Individual Year-end Tax Planning for 2022
My last column touched on the importance of year-end tax planning for businesses. Individuals can also benefit from moves that may help lower tax bills, not only this year but possibly next.
This year, the time-tested approach of deferring income and accelerating deductions to minimize taxes will work for most taxpayers, as will the bunching of expenses into this year or next to avoid restrictions and maximize deductions.
But word of warning, we have a lame duck Congress that, while not expected to do so as of this writing, could still make tax code changes that make the opposite strategy advisable for some. This will require careful analysis to determine the right course if Congress does move.
Due to space limitations, this will be a two-part series. Today we tackle primarily income related planning tips. Next time, we'll look at ideas related mostly to deductions.
With that said, let's look at some tips and information that could save you tax dollars if acted upon before year-end. Not all will apply to you, but you or someone in your family likely will benefit from some of them.
• Higher-income individuals must be wary of the 3.8% surtax on certain unearned income. The "net investment income tax", or NIIT, is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
As year-end nears, the approach taken to minimize or eliminate the 3.8% surtax will depend on the taxpayer's estimated MAGI and NII for the year. Some should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to reduce MAGI other than NII, and some individuals will need to consider ways to minimize both NII and other types of MAGI. An important exception is that NII does not include distributions from IRAs or most other retirement plans.
Note the Biden administration has proposed expanding the NIIT to certain higher income S shareholders, limited partners, and LLC members on their pass-through income and gain that is not subject to payroll tax. At this point, that proposal hasn't gained much traction.
• The 0.9% additional Medicare tax also may require higher-income earners to take year-end action. It applies to those whose employment wages and self-employment income total more than an amount equal to the NIIT thresholds, above. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account as well in figuring estimated tax.
There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. This would be the case, for example, if someone earns less than $200,000 from multiple employers but more than that amount in total. Such an employee would owe the additional Medicare tax, but nothing would have been withheld by any employer.
• Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on your taxable income. If you hold long-term appreciated assets, consider selling enough of them to generate long-term capital gains that can be sheltered by the 0% rate.
The 0% rate generally applies to net long-term capital gain to the extent that, when added to regular taxable income, it is not more than the maximum zero rate amount (e.g., $83,500 for a married couple filing jointly). If, say, $5,000 of long-term capital gains you took earlier this year qualifies for the zero rate then try not to sell assets yielding a capital loss before year-end, because the first $5,000 of those losses will offset $5,000 of capital gain that is already tax-free.
• Postpone income until 2023 and accelerate deductions into 2022 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2022 that are phased out over varying levels of AGI. These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest.
Postponing income also is desirable if you anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may actually pay to accelerate income into 2022. For example, that may be the case for a person who will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or who expects to be in a higher tax bracket in 2023.
• If you believe a Roth IRA is better for you than a traditional IRA, consider converting traditional-IRA money invested in any beaten-down stocks (or mutual funds) into a Roth IRA in 2022 if eligible to do so. Keep in mind that the conversion will increase your income for 2022, possibly reducing tax breaks subject to phaseout at higher AGI levels. This may be desirable, however, for those potentially subject to higher tax rates next year.
• It may be advantageous to try to arrange with your employer to defer, until early 2023, a bonus that may be coming your way. This might cut your tax, as well as defer it to next year. Again, considerations may be different for the highest income individuals.
Now, let's finish out with a focus mainly on deductions.
• Many people won't need to itemize because of the high basic standard deduction amounts that apply for 2022 ($25,900 for joint filers, $12,950 for singles and for marrieds filing separately, $19,400 for heads of household), and because many itemized deductions have been reduced or abolished, including a limit on state and local taxes, miscellaneous itemized deductions, and non-disaster related personal casualty losses.
You can still itemize medical expenses that exceed 7.5% of your AGI, state and local taxes up to $10,000, your charitable contributions, plus mortgage interest deductions on a restricted amount of debt, but these deductions won't save taxes unless they total more than your standard deduction.
You may be able to work around these deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, someone who will be able to itemize deductions this year, but not next, will benefit by making two years' worth of charitable contributions this year if possible.
• Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2022 deductions even if you don't pay your credit card bill until after the end of the year.
• If you expect to owe state and local income taxes when you file your return next year and you will itemize in 2022, consider asking your employer to increase withholding of state and local taxes (or make estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2022. Note, this strategy is not good to the extent it causes your state and local tax payments to exceed $10,000.
• If you are age 72 or older and have an IRA or 401(k) plan (or other employer-sponsored retirement plan), required minimum distributions, or RMDs, may have to be taken. If you were 72 or older in 2021, you must take an RMD during 2022 in most circumstances. Those who turn 72 this year have until April 1 of 2023 to take their first RMD, but may want to take it by the end of 2022 to avoid having to double up on RMDs next year.
• If you are age 70½ or older by the end of 2022, and especially if you are unable to itemize your deductions, consider making 2022 charitable donations via qualified charitable distributions from your traditional IRAs. These distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040.
However, you are still entitled to claim the entire standard deduction. This distribution to charity also counts towards any RMD you have for the year. I have had clients save thousands of dollars on their tax bill using this approach to, for example, give to their church!
• If you are facing a penalty for underpayment of estimated tax and increasing your wage withholding won't sufficiently address the problem, consider taking an eligible rollover distribution from a qualified retirement plan before the end of 2022. Income tax can be withheld from the distribution and will be applied toward the taxes owed for 2022. You can then timely (generally within 60 days) roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2022, but the withheld tax will be applied pro rata over the full 2022 tax year to reduce previous underpayments of estimated tax.
• Consider increasing the amount you set aside for next year in your employer's FSA if you set aside too little for this year and anticipate similar medical costs next year.
• If you become eligible in December of 2022 to make HSA contributions, you can make a full year's worth of deductible HSA contributions for 2022.
• Make gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift and estate taxes. The exclusion applies to gifts of up to $16,000 made in 2022 to each of an unlimited number of individuals. You can't carry over unused exclusions to another year. These transfers may also save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
• If you were in federally declared disaster area, and you suffered uninsured or unreimbursed disaster related losses, keep in mind you can choose to claim them either on the return for the year the loss occurred (in this instance, the 2022 return normally filed next year), or on the return for the prior year (2021), generating a quicker refund.
• If you were in a federally declared disaster area, you may want to settle an insurance or damage claim in 2022 to maximize your casualty loss deduction this year.
Careful planning and implementation of some of these nuggets can improve your financial health. But don't procrastinate. Time is of the essence. And if you need assistance, give us a call. We're here to help.
And finally, I want to wish you and yours a very Merry Christmas and Happy New Year! I'm taking a break from writing for the holidays, but will be back in the saddle in the new year.