tax saving strategies to consider

Here’s a breakdown of some strategies that reduce taxes and increase savings

FEDZONE Ed Zurndorfer

Edward A. Zurndorfer

End-of-year tax saving strategies have always been a challenge, but year-end 2021 presents an even greater challenge amid major uncertainties about tax law changes Congress is considering. Nevertheless, the following are some possible tax-saving strategies that federal employees should consider performing during the remaining two months of 2021:

“Harvesting” Capital Losses.

Tax-loss “harvesting” can be an effective method of generating tax savings. While the year 2021 has until now been another year of strong stock market gains for the average stock market investor, it is likely that the average investor focuses on their stock market “winners.” However, investors may want to check whether any of their stock investments have significantly decreased in value and consider selling some or all of these investments, thereby generating capital losses. Capital losses are often utilized to offset capital gains (which result when investors sell their investments at a gain) resulting in the capital gains not being taxed. Both capital gains and capital losses are “recognized” in the sense that the gains and losses were incurred as a result of selling securities held in a non-retirement brokerage account. Investors can offset recognized gains with recognized losses. If recognized losses exceed recognized gains in any year, then individual investors are permitted to deduct as much as $3,000 ($1,500 if married and filing separately) of the net losses that year against other income such as interest and salary income. Any net losses exceeding $3,000 ($1,500) gets carried into future years and used to offset recognized capital gains in those years.

   It needs to be emphasized that the above discussion on tax loss “harvesting” is strictly with respect to federal tax law. Individuals are advised to talk with their tax advisor regarding possible differences in state and local tax laws with respect to the treatment of capital gains and losses.  

   A word of caution: There are numerous questions that need to be answered about what if anything will happen in Congress with regard to proposals calling for higher capital gains taxes for higher-income individuals. Among the questions: Which individuals will be affected and starting when?

Beware of “Wash Sales.”

A “wash sale” occurs when an individual sells some of an investment security (for example, a stock, a bond, an open-ended fund, or a closed-ended fund) he or she owns resulting in a capital loss and subsequently buys back the same or substantially identical investment security within 30 days before or after the sale. This is called a “wash sale” in which the IRS disallows the capital loss for federal tax purposes. For example, suppose an individual purchased 200 shares of XYZ stock five years ago for a total cost of $2,000 and recently sold all 200 shares at a sales price of $1,500.  The individual has a recognized loss of $2,000 less $1,500, or $500. Within 30 days of the sale of the two hundred shares of XYZ stock, the same individual purchased 200 shares of the XYZ stock at a total cost of $1,200. The $500 loss is not allowed by the IRS because the $500 loss resulted from a “wash sale”. The $500 loss will instead be added to the cost basis of the newly purchased XYZ shares. The newly purchased 200 shares of XYZ stock will then have an adjusted cost basis of $1,200 plus $500, or $1,700.

Charitable Giving.

Part of tax legislation that became effective in 2020 allowed a tax deduction for individuals who donate to charity but who claim the standard deduction. Prior to the passage of this legislation, only individuals who itemized on their federal income tax returns were eligible to deduct their charitable contributions. During 2021, married couples filing jointly and who take the standard deduction can deduct a maximum of $600 of charitable donations while single filers who take the standard deduction can deduct a maximum of $300. During 2020, the maximum deduction was $300 per return for joint filers and singles who claimed the standard deduction.

 Also, for tax year 2020, the charitable deduction of $300 was an “above the line” deduction, meaning it was subtracted from “gross income” to arrive at adjusted gross income (AGI). Reducing AGI is important because one’s AGI can affect an individual’s eligibility for some tax credits and tax deductions. In 2021, the deduction is “below the line”, not reducing AGI but instead reducing taxable income.

    Two reminders about the $300/$600 charitable deduction: (1) It is available only to individuals who do not itemize on their tax returns (they do not file Schedule A on their federal income tax returns); and        (2) donations must be in the form of cash, check, or credit card. Contributions of “noncash” items such as clothing or securities are not allowed for purpose of the $300/$600 charitable deduction. As has always been the law, there must be required documentation of all charitable donations. Gifts must be made to qualified charities; donor-advised funds are not qualified for this provision.

Make Roth IRA Conversions Before the End of 2021 – Maybe.

There are several House Ways and Means committee proposals that would limit Roth IRA conversions. One such proposal would disallow Roth IRA conversions for married joint filers with more than $450,000 of taxable income and to single filers with more than $400,000 of taxable income. Currently, there are no such income limitations. In a Roth IRA conversion, an individual transfers assets held inside a traditional IRA to a Roth IRA and pays tax on any pre-taxed items (traditional deductible IRA contributions and accrued earnings) that are part of the transfer. In return, future payouts from the Roth IRA can often be tax-free. There are no required minimum distributions from a Roth IRA during the Roth IRA owner’s life. The somewhat good news is that the proposed limit for performing these transfers would not take effect until 2032.

“Backdoor” Roth IRA Contributions.

For those employees who are ineligible to make a Roth IRA contribution due to high income, make every effort to perform a “backdoor” Roth IRA contribution before Dec. 31. 2021. For those federal employees who are ineligible to contribute directly to a Roth IRA because their AGI is too large, an alternative way of contributing to a Roth IRA is via a ”backdoor” Roth IRA contribution. In particular, an individual contributes to a nondeductible traditional IRA (the contribution is made with after-taxed dollars resulting in no “upfront” tax savings. However, immediately after the individual makes the nondeductible traditional IRA contribution, the individual converts the entire contribution to a Roth IRA. There should be no tax liability because the entire contribution that was converted is composed of already-taxed money. Thus, the concept of a “back-door” Roth IRA contribution. This method of the “back-door” Roth IRA contribution has been used by upper-income Americans for many years. There is legislation in Congress that would do away with the “back-door” Roth IRA contribution effective January 1, 2022. Therefore, any federal employee who has in the past used the “back-door” Roth IRA contribution as a means of contributing to a Roth IRA to do so for the tax year before January 1, 2022.

Increase Gifting to Eliminate Possible Federal and State Estate Taxes.

Proposed legislation in Congress would decrease the lifetime gift-and estate-tax exemption to $6 million per individual indexed to inflation, decreased from the current year exemption of $11.7 million.

    Among the reasons for individuals to gift financial assets is to decrease the size of their estate to avoid exposure to potential future federal and state estate taxes. The 2021 federal estate tax exemption is $11.7 million. Legislation in Congress would decrease the exemption to $6 million effective January 1, 2026.

   Estate tax attorneys remind affected individuals that they can use the current year exemption of $11.7 million exemption to gift money to heirs or trusts without fear that the exemption will be reduced should the $11.7 exemption be scaled back.                                                                                                                         

    Employees are strongly encouraged to discuss these and other tax and estate issues with their tax advisors and estate attorneys in order to be sure that the recommendations and suggestions are appropriate to their financial situation.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

tax saving strategies to consider

Tax Saving Strategies to Consider