Year-end Tax Planning for Individuals
By: Tax Hotline
Fall 2022 (Vol. 40, No. 3)
With the end of the year fast approaching, now is the time to take a closer look at tax planning strategies that could reduce your tax bill for 2022.
General tax planning strategies for individuals include accelerating or deferring income and deductions and carefully considering timing-related tax planning strategies concerning investments, charitable gifts, and retirement planning. For example, you may consider selling any investments on which you have a gain (or loss) this year or if you anticipate an increase in taxable income in 2022, and are expecting a bonus at year-end, try to get it before December 31.
Bunching charitable deductions every other year is also a good strategy if it enables the taxpayer to get over the higher standard deduction threshold under the Tax Cuts and Jobs Act of 2017. Another option is to put money into a donor-advised fund that enables donors to make a charitable contribution and receive an immediate tax deduction.
Medical expenses are deductible only to the extent these expenses exceed 7.5 percent of your AGI; therefore, you might pay medical bills in whichever year they would do you the most tax good. By bunching medical expenses into one year you have a better chance of exceeding the thresholds.
If you think your income may increase in 2023 and your company grants stock options, you may want to exercise the option or sell stock acquired by exercising an option in 2022.
If your self-employment income is lower this year, send invoices or bills to clients or customers with incentives if they in full by the end of December. Conversely, if you want to minimize income this year, consider deferring sending invoices until January 2023. If you are worried you have not had enough taxes withheld this year, there is still time to increase your withholding before year-end and avoid or reduce the penalty by covering the extra tax in your final estimated tax payment and using the annualized income method.
Where tax benefits are phased out over a certain adjusted gross income (AGI) amount, a strategy of accelerating income and deductions might allow you to claim larger deductions, credits, and other tax breaks for 2022, depending on your situation.
Accelerating income into 2022 is also a good idea if you anticipate being in a higher tax bracket next year. Especially if your 2022 earnings are close to threshold amounts, making you liable for the Additional Medicare Tax or Net Investment Income Tax ($200,000 for single filers and $250,000 for married filing jointly). If you fall in this category, look out for the following concerns:
Taxpayers close to threshold amounts for the Net Investment Income Tax (3.8 percent of net investment income) should pay close attention to “one-time” income spikes such as those associated with Roth conversions, sale of a home or any other large asset that may be subject to tax. For example, paying an estimated state tax installment in December instead of at the January due date or paying your entire property tax bill, by year- end. (Note: The deduction for state and local taxes is capped at $10,000) Paying 2023 tuition in 2022 to take full advantage of the American Opportunity Tax Credit, an above-the-line tax credit worth up to $2,500 per student. Forty percent of the credit is refundable, which means you can get it even if you owe no tax.
Taxpayers whose income exceeds certain threshold amounts ($200,000 single filers and $250,000 married filing jointly) are liable for an additional Medicare tax of 0.9 percent on their tax returns. High net worth individuals should consider contributing to Roth IRAs and 401(k) because distributions are not subject to the Medicare Tax. Also, if you’re a taxpayer who is close to the threshold for the Medicare Tax, it might make sense to switch Roth retirement contributions to a traditional IRA plan, thereby avoiding the 3.8 percent Net Investment Income Tax (NIIT) as well.
The alternative minimum tax (AMT) applies to high- income taxpayers that take advantage of deductions and credits to reduce their taxable income. The AMT ensures that those taxpayers pay at least a minimum amount of tax. In 2022, the phaseout threshold increased to $539,900 ($1,079,800 for married filing jointly). AMT exemption amounts for 2022 are as follows: $75,900 for single and head of household filers, $118,100 for married people filing jointly and for qualifying widows or widowers, $59,050 for married people filing separately.
Charity. Property, as well as money, can be donated to a charity. You can generally take a deduction for the property’s fair market value. You may also be able to deduct charity-related travel expenses and some out- of-pocket expenses. You cannot deduct for the time or services you donate, but you may deduct related expenses such as materials, uniform expense, or travel. Taxpayers who are age 70 1/2 and older can reduce income tax owed on required minimum distributions (RMDs) from IRA accounts by donating them to a charitable organization(s) instead. There is an annual maximum amount of $100,000 for single filers and $200,000 for married couples.
