tax Planning for Physician
In summary, you might want to accelerate income this year, as the top tax bracket will increase for high-income individuals from 37% to 39.6%. In addition, the brackets will shrink significantly (the 35% will be tiny!), and you will be hit with the top tax at 400/450k (single, MFJ). This means the marriage penalty is back!
If you can take a bonus this year instead of next year, or otherwise accelerate your income, and you earn >400k, consider doing so.
And, you might want to recognize capital gains this year as well. Even though the increase from 20 to 25% (or 23.8 to 38.8% with NIIT) is backdated to September 2021, who knows if it will actually be backdated or will instead start in 2022. If you must recognize long term capital gains next year and are high-income, consider grabbing them this year instead.
Next, worry about the surcharge if you have a trust with income, or are leaving your IRA or 401k to a trust. This starts at 100k and complicates trusts that retain income. If you plan on leaving your IRA to a trust, first off, don’t, and second off, read about the 10-year rule which is new this year. And if you have estate tax issues, well, it is probably too late to do anything about those issues this year.
Bye-bye backdoor Roth, and expect further changes that preclude you from getting money in a Roth. If you have non-deductible money in your IRA, consider the after-tax IRA Roth Conversion before year end!
Major tax legislation is on its way. Since this needs all 50 democrats in the reconciliation process and large hand-outs for “infrastructure” are associated with the tax increases, who knows what actually will come to pass. But if you can accelerate income into 2021, you might be happy that you did.