Four Smart Ways to Close Out a Bewildering Tax Year

(Bloomberg Opinion) -- The countdown to the end of the year always comes with gobs of generic tax advice. Maximize 401(k) contributions. Deplete flexible savings accounts. Lock in stock losses to offset capital gains.

OK, fine. But there’s more to think about this year than usual. There are a handful of substantial tax changes on the horizon, and with congressional Democrats introducing half a dozen different flavors of cuts, hikes, credits and deductions, it’s easy to lose track.

So here's a rundown of the most important changes poised to take effect five weeks from now, and how to take advantage of them or at least minimize the pain they could cause.

Roth Runaround

Most of the changes to retirement tax breaks enjoyed by the wealthy in earlier iterations of Democrats' proposals have been scrapped or delayed. But there's one significant change that will bar high earners from using a special retirement account known as a Roth IRA. Roth savers don’t get a deduction for money they deposit but can make tax-free withdrawals later on.

The accounts were devised to help middle class people sock money away, so they have restrictions on who can use them and how much can be put in. But a loophole known as a "mega-backdoor" conversion has allowed top earners to circumvent the rules for years. The method involves using a 401(k) account that permits after-tax contributions and then converting some or all of that money into a Roth.

Pre-tax contributions to 401(k)s are capped at $19,500 this year (or $26,000 for those 50 and older), but the limit for total contributions is $58,000 (or $64,500 for those 50 and older) — meaning those looking to funnel money into a Roth have an extra $38,500 to play with.   

The version of the tax and spending bill passed earlier this month by the House of Representatives would put an end to those 401(k) after-tax swaps starting next year. Taxpayers usually have until April to make IRA contributions for the previous tax year, but accountants say the Internal Revenue Service may not look so favorably on those who still try to execute a mega-backdoor Roth next year. Consider yourself warned.

SALT Prepayment

Oh, SALT. The fate of the fiercely contested limit on deductions for state and local taxes is still up in the air, but there’s a possibility that the current deduction cap of $10,000, a product of the 2017 Republican tax overhaul, will be increased. The House bill calls for hiking the limit to $80,000 for all taxpayers, while key Senate Democrats have said they're working on a plan to create an unlimited deduction for those earning up to $400,000 and phase it out for higher earners.

It's important to note that the House plan would increase the cap retroactively. For residents of high-tax states who itemize their deductions, it may be a smart move to make quarterly estimated payments for state and local taxes for the fourth quarter of 2021 before Dec. 31, according to Steve Rossman, a certified public accountant and shareholder at Drucker and Scaccetti.

That way they’ll be able to take advantage of the higher itemized deduction for 2021 if the provision ends up passing, rather than having their 2021 payment be part of 2022's itemized deductions if they wait until January.

Still, while doing so could result in a bigger SALT deduction, it could also trigger the alternative minimum tax (since the purpose of the tax is to ensure all taxpayers face a minimum amount of tax), so proceed with caution.

Crypto Sales

Until now, cryptocurrency owners have enjoyed an advantage over stock investors. Crypto isn't subject to the wash/sale rule, which prohibits stock investors from taking a deduction for a loss if they repurchase the same or a similar security within 30 days. That has meant a crypto owner could sell unrealized losses by the end of the year, to offset some gains, and then buy the same crypto back a few days later in the new year.

Not so much anymore. The House bill added digital assets to the list of securities affected by the wash/sale rule and applied the change to dispositions made after Dec. 31. It's unclear how the Treasury Department and the IRS will define "similar" securities for digital coins though, so stay tuned.

Business Bunching

Many business owners haven't had to worry about the 3.8% tax on investment income that applies to everyone else who earns more than $200,000 (or $250,000 for those married filing jointly). That gift had been courtesy of an exemption for those whose income is derived from actively being involved in a business. 

But the House legislation says business owners who don't pay self-employment taxes and make more than $400,000 (or $500,000 for those married and filing jointly) will now be subject to the 3.8% tax, full stop.

Before it takes effect on Jan. 1, business owners should figure out if there are ways to get below those income thresholds. Those close to the limit may want to think about upping contributions to retirement plans or donating to charity to reduce their taxable income.  

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.

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