With only one month left to go in 2022… It’s time to review your year-end tax plans. Knowing the federal tax breaks to take advantage of and the pitfalls to avoid can save you money.
Let’s start with individual tax planning.
Look at the overall impact on 2022 and 2023. The end game is to reduce your taxes over both years. Most will benefit by accelerating write-offs from 2023 into 2022 while deferring taxable income. Others may profit by taking the opposite approach.
Itemizers have the most flexibility in shifting write-offs, as shown here.
Home interest. If you pay your Jan. 2023 mortgage bill before year-end, you can deduct the interest portion on Schedule A of your 2022 income tax return.
State and local taxes. If under the $10,000 cap and your locale allows it, pay the property tax bill due in Jan. 2023 in Dec. of this year so you can deduct it.
Bunch into 2022 charitable gifts you would usually give over multiple years.
And think about incurring additional medical expenses before year-end if your medicals are near or have topped the 7.5%-of-adjusted-gross-income threshold. The list of eligible medicals is broad. It includes out-of-pocket payments to doctors, dentists, optometrists and other medical professionals; mental health services; health insurance and Medicare premiums; prescription drugs; glasses and hearing aids. Also, the unreimbursed cost of long-term care and certain home improvements to accommodate a disability or physical illness, such as a ramp and wide doorways.
Heed the timing rules for charitable donations and other tax-deductible items. Put checks in the mail by year-end to lock in a 2022 deduction. For charges made with bank credit cards, you can claim the write-off in the year you charged the expense.
Use your annual gift tax exclusion. You can give up to $16,000 to each person this year without having to tap your lifetime estate and gift tax exemption, pay gift tax or file a gift tax return. The recipient isn’t taxed on the amount received, either. Any unused amount is gone forever. You can’t give extra next year to make up for it. Your spouse can also give $16,000. Say you’re married with two kids and one grandkid. You can give each relative up to $32,000 ($96,000 total) this year in excludable gifts. Annual gifts over the exclusion amount will trigger filing of a gift tax return for 2022, but no federal gift tax will be due unless your total lifetime gifts exceed $12,060,000.
Here are two ways to help your kids or grandkids with their college education:
Pay tuition directly to the school. The payment is nontaxable to the student, it doesn’t count against the $16,000 gift tax exclusion, and it reduces your estate.
Contribute to a 529 plan. You can shelter from gift tax up to $80,000 in contributions per beneficiary this year ($160,000 if your spouse agrees). If you put in the maximum, you’ll be treated as gifting $16,000 (or $32,000) to that beneficiary in 2022 and in each of the next four years…2023 through 2026.
With the stock market’s bumpy year so far…review your investment portfolio.
Think about selling some duds to offset any gains from the rare winners. Capital losses offset capital gains plus up to $3,000 of other income. Excess losses are then carried over to the next year and can help offset future capital gains.
But don’t run afoul of the wash-sale rule, which bars a capital loss write-off if you purchase substantially identical securities up to 30 days before or after a sale. Any disallowed loss is added to the tax basis of the replacement securities.
The wash-sale rule can catch you by surprise. For example, if you buy stock in an IRA after selling the same stock at a loss in your taxable investment account, or if you sell a mutual fund at a loss shortly after the date a dividend is reinvested.
If you have capital loss carryforwards, cull your portfolio for capital gains. That’s because your net gains…up to the carryover amount…won’t be taxed at all.
See if you qualify for the 0% rate on long-term gains and qualified dividends. If taxable income other than long-term gains or dividends does not exceed $41,675 on single returns…$55,800 for head-of-household filers or $83,350 on joint returns… then your qualified dividends and profits on sales of assets owned more than a year are taxed at a 0% federal rate until they push you over the threshold amounts.
Here are three scenarios to illustrate the rules. In the following examples, you have a married couple with $12,000 of qualified dividends and long-term gains, which are included in taxable income. In the first example, the couple has $70,000 of taxable income. The full $12,000 of gains and dividends is taxed at the 0% rate. Let’s now assume the couple has taxable income of $90,000. $5,350 of the gains and dividends ($83,350 - ($90,000 - $12,000)) gets the favorable 0% tax rate, and $6,650 is taxed at 15%. If the couple instead has $115,000 of taxable income, the 0% rate doesn’t apply and the full $12,000 of gains and dividends is taxed at 15%.
