DEBUNKED: EOY tax planning "tips and loopholes"

[Michael Plaks]

Yes, this is an angry kind of post. I don't have much patience or sympathy towards the annual flood of "Terrific End-of-Year Tips to Cut Your Taxes" webinars, podcasts, articles and whatnot. You want a sample of this garbage "education"? Find a recent 30-min podcast on this topic from Ben Kinney & his buddies. I won't honor their cr@p with a link.

In this generic post, I will try to give you a basic overview of the most common EOY tax strategies, obviously without an actual discussion of each one. If you discover one that sounds potentially relevant, and you have not explored it - see if you can still get hold of your accountant to ask. Don't ask on this thread, as most tax strategies require a good understanding of your current and future tax situation first. Which should be one-on-one.

GROUP 1: Not tax strategies, but for some reason often promoted as such

Organize your records. Sure, I'm all for it. How is it a tax strategy though? Oh yeah, if you did not record it, you will not deduct it on your taxes. Not rocket science. Frankly, if you don't keep track of what you spend for business, real tax strategies is not your problem at the moment. You can stop reading and start organizing.

Buy more properties. Wow, this is powerful. You've never thought of this one, have you? Aren't you glad that some antisocial media influencer brought this "tax strategy" to your attention? By the way, buying a property in late December will probably not change your taxes for this year. By all means, buy more properties, but not for taxes. Buy them to grow your portfolio, and buy good properties.

Form an LLC. An LLC by itself does not change anything for taxes. You don't get more deductions or lower your taxes with an LLC. You might have a good reason to create one, but it's almost never for tax reasons.

"Deduct everything." It's a sad state of affairs when this phrase passes as a tax strategy. On one hand, there're a number of legitimate tax deductions, credits, and loopholes that are not well-known. But the only strategic thing about them is that you need to keep good records and hire a tax professional who knows how to maximize the tax savings from things you already paid for. 

On the other hand, this phrase is often used by the likes of Uncle G (who, having an accounting degree, should really know better) to suggest claiming personal expenses as business deductions. Things like your vacations, entertainment, toys, food, clothes, housekeeping, pets, guns etc. There is some room for creativity here, but it takes careful planning and execution, and there is only so much you can push it before crossing the line from aggressive but legal to reckless and punishable.

GROUP 2: Tax strategies that do not belong on the EOY to-do list

Form an S-corporation. The tax benefits of S-corporations are widely misunderstood and over-promoted. Maybe it can help you in your specific situation, it depends. But if so, you don't have to convert your LLC to an S-corp (or create one) in December. Doing it in December will not save you any taxes anyway. While on the topic, an S-corp will never save you anything on your rental properties, so don't place rentals into an S-corp.

Form a C-corporation. It is far more complicated than an S-corporation. (Think "S" means "Simple", and "C" means "Complicated") Don't try it at home. Get C-ompetent help, not just S-omeone. And it is not something you do retroactively anyway, only proactively.

Contribute to retirement plans. Yes, 401(k) plans, IRAs, SEP-IRAs and all other kinds of retirement plans are still the backbone of your wealth accumulation, especially if they are self-directed. For the most part, they all can be created and funded next year, with a few exceptions. Probably too late to form the more complex plans for 2021, so plan for 2022.

Start an HSA plan. You cannot just casually start this medical expense plan, it's not an IRA. You need to carry a special type of health insurance, not the traditional kind. And you needed to have an HSA-compatible insurance on December 1st, otherwise it's too late for this year. And there're restrictions on how you can use these accounts. For example, you cannot fund your HSA account and then turn around and reimburse yourself for expenses previously paid. Maybe consider an HSA for the next year.

Hire your wife, kids and other relatives. First, this is not (just) a tax move. It changes the family dynamics, and not always for the better. But if employing your family works for you and for them - great, go ahead. Hire them for the next year. You just cannot start it on the last week of December and pay them for the work you suddenly "remembered" they did for you all year. Aka fraud.

Accelerated depreciation, bonus depreciation, Section 179. All of these are legitimate tax concepts. They may or may not help you, it is case-by-case. Either way, there is nothing you need to do - now or later. Your accountant will do it for you at tax time if applicable.

Cost segregation. It is actually just a tool to create the already mentioned accelerated depreciation. If this strategy can help you, you don't have to rush. To apply cost segregation to your 2021 taxes, you need to do it at any time before you file your taxes, not before the New Year's champagne toast.

Home office. It's great if you qualify, it has many benefits. It's not a strategy though, at least not something you do in December. You either had it in 2021 or not. If not, consider establishing one for 2022, after learning the rules. Answering your phone calls while watching the games does not turn your living room into a home office.

