Act Now – Save 2022 Taxes Later
With the calendar days in 2022 quickly ticking by, you must act now if you want to save on your 2022 tax bill! Here are some of the areas to focus on during the month of December (and in some cases beyond).
Withholding & Estimated Taxes
After a year of the highest inflation growth in four decades, the IRS has increased the penalty on tax underpayments to 6% and will likely raise this to 7% on January 1st. To avoid such penalties, most filers must pay 90% of their taxes long before the April tax deadline to avoid the penalty. The due date is December 31, 2022 for employees and January 17, 2023 for those making fourth quarter 2022 estimated tax payments.
The question becomes, have you had the right amount withheld from your paycheck? You should check at least once a year, or even more frequently if you’ve had a major life change. In general, the IRS advises taxpayers to make changes if they hold more than one job at a time or have income from sources not subject to withholding. The IRS has provided an online withholding estimator. The calculator may not be able to consider all issues, so if you have a complex tax and financial situation, be sure to reach out to us to ensure you have paid in enough to avoid penalties.
Retirees and self-employed taxpayers need to separately assess whether they have paid in enough through quarterly estimated tax payments to avoid penalties. We are here to help with those calculations as well!
Standard or Itemized Deductions?
Assess your deductions now! Filers can reduce taxable income by subtracting one overall amount called the standard deduction, or by detailing “itemized” deductions for mortgage interest, state and local taxes, charitable donations, medical expenses, and others. For 2022, the standard deduction is $25,900 for married joint filers and $12,950 for single filers. Inflation has lifted the amount for 2023 (see our separate blog post on this topic).
Filers taking the standard deduction for 2022 or 2023 should evaluate whether it makes sense to “bunch” deductions to benefit from itemizing in some years. Often the best candidates for bunching are charitable donations. For example, say Alex and Jess are married and give $10,000 a year to charity. But that and other deductions totaling $10,000 will come to less than the $25,900 standard deduction for 2022. By making two years of donations in either 2022 or 2023, the couple could take the standard deduction in one year and itemize for the other and maximize overall tax breaks. Donors may want to use a donor-advised fund, or DAF. These allow the donor to take an upfront deduction and wait until later to direct donations to specific charities.
Another strategy is to utilize qualified charitable distributions, whereby taxpayers aged 70 ½ and older can transfer up to $100,000 ($200,000 for married filers) of their traditional IRA assets directly to one or more charities and have the donation count toward their required minimum distribution. There’s no deduction for these gifts, but the withdrawals don’t count as taxable income either. This reduces income-adjusted Medicare premiums and taxes on investment income, among other things, and allows the donor to take the standard deduction.
Other examples for accelerating deductions, to allow for “bunching” include:
- Paying an estimated state tax installment in December instead of at the January due date. However, make sure the payment is based on a reasonable estimate of your state tax.
- Paying your entire property tax bill, including installments due in 2023, by year-end. This does not apply to mortgage escrow accounts. A prepayment of anticipated real property taxes that have not been assessed prior to 2023 is not deductible in 2022. Under TCJA, the deduction for state and local taxes (SALT) was capped at $10,000. Once a taxpayer reaches this limit the two strategies above are not effective for federal returns.
- 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 that helps cover the cost of tuition, fees, and course materials paid during the taxable year. Forty percent of the credit (up to $1,000) is refundable, which means you can get it even if you owe no tax.
Investment decisions are often more about managing capital gains than about minimizing taxes. For example, taxpayers below threshold amounts in 2022 might want to take gains, whereas taxpayers above threshold amounts might want to take losses. Tax loss harvesting – offsetting capital gains with losses – may be a good strategy to use if you have an unusually high income this year or significant losses. Where feasible, reduce all capital gains and generate short-term capital losses up to $3,000. Generally, 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.
Those who still like the investment can even harvest losses by selling and then repurchasing the same holding—as long as it’s not within 30 days before or after the sale. That runs afoul of the “wash-sale” rules and delays use of the loss. If you have losses, you might also 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 is restored, and you have a higher cost basis for your new investment (i.e., any future gain will be lower).
Roth conversions allow a taxpayer 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. Converting to a Roth IRA from a traditional IRA makes sense if you’ve experienced a loss of income (lowering your tax bracket) or your retirement accounts have decreased in value.
You do not have to convert your entire IRA to a Roth IRA at once; you can convert all or part of it during different tax years. For example, if you have $90,000 in a 401(k), you can convert it over three years – $30,000 in the first year and $30,000 per year for the next two years. This strategy works well for taxpayers who want to eliminate to minimize RMDs (Required Minimum Distributions) at age 72 from their IRAs and leave more of your retirement account funds to heirs.