The 0% federal rate isn’t all gravy. Zero-percent-rate gains and dividends might not be taxed at the federal level, but they do hike adjusted gross income. The extra AGI can cause more of your Social Security benefits to be taxed. Also, your state income tax bill may jump, since many states tax gains as ordinary income.
Take steps to limit the pesky 3.8% surtax on net investment income. The tax applies to single filers with modified adjusted gross incomes above $200,000 and joint filers over $250,000. Modified AGI is AGI plus tax-free foreign earned income. The tax is due on the smaller of NII or the excess of modified AGI over the thresholds.
Included in net investment income: Dividends, taxable interest, capital gains, passive rents, annuities and royalties. Income from a passive activity is also NII if the taxpayer doesn’t materially participate, even if the income is from a business.
Buying municipal bonds can help keep the surtax at bay. Tax-free interest is not only exempt from the 3.8% bite, but it also doesn’t affect the owner’s AGI.
Be wary of buying a mutual fund late in the year for your taxable portfolio. If you are thinking about investing in a dividend-paying mutual fund near year-end, check its dividend distribution schedule. Buying a fund shortly before the record date this year means you will get the dividend payout for 2022, which you will owe tax on when you file your return next year. You aren’t better off financially, however, because the fund’s share price falls by the amount of the distributed dividend. To avoid this, think about buying the mutual fund after the dividend record date.
Check your health flexible spending account. You must clean it out by Dec. 31 if your employer hasn’t implemented the 2½-month grace period or $570 carryover rule. Otherwise, you will forfeit any money left in your account.
Also, consider electing to contribute to a health FSA for 2023. You can put in up to $3,050 next year to your employer’s health FSA to cover out-of-pocket medicals. Amounts contributed to an FSA escape federal income tax as well as payroll taxes.
Max out your 2022 401(k) and IRA contributions. You have until Dec. 31 to stash money in 401(k)s, 403(b)s and other workplace retirement plans, and until April 18, 2023, to contribute to a traditional IRA or a Roth IRA for 2022. Individuals can contribute up to $20,500 to a 401(k), plus $6,500 more if age 50 or up. The 2022 payin cap for IRAs is $6,000, plus an extra $1,000 if age 50 and older.
Now might be a good time to convert a traditional IRA to a Roth IRA, given the ailing stock market. You will have to pay tax on the converted amount, but once the money is in the Roth, future earnings are tax-free. Key to any decision are present and future tax rates. If you expect that your tax rate in retirement will be the same as or higher than the rate on the conversion, switching to a Roth can pay off taxwise, provided you don’t have to tap IRA funds to pay the tax bill on the conversion. If your tax rate in retirement will be lower, then tax-free payouts could be less advantageous. You needn’t convert your entire account balance at once. You can transfer the money in increments over time, and space out the tax hit.
Heed the required minimum distribution rules for traditional IRAs.
Individuals 72 and older must take annual withdrawals or pay a 50% penalty. To arrive at the 2022 RMD amount, start with your IRA balances as of Dec. 31, 2021, and use the tables in IRS Pub. 590-B. The amounts can be taken from any IRA you pick.
If 2022 is your first RMD year, you have until April 3, 2023, to take the RMD. The distribution will still be based on your total IRA balance as of Dec. 31, 2021. If you opt to defer your first RMD to 2023, you will be taxed in 2023 on two payouts: The deferred one for 2022 and the RMD for 2023. This will hike your 2023 income.
Similar rules apply to 401(k)s, with two exceptions. People who work past 72 can generally delay taking RMDs from their current employer’s 401(k) until they retire. Additionally, if you have multiple 401(k)s, an RMD must be taken from each account.
Charitable donations made directly from a traditional IRA can save taxes. People 70½ and older can transfer up to $100,000 yearly from IRAs directly to charity. Qualified charitable distributions can count as RMDs, but they’re not taxable and they’re not added to your AGI, so they won’t trigger a Medicare premium surcharge in 2024. The QCD strategy can be a good way to get tax savings from charitable gifts for taxpayers not taking charitable write-offs because of higher standard deductions.
Be sure to get a receipt from the charity to substantiate the donation.
