By Len Green
By Len Green, CPA and John Wollenberg, CPA
In horse racing, the contest is not over until the horse crosses the finish line. The same is true with maximizing your tax deductions and minimizing your taxes. For those who think it is too late to save on your 2021 taxes, we are here to tell you, it is not!
With over 40 years' experience saving our clients taxes along with our knowledge of the new tax laws, we are confident the following information will help you as you approach the 2021 home stretch and allow you to hit the wire a winner.
Impact of Recent Tax Acts on The Horse Industry
Recent tax acts contain favorable developments for depreciating and expensing yearlings, breeding stock, farm equipment and other property.
- Bonus Depreciation: An increase in bonus depreciation allows a write-off to increase from 50% to 100%. Accordingly, you are now permitted to fully expense purchases in the first year for yearlings, breeding stock and farm equipment. Used property can now also qualify.
A few weeks still remain for 2021 asset additions with the potential benefit of a full tax write-off.
- IRC §179 Deduction: The maximum amount that may be expensed has been increased from $500,000 to $1,050,000. The phase-out threshold has been increased from $2 million to $2.6 million.
- Farm Equipment: The useful life has been reduced from seven years to five years and the 200% declining balance method can now be used.
- Racehorses: Certain thoroughbreds can still be depreciated as 3-year property. Even if business equipment (or horses) are purchased before year-end, they still qualify for tax benefits.
2021 Year-End Tax Planning Strategies
Due to the new administration in our nation's capital and the uncertainty of whether or not proposed tax law changes will be forthcoming, year-end tax planning for 2021 is more important than ever.
Steps Available for Individual Taxpayers
- Capital Gains: President Biden is proposing, for future years, an increase from 20% to 39.6% on capital gains for taxpayers with income above $1 million. Accordingly, if you are contemplating a sale of horses or real estate, you should consider accelerating the transaction into 2021 rather than waiting until 2022.
Even for taxpayers with income below the $1-million threshold, if you have realized capital gains in 2021, along with unrealized losses, you might want to trigger those losses before year-end to offset your gains, thereby reducing your tax liability.
On the flip side, if you have realized losses, consider taking some gains, as the deduction for capital losses is limited to $3,000 in any given year.
- Retirement Plan Alerts: First, required minimum distributions are reinstated for Year 2021. Please be sure to have sufficient taxes withheld.
Second, plan participants who turn 70 1/2 in 2021 or later, do not need to take required distributions until the year in which they turn 72.
Third, you are now permitted to contribute to a traditional IRA after age 70 1/2 as long as you have earned income.
Fourth, contributions to a Keogh Plan or a one-person 401(k) Plan can be significant and save you substantial 2021 tax dollars if set up before Dec. 31, 2021.
A SEP-IRA is another flexible alternative. A SEP can be set up before the filing date of your 2021 tax return, yet still provide you with a 2021 deduction.
- Avoid the Underpayment of Estimated Tax Penalty: If you have not prepared a 2021 income tax projection, you should have your advisor do so. If your 2021 projection shows a balance due, request that a disproportionate amount of withholding be taken from your December paychecks, year-end bonus or retirement plan distribution, rather than paying a comparable significant amount with a fourth quarter estimated tax voucher.
This withholding approach is more favorable than writing a check because taxes that are withheld in December are deemed to be “thrown back” and treated as evenly spread through the calendar year. This enables you to catch up on any shortfall and still avoid a penalty for the first three quarters.
- Business Losses: Of great importance, 2021 business losses are capped at $262,500 for single taxpayers and $524,000 for joint returns. Please take these loss limitations into consideration when preparing your 2021 income tax projections.
- Maximize the Pass-Through Business Income Deduction: This tax saving deduction allows certain taxpayers to deduct 20% of their qualified business income. To maximize the deduction, you should take action steps to qualify your taxable income so it is below this new provisions' phase-out thresholds.
- Charitable Contributions: Non-itemizing married couples filing jointly can now deduct up to $600 of cash charity for 2021.
Steps Available for Business Taxpayers
- Maximize Available Depreciation: Businesses should consider making expenditures that qualify for 100% first year bonus depreciation. Generally, both new and used depreciable assets are eligible. The full first year write-off is allowed even if the asset is purchased late in the year and even if the deduction gives rise to a taxable loss.
Also, make sure you are taking bonus depreciation on all assets that are eligible. Many times assets are missed as to leasehold improvements on horses purchased in overseas sales or horses put into training but not yet raced.
An alternative is IRC §179 depreciation, where for 2021 the expense limit has been raised to $1,050,000 if the investment purchases do not exceed $2,600,000. Keep in mind that §179 expensing cannot give rise to a loss.
- Qualified Business Income Deduction (QBID): Certain business owners may be entitled to a deduction of up to 20% of their qualified business income. You should take whatever steps are possible to keep your taxable income below the phase-out thresholds. The rules are complex, so contact your tax advisor so they can help you maximize the use of the QBID.
- Active Business Requirements:
- Operate your horse activities in a business-like manner. We go so far as to recommend that you form a Limited Liability Company (LLC) before year end and definitely have a separate checkbook. Keep a record of your horse business activities.
- Consult with someone knowledgeable in the horse business to ascertain if you meet some of the nine tests “to qualify” as “active” and therefore put yourself in the position to take “full advantage” of any tax losses you may incur.
Possible Tax Law Changes Proposed by the Biden Administration
The best way to sum up President Joe Biden's tax plan would be to say he wants to raise taxes on “high-income” households and corporations.
- Increase the corporate tax rate – The existing tax plan lowered the corporate rate from 35% to 21%. While Biden's camp generally agrees 35% was too high, the 21% rate will soon be raised, possibly to 26.5%.
- Increase taxes on high earners – Biden would restore the 39.6% top marginal tax rate that was in effect prior to the 2018 tax year.
- Phase out the pass-through deduction – Biden would phase out the 20% QBI deduction for taxpayers earning $400,000 or more.
- Increase capital gains tax on high earners – Currently capital gains get lower tax rates than ordinary income, but Biden would change this for taxpayers earning more than $1 million.
- Increase Social Security taxes – Biden would increase revenue to Social Security by imposing the 12.4% payroll tax (half of which is paid by the taxpayer) on all income above $400,000 in addition to the current structure of the tax.
- Changes in Estate Planning – This portion of the proposed plan is less “straightforward.” One the one hand, you have the estate tax exemption of $11.7 million being reduced by 50%. On the other hand, there is less clarity regarding important items such as step-up in basis, business asset exemptions, capital gains, etc.
Clearly there will be changes, adjustments and alterations during the “negotiation period” prior to any changes being implemented. Also note that it is highly unlikely that any new laws will be made retroactively to 2021. Our best advice is to keep an open line of communication with your tax and financial advisors prior to making any updates to your estate planning.
The Green Group welcomes the opportunity to discuss your 2021 year-end tax savings strategies with you by phone at (732) 634-5100 and ask for Len Green, CPA, John Wollenberg, CPA, Ava Agbulos, CPA, Jeff Greene, CPA or Tracy Zhang, CPA.
In the meantime, stay well.