Investment decisions are often more about managing capital gains. Taxpayers below threshold amounts in 2022 might want to take profits, whereas taxpayers above threshold amounts might want to take losses. Tax-loss harvesting - offsetting capital gains with losses - may be an excellent strategy to use if you have significant losses this year or an unusually high income.
Minimize taxes on investments by judicious matching of gains and losses. Where appropriate, try to avoid short- term capital gains, which are taxed as ordinary income (i.e., the rate is the same as your tax bracket). In 2022, tax rates on capital gains and dividends remain the same as 2021 rates.
0% - Maximum capital gains tax rate for income up to $41,675 for single filers, $83,350 for married filing jointly.
15% - Capital gains tax rate for income of $41,675 to $459,750 for single filers and $83,350 to $517,200 for married filing jointly.
20% - Capital gains tax rate for taxpayers above $459,750 for single filers, $517,200 for married filing jointly.
As a general rule, if you have a significant capital gain this year, consider selling an investment on which you have an accumulated loss. You can claim capital losses up to the amount of your capital gains plus $3,000 per year ($1,500 if married filing separately) as a deduction against income.
The Wash Rule Sale. After selling a securities investment to generate a capital loss, you can repurchase it after 30 days. The loss will be disallowed if you repurchase it within 30 days. Or you can immediately repurchase a similar (but not the same) investment, e.g., an ETF or another mutual fund with the same objectives as the one you sold. If you have losses, you might consider selling securities at a gain and then immediately repurchasing them since the 30-day rule does not apply to gains. That way, your gain will be tax-free, your original investment will be restored, and you will have a higher cost basis for your new investment (i.e., any future gain will be lower).
Another concern when selling investments is the Net Investment Income Tax (NIIT), a 3.8 percent tax applied to investment income such as long-term capital gains for earners above a certain threshold amount ($200,000 for single filers and $250,000 for married taxpayers filing jointly). Short-term capital gains are subject to ordinary income tax rates and the 3.8 percent NIIT.
Don’t forget about year-end dividends, a last minute payment could make a substantial difference in the tax you pay.
The federal gift and estate tax exemption is currently set at $12.06 million in 2022. The maximum estate tax rate is set at 40 percent. Sound estate planning often begins with lifetime gifts to family members. In other words, gifts that reduce the donor’s assets are subject to future estate tax. Such gifts are often made at year-end, during the holiday season, in ways that qualify for exemption from federal gift tax. Gifts to a donee are exempt from the gift tax for amounts up to $16,000 a year per donee in 2022 and increase to $17,000 for 2023. To use the exemption for 2022, you must make your gift by December 31. Husband-wife joint gifts to any third person are exempt from gift tax for amounts up to $32,000 ($16,000 each).
You may also choose to give property you expect to increase substantially in value later. Shifting future appreciation to your heirs keeps that value out of your estate. You may choose to give property that has already appreciated. The idea here is that the donee, not you, will realize and pay income tax on future earnings and built-in gain on the sale.
Children with unearned income are allowed a standard deduction of the greater of $1,150 or the child’s earned income plus $400, but not more than the regular standard deduction ($12,950 in 2022). The next $1,150 of unearned income is taxed at the child’s tax rate. Any amounts over $2,300 are taxed at the rates for single individual filers. However, if the child is under age 19 (or under age 24 and a full-time student) and both the parent and child meet certain qualifications, then the parent can include the child’s income on the parent’s tax return.
Roth conversions allow taxpayers to convert funds in a pre-tax individual retirement account or 401(k) to a post- tax Roth IRA. The amount withdrawn from the IRA is considered income and subject to tax; however, future Roth IRA distributions are tax-free. You can convert all or part of it during different tax years. For many experiencing decreased value in your IRA, converting to a Roth IRA from a traditional IRA makes sense in 2022. Lower account value equals less tax due.
If your insurance qualifies as a high deductible plan, consider setting up a Health Savings Account (HSA). You can deduct contributions to the account, investment earnings are tax-deferred until withdrawn, and any amounts you withdraw are tax-free when used to pay medical bills. In effect, medical expenses paid from the account are deductible from the first dollar (unlike the usual rule limiting such deductions to the amount of excess over 7.5 percent of AGI). For amounts withdrawn at age 65 or later not used for medical bills, the HSA functions much like an IRA.
Maximize contributions to 529 plans, which can be used for elementary and secondary school tuition, college, or vocational school.