Make the most of your generosity when donating to charitable organizations.
Contribute appreciated property, such as stocks or shares in mutual funds. If you’ve owned the property for more than a year, you can deduct its full value in most cases if you itemize. Neither you nor the charity pays tax on the appreciation.
Don’t donate assets that have dropped in value. If you do, the loss is wasted.
Boost your federal income tax withholding if you expect to owe tax for 2022.
It can help avoid an underpayment penalty. You’re off the hook for the fine if you prepay, via tax payments or withholding, at least 90% of your 2022 total tax bill or 100% of what you owed for 2021 (110% if your 2021 AGI exceeded $150,000). The Revenue Service has a helpful withholding tax estimator tool on its website.
You can give your employer a new W-4 to have more tax taken from wages.
IRA owners taking RMDs can use this income tax withholding strategy: Have more tax withheld from a year-end distribution from your traditional IRA. Tax withheld at any point in the year is treated as if evenly paid throughout the year.
Don’t forget about the 0.9% Medicare surtax on earned income. It kicks in for joint filers with earnings over $250,000…$200,000 for singles and household heads. Employers must begin to withhold the tax from worker paychecks in the period when wages first exceed $200,000, regardless of the employee’s marital status.
There are very generous write-offs for business asset purchases this year.
Businesses can save lots on taxes with first-year 100% bonus depreciation. Firms can deduct the full cost of new and used qualifying business assets, with lives of 20 years or less, that they buy and place in service by Dec. 31. The cost of a qualified film, television or theatrical production is eligible, too.
Purchase and place assets in service this year if you want the full break.
Bonus depreciation isn’t as valuable after 2022. Unless Congress acts, the 100% write-off phases out 20% for each year after 2022. So for 2023, it’s 80%.
Expensing is also available. Businesses can expense up to $1,080,000 of new or used business assets. This limit phases out once more than $2,700,000 of assets are put into service during 2022. Note that the amount expensed can’t exceed the business’s taxable income. Bonus depreciation doesn’t have this rule.
There are lots of breaks for buyers of business vehicles under the tax laws. If bonus depreciation is claimed, the first-year ceiling is $19,200 for new and used cars first put in service this year. The second- and third-year caps are $18,000 and $10,800. After that…$6,460. If no bonus depreciation is taken, the first-year cap is $11,200.
Buyers of heavy SUVs used solely for business can write off the full cost, thanks to bonus depreciation. SUVs must have a gross weight rating over 6,000 pounds.
With 80% bonus depreciation in 2023, the above breaks won’t be as valuable.
Up to 100% of the cost of a big truck used in business can be expensed, subject to the rule that total expensing can’t exceed taxable income from the business.
Don’t forget about the 20% deduction you can take on pass-through income. The self-employed and owners of LLCs, S corporations and other pass-through entities can deduct 20% of their qualified business income, subject to limitations for individuals with taxable incomes of more than $340,100 for joint filers and $170,050 for all others. If you’re close to or just above the income limits, consider accelerating deductions or deferring income so that you can come in under the dollar thresholds for the year.
Gig workers who aren’t employees can claim this write-off from their earnings.
Also, Schedule E rental income may be eligible for the deduction. But applying the QBI rules to income from rentals of real property is thorny. IRS regs say the rental activity must generally rise to the level of a trade or business, a standard which is based on each taxpayer’s particular facts and circumstances. Alternatively, there is a safe harbor if at least 250 hours a year of qualifying time are devoted to the activity by the taxpayer, employees or independent contractors.
Shareholders in C corps should weigh taking dividends in lieu of salary if the owner is in a high tax bracket. The owner’s preferential tax rate on dividends plus the corporation’s payroll tax savings from paying dividends instead of salaries can exceed the firm’s forgone tax benefit from not being able to deduct the dividend. This doesn’t work for S corporations, since their income passes through to owners.
Business owners can shift income and expenses between 2022 and 2023. Professionals can postpone their year-end billings to collect less revenue in 2022. Or they can speed them up if they expect to be in a higher tax bracket next year. Firms can juggle their income by shifting some expenses from one year to another.
It’s easier for cash-method firms to shift income and expenses between years than for taxpayers who adopt the more complicated accrual method of accounting.
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