5 Middle Class Tax Planning Strategies Under Joe BidenPersonal Taxes
Tax season ended a few months ago, so you may be wondering what accountants like myself do the rest of the year. Aside from helping people with their back taxes, which is the majority of my practice, we usually do a lot of planning for the next year.
Why? If you do your tax planning for 2021 in April 2022 right before filing your return, you’re likely to miss out on some tax savings. Outside of contributing to a Traditional IRA, SEP IRA, or HSA, there aren’t many ways for middle-class taxpayers to save money on taxes for the previous year, meaning the majority of your tax planning for 2021 must be done in 2021, not in 2022.
I frequently receive emails from high-income wage earners asking how to mitigate tens of thousands of dollars in taxes. Unless the taxpayer made a mistake on their tax software, though, there’s not much I can do about the previous year’s taxes. Because of this, it is extremely important to plan your taxes well before the end of the year, especially in a year like this with a new administration with aggressive tax goals.
Today, I’m discussing five middle-class tax planning strategies in light of the Biden tax plan. The discussion of this plan has largely concerned how it will affect the wealthy given the reinstatement of the 39.6% top marginal rate for households making over $400,000 a year and the basis step-up at death.
For the majority of the middle class, though, this discussion doesn’t directly apply; in most parts of the country, a household with an income of over $400,000 is not considered middle-class. Today, therefore, I’m going to focus on the middle class, laying out five planning strategies that you should use in light of the Biden agenda and how it may affect your taxes.
Bear in mind that there’s still a lot we don’t know about the Biden tax plan; for example, we don’t know if the 39.6% top marginal rate applies to singles who make $200,000. Further, the Biden tax plan is not a unified piece of legislation yet, with some proposals from various members of Congress that may or may not be incorporated into the final plan.
Until we see a unified piece of legislation, then, I’m basing my information off the fact sheets from the White House, Biden’s speech to the joint session of Congress, and proposals set forth by various Democratic members of Congress.
1. Reduce your withholdings in light of a potential SALT cap repeal.
As I discussed in my April 27 video, many members of the Democratic caucus have set their sights on repealing the $10,000 limitation on the itemized deduction for state and local taxes. Prominent members of the caucus- including Speaker Pelosi and Leader Schumer- hail from high-tax states with high property values, meaning their constituents hope to see the SALT cap repealed.
If line 5e of your 2020 Schedule A shows $10,000 even, you ran up against the SALT cap. If this is you and this repeal passes, effective in 2022, you might want to adjust your W-4 to take less withholdings out, since this will allow you to pay your 2021 state taxes in 2022, when you’ll be eligible to deduct more than $10,000 of state, local, and property taxes.
You might even benefit from paying an underpayment of tax penalty for underwithholding to your state for 2021 if the value of your additional deduction in 2022 exceeds the underpayment penalty. However, the benefits of this are very state-specific, so you have to calculate the numbers for yourself before making a decision.
No one knows the future, but if it starts looking like this SALT repeal is a done deal, it may be time to reduce your withholdings on your Form W-4.
2. Be smart with the timing of your charitable contributions.
Imagine you’re married filing jointly and paid $20,000 of state income and property taxes in 2020. You’re also a big giver, so you further gave $10,000 to your church or other qualifying organization.
Because the 2017 Tax Cuts and Jobs Act raised standard deductions, your 2020 standard deduction for married filing jointly would have been $24,800. However, the total of your itemized deductions would have been $20,000- $10,000 for state, local, and property taxes under the SALT cap, and $10,000 that you gave to your church. In that case, you would receive only the standard deduction, meaning your tax payments and charitable giving wouldn’t do anything to mitigate your taxes.
If the SALT cap were repealed effective in 2022, though, you would be able to itemize your deductions in 2022 but not 2021. In that case, it might be advantageous to defer your charitable contributions until 2022, when you would get a tax benefit for them.
In other words, instead of making a $10,000 contribution in 2021 without benefit due to the SALT limit and then making a $10,000 contribution in 2022 that you do get a benefit for, you might want to consider simply making a $20,000 contribution in 2022 so that you get an itemized deduction on all of it.