14-day free rent aka Augusta rule loophole. It's a good little loophole for a short-term rental of your home, including renting it to your own separate business. If it's something that can help you, then plan to implement it next year. You should not manufacture it retroactively for this year.

GROUP 3: Tax strategies that are really for EOY consideration

Delay receiving income into January. Yes, it will delay your taxes on this income for another year. And I will always be against delaying the receipt of money, no exceptions, including for tax reasons. You never know what will happen or not happen tomorrow. I have stories for a book or two. Get you money ASAP, period.

Prepay your expenses in December. Yes, it might give you the deduction for 2021, one year sooner than if you wait. For example, you can prepay for your marketing, your entire office rent for next year, your insurance premiums, your property taxes, your attorney's and accountant's fees, and so on. Before you do so, make sure that it will, in fact, reduce your current year's taxes. Often it won't, so there's no point to prepay. By the way, credit card expenses count when charged, not when the credit card bill is paid.

Buy more stuff. This popular advice really irks me. If you buy a computer for $1,000 and write it off of your taxes, it is not free to you! You simply get a discount on this purchase, equal to your tax rate. Only buy stuff that you actually need, and only if you need it now or soon. And remember: if you bought it now, you won't be buying it next year, so you basically rob your next year of this tax deduction. You usually end up with the same amount of taxes over two years, you just get your Amazon package and your tax deduction one year sooner.

Buy a new car. Argh. Maybe, but... First: see above about buying more stuff in general. It won't be a free truck. So, do you need a new truck? Like, right now? Second: writing off the full cost of a new car is badly overhyped. It's not just any kind of car, and even if you buy the "right" vehicle, it has to be used 100% for business, which is rare. Otherwise, you can only write off the business portion. Third: even if your new toy qualifies for a huge depreciation deduction, your allowable deduction may be limited, and may even be zero. Fourth: even if the entire deduction is available, it results in much smaller automobile deductions in future years and extra taxable income when you sell the vehicle or trade it in. No, you cannot "write off a new truck every 3 years" as these reckless YouTube professors suggest.

Prepay or delay personal itemized deductions. This has to do mainly with the timing of property tax payments for your own home (not for your investment properties) and your charitable donations. It is very much case-by-case and requires understanding of the current regime for personal itemized deductions, as well as gambling on the proposed changes to this regime by the current administration. Very large out-of-pocket medical expenses are also part of this game.

Balance gains and losses on your investments. The goal is legitimate: due to complex tax rules, you have opportunities to game the system by selling some of your investments and intentionally generating either gains or losses. However, I shudder at the popular suggestion to sell some of your investments for tax purposes, often coming from commission-based brokers and financial advisors. Very wrong approach! You sell your investments whenever it no longer makes business sense to hold them, not when you "need" it for tax reasons! Sell only when the timing is right from an investment angle. Wait to sell for tax reasons - and watch your investment suddenly lose value. Sell too soon for tax reasons - and pull your hair watching this investment climb up while no longer in your portfolio.

Harvest investment gains or losses. This is a variation of the above strategy, except you do not dump the investment. You sell it and immediately buy it back. Why? Because it allows you to "harvest" the accumulated gain or loss for tax purposes while still holding the investment. You need to be careful around the risks of sudden price changes, market stoppages and watch for transaction fees. Most importantly, harvesting losses is only possible if you reinvest in a similar but not the same exact investment. This has its own risks.

Harvest crypto losses. Unlike investments in stocks and mutual funds, crypto investments allow loss harvesting without the 30-day "wash sale" rules. Due to the extreme volatility of crypto and potentially high transaction costs, you need to be careful with harvesting crypto losses.

Pick tax-efficient investments. In my book (not yet written, in case you ask), this is the worst kind of advice. Example: invest in syndications / short-term rentals / oil & gas wells / solar projects / conservation easements, and so on, due to the tax losses they generate. Or, the opposite: avoid such and such investments because you pay a lot of taxes when they grow. Huh? My tombstone should read: pick efficient investments, not tax-efficient investments. Whether it's stocks, real estate or any other investments: focus on their cash flow, appreciation/growth potential and risks, not on their taxation. Don't miss the forest for the trees.

Set up last-minute payroll. If you operate as a separate business entity - S-corp, C-corp or a partnership - you may be required to have formal compensation for yourself: either a W-2 salary or so-called guaranteed payments. If none has been set up yet, it may be urgent, depending on your situation.

