While it’s always a good idea to review your tax situation and evaluate opportunities, now is a particularly ideal time for a thorough review of your affairs because there are many tax provisions currently available that are set to expire in 2025. Barring any new tax legislation to update these provisions, they’ll revert to the laws that were in place before the tax reform of 2017.
As you take the time to review your personal finances and assess opportunities, here is an overview of some individual provisions, such as deductions and credits, alternative minimum (AMT) tax, and estate planning—are all outlined below.
While there’s been an overall limitation on itemized deductions in prior years, there’s no such limitation for 2020 and 2021. However, President Joe Biden has proposed to:
- Limit the deduction for itemized deductions to the 28% tax bracket
- Restore the prior limitation for higher-income earners
No legislative action has been taken on these proposals at the time of publication.
If you do itemize, here are some important items to consider.
Medical Expense Deduction
The threshold for deducting such unreimbursed expenses is 7.5% of adjusted gross income for all taxpayers for both regular and alternative minimum tax purposes.
State and Local Tax Deduction
Through 2025, a taxpayer’s deduction for state and local taxes, including property taxes, is limited to $10,000 if they itemize their deductions. Additionally, the taxpayer still has the option to choose between deducting income taxes or deducting sales tax, but they can’t deduct both.
Mortgage Interest Deduction
A taxpayer is allowed to deduct interest on mortgage debt up to $750,000 annually ($375,000 each if married filing separately).
The limit for mortgage debt incurred or under written contract before December 15, 2017, is $1 million ($500,000 each if married filing separately). The $1 million limit also applies for refinanced debt originally incurred before December 15, 2017, when the balance doesn’t exceed the amount of refinanced indebtedness.
Deductions for interest on home equity debt are only deductible if the debt was used to buy, build, or substantially improve the taxpayer’s home that secures the loan. Home equity debt is subject to the same debt balance limits as mortgage debt.
The limit on the deduction for cash donations to public charities is 60% of adjusted gross income. In 2020 and 2021, deductions for certain cash donations and can be 100% of adjusted gross income (AGI). To qualify for the 100% of AGI limit, the donation is required to be given in cash directly to a qualified organization, and it can’t be given to a donor-advised fund. In addition, charitable deductions for payments made in exchange for college athletic event seating rights are eliminated.
Personal Casualty and Theft Loss Deduction
Through 2025, this deduction is suspended, except if the loss was due to an event officially declared a disaster by the president of the United States. Personal casualty and theft losses are losses from theft or loss due to damage or destruction from a flood, hurricane, earthquake, or similar event.
The deduction for work-related moving expenses is suspended through 2025, except for active-duty members of the armed forces and their spouses or dependents who move because of a military order that calls for a permanent change of station.
The exclusion from gross income and wages for qualified moving expense reimbursements is also suspended through 2025, except for active-duty members of the armed forces who move due to a military order.
Alimony payments aren’t deductible—and are excluded from the recipient’s taxable income—for divorce agreements executed or, in some cases, modified after December 31, 2018.
For divorce agreements executed prior to January 1, 2019, the alimony payments are deductible by the payer and are included in the recipient’s taxable income. This change will likely produce a higher overall tax burden as the recipient spouse typically pays income taxes at a rate lower than the paying spouse.
Distributions from 529 plans to pay qualifying education expenses are generally tax-free.
Typical qualified expenses include:
- Tuition and fees
- Books and supplies
- Room and board
- Computers and internet access
The definition of qualified education expenses includes not just postsecondary school expenses, but also primary and secondary school expenses. However, primary and secondary school expenses are limited to $10,000 annually, unlike postsecondary school expenses.
Qualified Business Income Deduction
The qualified business income deduction under Section 199A provides many owners of sole proprietorships, partnerships, S corporations, and some trusts and estates, a deduction related to income from a qualified trade or business and subject to certain limitations for professional service trades or business.
These limitations may apply once the taxpayer reaches the following income thresholds:
- $163,300 for singles filers
- $326,600 for joint filers
Other factors that can limit the deduction for qualified business income are the amount of W-2 wages paid by the qualified business and unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business.
Not all activities rise to the level of a trade or business. For taxpayers with qualified business income from more than one trade or business, aggregating such businesses may allow for additional deductions if the taxpayer is subject to the limitations. Aggregation rules should be carefully considered because once an aggregation election is made, it must be consistently applied unless facts or circumstances change and requirements are no longer met.
Other Miscellaneous Deductions
The deduction for certain miscellaneous deductions, such as tax preparation fees, investment expenses, and unreimbursed employee business expenses, is suspended through 2025.
Tax credits are a savings opportunity that allows taxpayers to subtract the value of a credit amount from the total taxes owed. Many credits exist—below are a couple common ones.
