Five Late-Breaking Tax Return Moves
Popular ways to reduce tax liability
The April 18 deadline for filing your 2021 federal income tax return is fast approaching. Fortunately, some individuals and small business owners still have time to benefit from last-minute tax return moves. Consider these five tax-saving ideas.
1. IRA contributions: Depending on your situation, you may be able to cut your tax bill while saving for retirement. If you qualify, contributions to a traditional IRA of up to $6,000 ($7,000 if age 50 or older) are deductible “above the line.” However, the deduction starts to phase out if you actively participate in an employer retirement plan and your modified adjusted income (MAGI) exceeds $66,000 for single filers or $105,000 for joint filers. Other limits apply if only your spouse is an active participant.
2. SEP contributions: Similarly, self-employed individuals may contribute to a Simplified Employee Pension (SEP) prior to the tax return due date. Even better, the contribution thresholds for SEPs are higher than those for traditional IRAs. For 2021 returns, the limit for deductible contributions is the lesser of 25% of compensation or $58,000. Note: This above-the-line deduction reduces your AGI for various other tax return purposes.
3. Carryovers: If you reported excess capital losses in 2020, you can use those losses to offset income on your 2021 return. Capital losses offset capital gains plus up to $3,000 of highly-taxed ordinary income. Any excess is carried forward indefinitely. Along the same lines, you may have carried over an excess charitable deduction from 2020 that can reduce 2021 tax liability. This amount may be carried forward for up to five years.
4. Home office deductions: This deduction is often available to qualified self-employed individuals. Typically, you can deduct home office expenses, including direct expenses and a portion of overall home expenses, based on the percentage of business use of the home if the office is used regularly and exclusively as your principal place of business. You may elect to claim a simplified $5-per-square-foot deduction, up to a maximum of $1,500, but relying on actual expense records generally produces a bigger deduction.
5. Estimated taxes: If you are in line for a tax refund, you can pocket the money and splurge on a luxury. But a better approach may be to apply the excess to your 2022 estimated taxes, especially if you are required to make a quarterly installment payment by April 18. Generally, you will owe an estimated tax penalty if your annual installments don’t equal at least 90% of your current tax liability or 100% of last year’s tax liability (110% if your AGI exceeded $150,000).
Finally, if you need more time to pull things together, you can obtain an automatic six-month filing extension from the IRS—no questions asked—by filing Form 4868 by the tax return deadline. But the extension is only for filing, not payment, so you still must make a good-faith estimate of your taxes. Also, note that an extension gives you more time to contribute to a SEP for 2021, but not to an IRA.
Reminder: Do not make assumptions. Obtain professional guidance for your situation.
How to Pivot Your Small Business
Going in a different direction
As the pandemic unfolded in 2020, many businesses were forced to “pivot” into different undertakings for public safety or economic considerations. So a clothing manufacturer may have started producing personal protective equipment (PPE) instead of suits or dresses. Some small business owners are facing similar challenges today.
In fact, even businesses that have been up-and-running for a short period of time—perhaps even less than a year—may be rethinking their line of work. You may see opportunities you did not see before.
The question is: Should you pivot your business? If the answer is “yes,” how do you ensure a smooth transition?
Starting point: First, be aware that the concept of pivoting is hardly new. Many famous pivots date back to the twentieth century. The company that produces Play-Doh initially intended it to be a wall-cleaning product. More recently, Twitter can trace its roots back to a network for subscribing to podcasts before it evolved into a social media platform. There are numerous other examples.
Frequently, a business owner will pivot if the company’s revenue is not meeting its projections. But the change may be attributable to reasons that are not directly related to the bottom line. For instance, you may be providing certain goods that are far-and-away your best sellers and you want to focus solely on those offerings. Or the marketplace is too crowded and your company is getting lost in the shuffle. Or maybe you simply want to go in a different direction.
Whatever the reason, pivoting is not as simple as just snapping your fingers. Although there are no absolute guarantees for success, following these basic steps should put you on the right path.
• Do your homework. Before you commit to a pivot, conduct extensive tests and analyze the results. Make sure your staff is up-to-date on all the latest developments. Once you turn the corner, there usually is no going back.
• Create new goals. The old projections have little meaning for an operation that is pivoting. Rework your business model to coincide with the revised outlook.
• Do not discard everything. Depending on the nature of the pivot, you may not have to reinvent the wheel. Keep what makes sense going forward and concentrate on the products or services that have been successful.
• Appeal to your target audience. Once you have determined who your target audience is—be it the same as before or a different demographic—tailor your marketing pitch accordingly. For instance, you might want to highlight specialized products or services you are now emphasizing by offering discounts.
• Check out the competition. What are others in your niche doing? How can you improve your position in the marketplace? You can learn a lot by watching the other guy, especially related to pricing.
End point: Regardless of whether your company is a start-up or has been around for decades, making a pivot is a major move. Do not hesitate to contact your professional business advisors for assistance.
Key Points About Deducting Points
Learn about tricky tax rules
Because inflation increased early in 2022, mortgage interest rates are expected to keep rising from recent historic lows. Right on cue, on March 17 the average 30-year fixed-rate mortgage rate climbed above 4% for the first time since 2019. If you are buying a home and need a mortgage, or looking to refinance an existing mortgage, you may now have to pay one or more points to obtain a more favorable rate.
Can you take a current tax deduction for the points? It depends. As long as you itemize deductions, you can usually write off the full amount of points paid on a new acquisition debt. Conversely, if you are refinancing, the deduction for points is generally spread out over a period of years.