Reimburse the owners for business expense. If your business entity has an accountable plan for business expense reimbursements, make sure to issue the appropriate reimbursements in December. If you do not yet have such a plan, create one ASAP. Why bother? Without an accountable plan, an owner of an S-corporation has no way to deduct his personally-paid expenses such as business use of his car/truck. This can really hurt.

Convert IRAs and 401(k) to Roth. In the long run, Roth-style retirement accounts beat the Traditional retirement accounts. In other words, you're better off with Roth. If you have non-Roth retirement accounts, consider converting them to Roth accounts. You can always do it with your own IRAs, however your employer's 401(k) may or may not have such an option. Since conversion to Roth creates a one-time tax hit, it should be carefully planned. Timing matters, and there're some aggressive strategies for self-directed accounts. If you want your Roth conversion to count for 2021, it must be completed in December, so hurry up.

Take RMDs. If you're over 72, you may have to take Required Minimum Distributions (RMDs) out of your retirement accounts by the end of the year - or pay stiff IRS penalties. Your IRA custodian should have advised you by now and calculated the amount for you. If you have self-directed accounts and are your own custodian, this burden is on you.

Use your employer's tax-advantaged benefits. Depending on your employer's plans, you may have to use some of your "use it or lose it" benefits urgently.

Save for college. There're various financial plans designed to help with college financing, and some of them come with tax benefits. More than a tax strategy, these are education planning tools, and they need to be addressed in a broader context than just taxes. Many of those plans have a December 31 deadline for annual contributions. Unless you believe that our government should and will provide free education for all.

Give to charities. If you have substantial (usually means 5 digits or more) donations, tax planning opportunities can get very complex. Get professional advice before donating.

Gift to family and others. There are no tax deductions for such gifts, however you have a $15k per recipient annual gift limit that avoids the chore of filing a gift tax return. Gifts don't have to be in cash. Large gifts, including real estate, may benefit from structuring around this limitation. 

Cancel bad debts. If you have some debts owed to you that you gave up on, you may want to establish them as uncollectible in December. This way, you may be able to write off the losses on your 2021 tax return. The exact steps depend on the nature of the defaulted debts and on your local laws.

State income tax planning. Depending on your state and your business, you may have some unique and potentially urgent opportunities. They include purchasing state tax credits and prepaying state income tax via pass-through entities: S-corporations and partnerships. Definitely requires professional advice from someone familiar with your state tax laws.

GROUP 4: Tax strategies specific to December of 2021

Roth conversion. Roth conversion might be restricted by the proposed Biden tax reform if it happens in 2022. This is an incentive to do your Roth conversion this December if you decided to convert.

Backdoor/Mega Roth contribution. This popular loophole might be closed in 2022 by the pending legislation. It is possible that your window is closing this week, so don't wait if you're planning to do it. Warning: backdoor Roth technique is tricky and may accidentally create more taxable income for you in some cases.

Small charitable cash donations. In 2021, almost anybody can benefit from up to $300 of cash donations to charities. For married couples, it doubles to $600. It makes sense to hit this limit by the end of December. Cash only, not your used underwear or broken appliances from teardowns.

Opportunity Zone Funds investments. It's probably too late by now, unless you have started the process already. If this concept is unfamiliar, then continue to ignore it.

In closing: The dangers of shifting the timing of your income, expenses, and business transactions.

A purely mathematical exercise may indicate some beneficial timing for this or that. Before implementing such timing manipulations, consider the risks:

1. You may not be able to receive the money later
2. You may not be able to close the deal later
3. You may not be able to buy the goods or services later
4. Even if you are able to do it, you may not be able to keep the same price or the same timeline
5. You may miss other opportunities meanwhile

Now tell me - are these risks worth potential tax savings? Does it matter how much you could have saved on taxes if your deal fell apart while you waited? Did Covid teach you anything about predictability? 

And besides, you usually do not save taxes by these timing maneuvers. You simply delay them for a year. 

But wait - there is more! Next year, your income may change; your family or tax situation may change; tax laws may change. As a result, you might end up increasing your taxes by delaying income and accelerating deductions.

Did I miss something?

Absolutely. There're quite a few more opportunities/strategies to consider, especially for high-net-worth and/or high-earnings investors. There're also many narrow scope planning opportunities that are less common than those I listed. And some good ones I may have overlooked unintentionally. Feel free to add yours in comments.

PS. This post is a generic overview for educational purposes. It is not tax advice for your situation, which I have no way of evaluating. All real tax advice should be custom and one-on-one.

PPS. If you ask specific "what about my situation" questions and clarifications on this thread, I am unlikely to have time to provide such personalized help here, sorry. This should be a job for your personal accountant/tax strategist, just like I do it for my clients.