Family Tax Credits
The American Rescue Plan Act of 2021, signed by President Joe Biden on March 11, 2021, implemented a $3,600 tax credit for children under six years old and $3,000 for children between ages six and 17. These credits are in place for 2021 only. After 2021, it will revert to the amounts below.
The credit is $2,000 per child under age 17. The maximum amount refundable—because a taxpayer’s credits exceed his or her tax liability—is limited to $1,400 per child.
The credit doesn’t begin to phase out until adjusted gross income exceeds $400,000 for married couples or $200,000 for all other filers. However, the phaseout thresholds aren’t indexed for inflation, meaning the credit will lose value over time.
A $500 nonrefundable credit is available for qualifying dependents other than qualifying children, such as a taxpayer’s parent, sibling, niece, nephew, aunt, uncle, or 17-year-old child.
All of the family tax credit provisions expire after 2025.
Learn more about the act here.
Residential Energy Credit
Tax credits still exist for the installation of residential energy efficient credit, such as solar panels. The credit allowed is:
- 26% for property placed in service in 2020
- 26% for property placed in service in 2021
Alternative Minimum Tax
The alternative minimum tax (AMT) is an additional tax to which taxpayers may be subject. The calculation of AMT prevents overutilization of tax breaks by disallowing certain deductions and requiring additional income recognition.
Who’s Targeted by the AMT
The alternative minimum tax (AMT) targets higher-income earners and therefore provides an exemption for taxpayers with income levels below a certain threshold.
AMT Exemption Amounts
- $56,700 for separate filers
- $113,400 for married couples filing jointly
- $72,900 for singles and heads of households
Exemption Phaseout Thresholds
- $1,036,800 for married couples
- $518,400 for all other taxpayers with the exception of estates and trusts
Most taxpayers won’t find themselves subject to AMT for the following reasons:
- Nonbusiness miscellaneous deductions aren’t currently deductible.
- The state and local tax deduction is significantly limited.
- There’s a substantial increase to the AMT exemption phaseout level.
Note that the first two are historical add-backs for AMT.
AMT will continue to impact taxpayers with more substantial transactions that have AMT adjustments, such as incentive stock options. The planning opportunities will revolve around keeping taxable income below the income threshold amounts during the years that the AMT transaction transpires.
For example, taxpayers could potentially exclude gain from certain small business stock if it meets the Internal Revenue Code (IRC) Section 1202 guidelines. The exclusion does include an AMT add-back component, which historically made the provision less lucrative.
If you’re expecting a transaction that meets the IRC Section 1202 guidelines, it will be vital to defer income or accelerate deductions to remain below the income threshold of $1 million for married filers or $500,000 for other taxpayers.
With income and estate taxes seemingly in constant flux, providing flexibility in an estate plan could prove vital.
The increased exemption amounts were projected to reduce the number of estates subject to estate tax to around 40% of the past estate returns filed. While the increased exemption amounts changed the way individuals and families plan their estates, there are still many nontax issues to consider, such as asset protection, guardianship of children who are minors, family business succession, and planning for loved ones with special needs.
Some states have responded to the federal tax law changes. If you live in a state that imposes its own significant estate tax, many traditional tax-reduction strategies will continue to be relevant on a state level.
Gift and Estate Tax Exemption
The combined gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption was increased for inflation and presents several estate planning opportunities for taxpayers to consider.
Exemptions for 2021
- $11.7 million per individual ($11.58 million for 2020)
- $23.4 million for a married couple ($23.16 million for 2020)
The gift and estate tax exemptions remain unified so any use of the gift tax exemption during the taxpayer’s lifetime would decrease the estate tax exemption available at death. The tax rate for all three taxes remains at a maximum of 40%.
Estate Exemption Reductions
The exemption amount is set to revert to 2017 levels after 2025, about half of their current levels. This means you have roughly seven more years to utilize the increased exemption. There’s also no guarantee that the current or future administration won’t reduce the exemption amounts even lower than the proposed amounts. The lowering of the estate exemption amount was part of the current administration tax plan. No formal legislation has been introduced, but the expectation is that tax law changes may get attention later in 2021 or early 2022.
The scheduled reversion raises possible, but unlikely, claw-back concerns that should be considered.
Taxpayers with larger estate values have some factors to consider.
Taxpayers can consider gifting during their lifetime to receive the tax benefits of the lifetime exemption while they’re alive. With the possibility of the lifetime exclusion decreasing, utilizing the higher limits now, before the decrease, can allow more assets to be transferred.
Married taxpayers with estates between $10 million and $24 million will typically have an estate plan that includes a provision in the living trust to fund a so-called bypass trust. This trust would utilize the remaining lifetime exemption of the deceased spouse while giving the surviving spouse access to the funds in the trust. When the surviving spouse passes away, the assets of the bypass trust aren’t included in the surviving spouse’s estate.