However, bear in mind that Democrats are looking to cap itemized deductions in other ways, like through a 28% benefit cap or the 3% Pease limitation, so you may want to consult a tax professional about your personal situation before making a decision.
3. Plan for the Recovery Rebate Credit.
The third stimulus payment came with a maximum threshold of $80,000, with those with incomes under $75,000 receiving $1,400 and those with incomes between $75,000 and $80,000 receiving increasingly less. For head of household, the maximum increased to $112,500, and for married filing jointly, it increased to $150,000.
However, if you were excluded from the third stimulus payment (or only got a partial payment) based on income, you have another chance to get your full $1,400 through the 2021 recovery rebate credit. According to this recovery rebate, you can receive this $1,400 if you originally didn’t qualify based on your 2020 income but then made less than $75,000 in 2021.
If you were originally close to the cutoff, then, you might want to consider reducing your income by beefing up your 401(k) contributions at work or opening a Traditional IRA or HSA, as I discuss in my Prosper course. You can also decrease your 2021 income by asking your employer to defer your year-end bonus until the beginning of 2022.
4. Consider doing 1031 exchanges now.
In the early 2010s, I bought a four-unit in the Los Angeles area with an FHA loan, putting only 3.5% down. Since then, the property has significantly appreciated, and I’ve contemplated using a 1031 to turn it into an eight-unit.
As I mentioned when I went over the White House Fact Sheet on the American Families Plan, though, Biden is targeting 1031 exchanges for gains over $500,000.
Therefore, if you’re sitting on a rental property with significantly more than $500,000 in gains in it and want to transition to a more cash-flow based portfolio, you should probably start talking to a CPA and a qualified intermediary about that transaction sooner soon since if Biden gets his way, you might be looking at gain recognition for your gains over $500,000 even if you do a 1031 exchange.
5. Deal with your back taxes.
As I explained in my April 27 video, Biden plans on giving the IRS $80,000,000,000 to beef up audit and collections activities. This is ostensibly to target the rich, but we all know that the IRS has no problem slapping liens on houses and taking other measures against people who are not rich.
Therefore, if you owe back taxes, I strongly encourage you to watch my video on offer in compromise– the best tool you have to deal with back taxes- and stay tuned for my other upcoming tax relief videos. You can also contact me at [email protected] to get help from myself and my team of professionals.
Bonus strategy for the rich!
You may want to talk to your wealthy friends and relatives about Biden’s planned tax changes, especially if they’re newly rich and don’t have a network of tax and legal professionals.
It’s important that your rich friends and relatives know to update their estate plan, since the Biden plan will have huge ramifications for estate planning with the butchering of the basis step-up at death and a reduction in the lifetime exemption.
Anyone making over $1,000,000 a year may also want to consider gain harvesting in 2021 if they have significant personal cash outlays coming up in 2022. If Mr. Millionaire needs to take $300,000 out of his stock portfolio to make a purchase the next year, for example, he may want to do so before the end of 2021. In so doing, Mr. Millionaire will pay 23.8% in tax- the statutory 20% plus the 3.8% Obamacare surtax. On the other hand, assuming the increased tax rate takes effect in 2022, Mr. Millionaire will pay 43.4% in tax if he waits until 2022 to cash out.
By cashing out early, Mr. Millionaire may lose out on some gains in the market, but this loss seems minimal compared to the sizable increase in tax he would suffer in doing otherwise. For example, if he had a $100,000 basis in the $300,000 of stock, for a gain of $200,000, he would pay $47,600 in federal tax under the 2021 tax rules. However, if he cashed out in 2022 under the Biden tax plan, he would pay $86,800 in federal tax on the same gain, for a difference of $39,200. And even assuming an aggressive 10% annualized rate, an extra 6-12 months of appreciation on the original stocks would only cause a $15,000-$30,000 increase.
Even though you may be middle class, you may want to let your rich friends know about the upcoming changes so that they can plan in advance and save a significant amount of money.
Be sure to keep an eye out for further information I will release concerning upcoming tax changes so that you have a good idea of how they will affect you and your taxes.
Logan is a practicing CPA, Certified Student Loan Professional, and founder of Money Done Right, which he launched in 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.