Year-end planning can help reduce tax burden while also improving your financial picture, now and into the future. What are the key 2022 year-end tax planning strategies to consider?
Important 2022 Year-End Tax Planning Strategies
It is the 2022 homestretch and numerous important tax planning deadlines are fast approaching. The fourth quarter of the calendar year is an important time to execute on key planning strategies that will deliver progress relative to your financial objectives. One of these goals should be to reduce your taxable income and in doing so, free up more resources to build wealth and meet lifestyle goals.
So, where do you start? We suggest scheduling an appointment with your accountant and financial advisor to update and review your tax projection. Understanding your expected tax burden for 2022 is a great basis for evaluating year-end tax planning opportunities and the value they could provide. Working together, your tax and financial advisor should help you select and implement appropriate strategies while maximizing the benefit they deliver.
Your accountant will help estimate your expected tax burden for 2022 by considering your expected income for the year and any available deductions and tax credits. Then, you and your financial advisor will evaluate and implement the appropriate techniques for further reducing your taxable income, while also improving your financial position relative to lifestyle goals.
Let’s first review some of the key deadlines….
The fourth quarter of the calendar year is full of important dates of which to be mindful. Some of these deadlines may apply and some may not.
November 29th – Wash Sale Avoidance
If you plan on selling a security to lock in a loss and desire to repurchase the same security before the end of the year, this is the last trading day you can do so to avoid a wash sale. Any security repurchased within 30 days is treated as a wash sale and any associated loss may not be recognized in the current year.
December 7th – Medicare Open Enrollment
This deadline applies to Medicare beneficiaries already enrolled in an Original Medicare or Medicare Advantage plan. Any coverage changes to either of these plans along with Medicare Part D (prescription drug coverage) must happen during open enrollment from October 15th to December 7th.
December 30th – Final Trading Day
This is the last trading day of 2022 for selling securities to lock in capital gains or losses.
Before December 31st – Multiple Deadlines
- Flexible Spending Account (FSA) must be spent on qualified medical expenses otherwise any remaining funds will be forfeited at the start of the new year.
- Last day for making retirement plan contributions to a 401(k) or 403(b).
- Final date for making a 2022 contribution to a 529 College Savings Plan.
- For those age 73 or older, this is the deadline for taking your 2022 Required Minimum Distribution (RMD). RMDs begin upon turning 72, however, the first RMD may be delayed to April 1st of the following year. All subsequent years require RMDs to be taken by December 31st.
Important 2022 Year-End Tax Planning Checklist
Keeping the above deadlines in mind, be sure to review the following year-end checklist for planning opportunities that could help to improve your financial position.
Managing Taxable Income
“Stack” Charitable Contributions. The higher standard deduction (2022 tax year: $25,900 for Married Filing Joint and $12,950 for Single) passed by the 2017 Tax Cuts and Jobs Act is not scheduled to expire until the end of 2025. This provision means most taxpayers will not itemize. If you make regular charitable contributions, consider pulling future charitable gifts into the current tax year to maximize your benefit. For example, if you are a married couple filing jointly with $10,000 in non-charitable itemized deductions and make annual charitable cash donations of $10,000, you might instead contribute $20,000 to your favorite charity and forgo your giving the following year. This would enable you to itemize $30,000 in deductions and maximize your reduction in taxable income.
Defer Income. Pre-tax contributions to tax-qualified retirement savings accounts like a 401(k), 403(b) and tax-deductible IRAs can significantly reduce your taxable income. A married couple over age 50 can each defer up to $27,000 ($54,000 total) of income into a qualified retirement plan on a pre-tax basis. For high earners, these pre-tax deferrals can be a great way to reduce your income tax burden. Those who qualify to make tax-deductible IRA contributions can reduce taxable income by up to $6,000 ($7,000 for those over age 50) or $12,00 ($14,000 over 50) for joint filers. IRA contributions can be made for 2022 up to April 18th of next year, while 401(k) or 403(b) deferrals must be done before December 31st of this year.
Qualified Charitable Distributions (QCDs). If you are a retiree taking Required Minimum Distributions (RMDs), don’t forget about QCD election. RMDs may have fulfillment by making a direct transfer from an IRA, for example, to a qualified charity. Not only do these QCDs count towards your fulfilling your RMD for the year, but they are also income tax-free. This can result in a sizable reduction in taxable income. If you haven’t taken your 2022 RMD, you might consider the benefits of this QCD option. But be sure to understand the requirements to qualify for a QCD before electing to make one.
529 College Savings Contributions. These savings plans offer significant benefits to parents working to save for their child’s future college education. Contributions to a 529 Plan are tax deductible in most states with Utah, Indiana, and Vermont offering tax credits. Plan funds grow tax-deferred, and withdrawals are tax-exempt if used for qualified expenses. Consider making a 529 plan contribution before December 30th, 2022 to qualify for any tax advantages. Find out more about your state’s tax benefits using Charles Schwab’s 529 State Tax Calculator.