With the current estate exemption, married taxpayers may want to consider including a provision in their revocable trusts or wills that would give them the flexibility to leave their assets to a trust that qualifies for the marital deduction. Upon the surviving spouse’s death, the entire trust is taxed in their estate. This could result in getting a second-basis step-up for the assets taxed in the surviving spouse’s estate.
While most states don’t have a gift tax system, some do have an estate tax. It’s important to review state laws in these areas when developing your estate plan.
Community Property State Rules
One should also watch the community property state rules. The use of portability allows the first-to-die exemption to be transferred to the surviving spouse; that exemption doesn’t get reduced until 2025. Therefore, there’s also an ability to use the first-to-die portability exemption without reduction, even though there could be a legislative reduction in the exemption.
It’s important to understand the drawbacks associated with gifting assets. Gifted assets don’t receive a step-up in tax basis. This step-up is valuable for low-basis assets that depreciate or will be sold. By keeping them as part of an estate, these assets will receive a step-up, under the current law. The current administration is considering changes to the step-up in basis rules.
Most states conform to federal basis provisions. With state income taxes no longer deductible, taxpayers in high-taxed states such as California could see their federal and marginal tax rates be as high as 50% depending on the type of asset. The estate tax rate is 40%. Note that there might be an incentive to pay 40% estate tax rate to receive a 50% benefit.
It’s important to note that capital gain rates could be substantially lower than estate tax rates, so a separate determination could be made. Certain trust planning could be done to help reduce the effect of income and estate taxes.
President Biden has proposed the elimination of the step-up basis, but no actual legislation has been brought forward at the time of publication.
Some states are contemplating new taxes that could cause trusts in those states to be taxed. Depending on where they’re based, there could potentially be a greater burden on the trustees and the beneficiaries regarding the reporting and taxation of trust income. Understanding what’s happening in the state where your trust situs is based is important.
Situs means which state laws have jurisdiction over the trust. This generally is determined by the location the trust resides.
199A Deduction for Trusts
Additionally, there may be an option to make distributions from a trust and better utilize the Section 199A deduction, which provides a 20% deduction on qualified business income.
This can be complicated, but trustees might want to ask whether the beneficiaries need additional income to fully utilize the deduction or if too much would result in a phaseout of the deduction. The trustee must pay attention to whether there would be uneven distributions that are proper and the eventual effect on future distributions.
Other Distribution Considerations
There are other taxes that could be affected by distributions. The net investment income tax of 3.8% is on a portion of the adjusted gross income over certain thresholds—generally $200,000 if single and $250,000 if married filing jointly. If distributions occur when there are multiple beneficiaries, there may be tax at the trust level but not at the beneficiary level.
State and Local Tax Deduction Limit
With the $10,000 limit on state and local tax deductions, trustees may need to monitor distributions, particularly when distributable net income will face a greater tax burden due to the lack of the deduction. Consider if the tax benefits outweigh other issues, such as asset protection and unequal distributions.
Other Planning Opportunities
Some items you should review in your planning include:
- Trust situs. Explore if trust situs should be changed to a more trust-favorable state if the current resident state is contemplating an increase in income or commerce tax.
- State taxation. Review state taxation of non-grantor trusts that accumulate income, which affects corpus and income for future beneficiaries. Determine if a distribution should occur and for what reason.
- State exemptions. Consult state rules that may limit the length of time a trust can exist to see if it’s possible to exempt estate, gift, and generation-skipping transfer tax for your desired length of time.
- Decanting rules. Look to the statutory rights to change trust through the decanting provision according to what the state provisions allow. Determine if there are more flexible provisions that can be added to an existing trust. Decanting provisions allow modifications to move assets from an old trust to a new trust.
- Charitable trust provisions. Consider if a charitable trust still allows access to income as well as if a charitable remainder trust can be formed to provide annuity income to additional beneficiaries while still reducing tax liabilities.
- Distributions. Consider whether decanting your current trust can impact the income tax liability of the trust. Further, verify that trust accounting income and distributions are being reviewed for tax efficiency.
- Family office. Consider restructuring your family office to better utilize certain expenses and available deductions.
Long-term capital gain rates are still assessed at 0%, 15%, or 20% depending on your income level for the year. The additional 3.8% Medicare tax for taxpayers who qualify is still in effect.
President Biden proposed to remove the preferential tax rate for long-term capital gains and qualified dividends for taxpayers with income exceeding $1,000,000. No legislative action has been introduced at the time of publication.
Planning opportunities remain largely the same as prior year. Appreciated securities could be good assets to donate to charity to help avoid the capital gain tax and preserve your liquid cash. Gifting appreciated assets to children who are in lower tax brackets may also help reduce the tax burden when securities are sold later.
We’re Here to Help
If you have questions on personal planning opportunities and wealth management, please contact your Moss Adams professional.