Details: A point equals one percent of the amount you borrow from the lending institution. For instance, if you are charged two points on a $300,000 loan, it costs you $6,000. But the extra payment is generally worth it if you will save tens of thousands in the long run.
The points paid on a new mortgage are deductible if you meet certain requirements. For instance, the acquisition debt must be secured by your principal residence and you must reside in an area where paying points is an established business practice. The points are deductible along with mortgage interest on your personal return if you itemize deductions rather than claiming the standard deduction.
However, the rules differ if you are refinancing an existing acquisition debt instead of taking out a new loan. In this case, you must amortize the points over the life of the refinanced loan.
Example: Assume you can obtain a more favorable rate for a 10-year mortgage if you pay one point. The loan principal is $150,000, so the point sets you back $1,500. Therefore, you deduct $150 each year for the next ten years.
On the other hand, if you are using a home equity loan or line of credit (when permitted by state law), the rules differ again. Under recent legislation, the deduction for mortgage interest paid on home equity debt is suspended for 2018 through 2025. But the loan can still qualify as acquisition debt if the proceeds are used for substantial home improvements. As a result, you may be able to write off the points, subject to the rules for acquisition debt discussed above.
Finally, if you use home equity loan proceeds for other purposes—say, to buy a car or take a vacation—the loan is treated as home equity debt. So you get no deduction.
Note: If interest rates reverse course and begin to trend downward in the future, you might decide to refinance a mortgage a second or even third time. In this situation, you qualify for an immediate tax break on the points, plus you can deduct the full amount of points remaining from the prior refinancing. You no longer have to amortize those points.
Caution: The tax rules for points can be tricky. Consult with your professional tax advisor prior to refinancing.
Q’s and A’s About 529 Plans
What families need to know
Saving enough to pay for the future higher education of your children is a daunting task. Some consolation: There is no foolproof method, but at least a Section 529 plan may help you set aside funds, up to generous limits.
Q. What exactly is a Section 529 plan?
A. Named after the tax code section authorizing the use, Section 529 plans are educational savings plans, generally operated by individual states, that encourage families to build up funds for the future education of the younger generation. If certain requirements are met, there is no tax due on the accumulation of earnings and no tax owed on qualified distributions.
There are two main types of Section 529 plans: Prepaid tuition plans and college savings plans.
Q. How does a prepaid tuition plan work?
A. Essentially, the plan is guaranteed to keep pace with the rising cost of college tuition. For instance, say that it currently costs $10,000 annually to send a child to a state university. You pay $10,000 now to buy shares for a youngster. When the child is ready to go to school, your shares can pay for an entire year of tuition, no matter what it costs at that point.
This type of plan offers some peace of mind. There is no risk of loss of principal and the investment is usually guaranteed by the state.
Q. How does a college savings plan work?
A. As opposed to a prepaid tuition plan, there is no guaranteed lock on future tuition costs under a college savings plan. In fact, the savings may not be enough to cover all of the costs. But you have a bigger potential upside as well, since it is possible to generate a better return with this type of plan. (Of course, there are no guarantees.)
Usually, the plan will offer an asset allocation strategy geared to the current age of the child or the year they will enter school. For example, the plan may provide more aggressive investments in the early years and switch over to more conservative investments as college approaches. Most college savings plans also offer a wide variety of risk-based asset allocation portfolios managed by professionals.
Q. What are the restrictions on contributions?
A. Anyone can contribute to a Section 529 plan on behalf of a named beneficiary.
Each state is responsible for setting its own limits on the amount of contributions allowed to a college savings plan. Check the limits in the applicable state.
Note: In the event a child decides to not attend college or attends school in another state, you may be able to transfer funds to another plan or “roll over” funds for a successor beneficiary (e.g., a younger child).
Q. Can a 529 plan ever be used for pre-college purposes?
A. Yes. Recent legislation allows taxpayers to use a plan to pay for up to $10,000 of tuition to attend grades K-12 at a public, private or religious school.
Reminder: A Section 529 plan is suitable for many families, but it is not for everyone. Investigate the options carefully to determine if this meets your family’s personal needs.
How Tax-Friendly Is Your State?
What are the tax-friendliest states to do business in? According to the State Business Tax Climate Index (SBTCI) for 2022 produced by the Tax Foundation, the five most favorable states are Wyoming, South Dakota, Alaska, Florida and Montana.
On the other hand, Maryland, Connecticut, California, New York and lastly New Jersey bring up the rear. These rankings are based on an analysis of major individual, corporate and other taxes.
Where does your state stand? You can view the full SBTCI at https://taxfoundation.org/2022-state-business-tax-climate-index.
Facts and Figures
Timely points of particular interest
Foreign Intrigue—The IRS has announced that it is delaying changes required for certain U.S. businesses that operate in foreign countries. Under the Tax Cuts and Jobs Act (TCJA), S corporations and partnerships were required to provide detailed information in new Forms K-2 and K-3 for the 2021 tax year. However, after the tax community raised strong objections, the IRS put the new forms on hold for the time being. Stay tuned for more developments.
Employee Training—Usually, training initiatives are aimed at shoring up someone’s weaknesses in the workplace. However, recent research shows that you may be better off focusing on the employee’s strengths. According to a survey from Gallup, employee training is more effective when it accentuates the skills a person already has rather than trying to turn them into a well-rounded performer. Consider this shift in emphasis.