While the markets haven't provided many reasons to celebrate, the year doesn't have to be a complete financial disaster. With some planning, you could cash in on tax-saving moves that can pay off when it comes time to file your taxes. But you must get it in gear since the window for most tax-saving actions closes on December 31st. Before you shut down and go full swing into holiday mode; consider the following potential tax moves:
Defer Income and Accelerate Deductions
Effective planning usually requires a good understanding of your current tax situation and a reasonable estimate of how things might change next year. Consider which year you think you will be in a higher bracket and which you will be in a lower bracket and adjust accordingly.
For example, if you plan on retiring at the end of this year, you probably expect to be in a lower tax bracket next year. Consider postponing any extra income from business debts, rent, or service payments until next year. Try to bunch allowable deductions this year if they exceed the current standard deduction. Before year-end, pay your property tax, consider charitable donations, or move up doctors' appointments to before the end of the year if you can claim medical expenses.
On the flip side, if you expect more income into 2023, try accelerating your income in 2022 and postponing and bunching deductions to next year.
Plan your Federal Withholding to Avoid Penalties
Our tax system is set up on a "pay as you go" basis, meaning taxpayers are required to pay taxes throughout the year as they earn income or make estimated tax payments. Taxpayers who ignore the rules that don't make timely payments may be assessed estimated tax penalties by the IRS. Those who anticipate they will owe taxes and penalties can consider a few changes before it's too late.
If you haven’t been paying estimated taxes, but should have, two strategies exist to "trick" the IRS into considering funds as being paid evenly throughout the year. If you are working, increase your withholding on forms 2-4 for the remainder of the year. If you are already retired, consider an IRA distribution equal to your estimated underpayment and have 100% of your payment withheld for federal taxes. Both strategies can fulfill your tax obligations and help you to void penalties.
Save More for Retirement
Two birds, one stone. The more money you earmark for retirement, the better or sooner that goal can become a reality. It's even better when saving for your goal provides a current tax break.
Deductible contributions to a traditional IRA and pre-tax contributions to an employer-sponsored retirement plan can reduce your taxes this year. For 2022, you can contribute up to $20,500 to an employer-sponsored pan, plus an additional $6,500 if you are over 50. The window to make 2022 contributions to an employer plan generally closes at the end of the year.
For the procrastinators, you have until April 18th, 2023, to make your 2022 IRA contributions. If you go straight from your turkey coma this thanksgiving into 2023 without making it through your year-end checklist, you may still be able to get a qualified deduction. The 2022 IRA contributions are capped at $6,000, or $7,000 if you are 50 or older. Qualifying deductions are subject to limitations.
Required Minimum Distributions
By far and away, one of the harshest IRS penalties are awarded to those that miss Required Minimum Distributions (RMDs). The penalty is 50% of any amount you fail to distribute as required. Over the last few years, adjustments to the calculation, COVID waivers, and changes to the requirements have caused some confusion.
Once you hit the golden age, currently 72, the IRS generally mandates that you take minimum distributions from your taxable retirement accounts. They want to begin collecting taxes on the funds you have deferred for years and offer few exceptions to avoid taxation. Distributions must be taken by December 31st to avoid penalties.
Better yet, if you are charitably inclined, consider gifting your RMD, up to a maximum of $100,000 to a charity and avoid federal tax liability on the portion directly gifted. Qualified Charitable Distributions (QCD) are a great way to lower you tax liability even if you don’t itemize and possibly help keep your income low enough to avoid IRMAA surcharges.
Save Money and Give More
Most people associate charitable planning strategies with complex ideas for the super-wealthy, but it doesn't have to be the case. Simple planning opportunities exist for everyday people who like the idea of reducing taxes and having more to give.
Not only does giving provide the heartfelt satisfaction of doing a good deed if done correctly, but you could also reduce your current income tax and avoid capital gains and lower future estate tax. If you itemize deductions on your federal income tax return, you can generally deduct charitable contributions within limits. Contributions of highly appreciated; [CM1] publicly traded securities offer an added incentive by eliminating the capital gains too. Finally, individuals can contribute $300 ($600 for married couples) directly to charities and write it off even if you do not itemize.
No one invests to lose money, but losses obviously can and do occur. If 2022 has brought us nothing else, it has brought loss harvesting strategies to the forefront.
Realizing losses can help you save on taxes in three ways:
- You can use the losses to offset capital gains realized from other securities. That is important as they help offset or negate the tax cost of rebalancing a taxable portfolio.
- If you have more significant losses than gains, up to $3,000 can reduce your annual income.
- The remaining losses carry forward into future years.
You need to sell the security in a taxable account to realize a loss. You can buy something else or wait 31 days to repurchase the same security to avoid wash sale rules.
Even if you do not sell any securities, you may end up with capital gains because mutual funds and ETFs that you hold may end up distributing gains, regardless of whether you want them. Even worse, a fund could end up paying a taxable capital gain when you have a loss. Funds generally publish estimates in November and December before they pay them. If you have a loss on a fund that is expected to pay a capital gain distribution, you could sell it before the ex-dividend date and avoid the associated taxes altogether. Depending on the situation, sometimes it's best to continue to hold the fund; sometimes, the benefits of selling outweigh the benefits of holding.
It's important to note tax considerations shouldn't drive your investment decisions. But if it makes sense, making lemonade with this year's sour market performance could save you some money.
In my years as an advisor, I have never had a client request strategy to increase tax liability or provide a tip to their least favorite Uncle, Uncle Sam. Considering tax saving strategies can put money back into your pocket, and in a year like 2022 with ugly market performance and high inflation seems just plain smart.
Ultimately, tax laws are complicated. Understanding the requirements and various opportunities can be downright confusing. These year-end tax tips just scratch the surface of each strategy. Advisors can help simplify your options and help you avoid any unnecessary payments to the IRS. Reach out to us if you need help.
This material is provided as a courtesy and for educational purposes only. Investing involves risk including loss of principal. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. This article contains links to articles or other information that may be contained on a third-party website. River City Wealth Management is not responsible for and does not control, adopt, or endorse any content contained on any third-party website. The information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. Past performance is not indicative of future results.