Tax Loss Harvesting. The fourth quarter is a great time to review long-term capital “gain” and “loss” positions in your brokerage account. Perhaps you hold an investment in a gain position that no longer makes sense to hold or accounts for an outsized share of your portfolio. Offsetting the tax impact of a recognized gain by harvesting losses elsewhere in the same portfolio can be beneficial. Any realized capital losses exceeding gains may also be used to offset up to $3,000 of ordinary income. Losses greater than $3,000 can be carried forward and used in future tax years.
Please be mindful of the different tax implications for long-term and short-term (taxed as ordinary income) capital gains. This strategy works best for positions that have been in holding for more than 12 months (i.e., long-term). It is also important to be aware of the wash-sale rule. You are unable to claim a loss if you repurchase the same or substantially similar investment within 30 days.
Rebalancing. It is good practice to regularly review the allocation balance of your portfolio relative to its target. The end of the year is a great time to do this, particularly with brokerage accounts for the reasons highlighted above (opportunity to harvest losses and offset gains).
Avoid Buying the Distribution. Mutual funds often pay out their distributions in the fourth quarter. Individual stocks can pay dividends this time of the year as well. Since these dividends and distributions are taxable, consider delaying purchases until after these investments have “paid out”. Mutual funds and stocks have the requirement to announce these distribution dates allowing you to plan accordingly. This strategy only applies to taxable accounts like brokerages. Investments in IRAs or 401(k)s grow tax-deferred. Payouts also do not affect these investments.
Mega Backdoor Roth Conversions. If your employer’s retirement plan allows for it, a mega backdoor Roth conversion can be a great way to save a substantial amount of money into a tax-exempt account. This strategy entails making an after-tax 401(k) contribution that immediately converts to your plan’s Roth-401(k) account. It provides participants an opportunity to make retirement savings contributions beyond the 2022 plan limit of $20,500 ($27,00 for those age 50 or older) and must occur before the end of the year. Interested in learning more? Read all about the mega backdoor Roth conversion here.
Roth Conversions. Converting pre-tax IRA funds to a Roth-IRA is a great way to build tax-exempt savings for retirement. Consider these conversions during years in which your taxable income has expectations of being lower. Roth conversions are worth considering for those who are temporarily earning less (i.e., career transition), expect significant future income growth, or have recently retired. Retirees might consider a Roth conversion during the years before claiming Social Security or being required to take RMDs (Required Minimum Distributions). Conversions are a taxable event during the calendar year in which they occur. If you’re considering this planning strategy for 2022, you have until December 30th to elect to do so!
Required Minimum Distributions (RMDs). RMDs must be taken from qualified retirement accounts (Roth-IRAs are excluded) by the end of each calendar year after you turn age 72 (you may delay your first RMD to April 1st of the year after turning 72). While RMDs cannot be avoided their tax implication may be negated through techniques like Qualified Charitable Distributions (see above).
Retirement Income Planning. For current retirees, the fourth calendar quarter is a great time to review your budget and plan your income needs for the following year. Planning in advance can help identify ways to take investment distributions in a tax-efficient manner. Your retirement income not only has obvious tax implications but can also impact your Medicare Part B and Part D premiums.
Health Insurance Deductible. This time of the year can be an advantageous time to schedule medical appointments or procedures if you have already met your health insurance plan deductible.
Flexible Spending Accounts (FSAs). FSA balances expire at the end of the calendar year. They are the epitome of “use it or lose it”. If you have funds remaining in your FSA, review how you might use them on qualified medical expenses. Remember that qualified expenses may be incurred by you, your spouse, and any dependents including a child under age 27 at the end of the tax year. For a list of qualified medical expenses go here.
Health Savings Accounts (HSAs). HSAs are like FSAs but have several advantageous differences. Unused contributions in an HSA will rollover to the next year and do not expire. This advantage among others makes these accounts generally more appealing than FSAs. However, to contribute to an HSA you must have coverage from a high-deductible health plan (HDHP). While you may contribute to HSAs up until April 18th, 2023 for the current calendar year, now is a great time to budget for any unused contributions. Individuals may contribute up to $3,650 and families up to $7,300 ($1,000 catch-up for those 55 and older).
Medicare Open Enrollment. Existing Medicare participants have from October 15th to December 7th to make any coverage changes to their Part D prescription drug plan. They may also elect to change between Original Medicare and Medicare Advantage, change Medicare Advantage plans or change supplemental plans (subject to underwriting. Make sure you review your coverage needs. Evaluate your coverage needs against both your existing coverage (plans can change!) and other options. Submit any changes by December 7th.
Did you enjoy our 2022 year-end tax planning strategies? If so, learn other helpful financial strategies with the help of Dickmeyer Boyce.