Taxes aren’t exactly on everyone’s mind during the holiday season. However, there are critical federal tax moves you can make in the final days of 2022 that could save you a significant amount of money come April.
Tax planning is especially important in a year when Americans are already feeling the pinch from the highest inflation in a generation and may not even receive a large tax refund in 2023. The IRS issued a warning last week that refunds may be reduced next year.
With that in mind, here are some ideas for getting a head start on saving money and maximising your refund:
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Should I sell stocks that are losing money at the end of the year?
Uncle Sam provides some solace in years like 2022, when stock and bond prices have plummeted dramatically. Capital losses can be used to offset taxable gains. Any additional net losses can reduce ordinary income by up to $3,000 per year. That $3,000 figure hasn’t risen in a long time and represents a small consolation prize for investors who have been burned this year, though losses above that amount can be carried forward for use in future years.
Short-term losses are applied first against short-term gains, and long-term losses are applied first against long-term gains. If an investment is held for more than a year, it is considered long-term.
This tax break is only available for gains and losses held in taxable accounts. It does not apply to losses in Individual Retirement Accounts, workplace 401(k) plans, or other tax-sheltered accounts.
“It’s a very good strategy for people to ultimately lower the amount of tax they pay, which means they keep more of what they’ve made,” says Adam Frank, J.P. Morgan Wealth Management’s head of wealth planning and advice.
However, if you sell a stock or other asset at a loss, you will not be able to claim the tax deduction if you or a spouse purchased the same or a substantially similar security 30 days before or after the sale. For example, if you sold shares of AMC at a loss but bought their preferred stock under the APE ticker 30 days before or after the sale, you would be unable to claim the deduction. This is referred to as a wash sale.
According to Frank, you may be able to claim the deduction if you sold shares of a company at a loss and bought shares of one of their competitors during the 61-day period. This allows you to keep a similar level of exposure to an asset class or sector. If you’re thinking about doing so, he recommends consulting with a tax professional to ensure you’ll still be eligible for the deduction.
Standard and itemised deductions in 2022
Several years ago, Congress increased the standard deduction while making it more difficult for taxpayers to itemise deductions. Property taxes, state and local taxes, mortgage interest, and charitable contributions are among the main itemised deductions you can claim, but you’d need more than $12,950 in such expenses if you’re single, or $25,900 if you’re married. Otherwise, the standard deduction is preferable. In 2021, taxpayers taking the standard deduction could also deduct charitable contributions of up to $300 for singles and $600 for married couples, but that provision has since expired.
In a recent webinar, Kelsey Clair, a tax strategist and certified public accountant at Baird Wealth Strategies, noted that charitable contributions are typically the deductions over which most people have more control. That is, you have discretion over how much you donate and to which nonprofit organisations in a given year.
For those nearing the $12,950 or $25,900 thresholds, it may be worthwhile to group deductions to qualify for itemising at least every other year or so. One strategy is to give more money to charities one year and then cut back the next.
Importantly, the thresholds will rise next year, so make any routine donations before the end of the year, according to Richard Lavina, CEO and founder of Taxfyle, a tax software designed for small businesses.
The same holds true for small business owners. Try to pay as many tax-deductible business expenses as possible before the end of the year so that you can deduct them from your taxable business income, according to Lavina, a certified public accountant.
Donate your IRA funds to charity.
If you have IRA funds that you don’t need for living expenses and are at least 7012 years old, you may be eligible for another charitable tax break. This one entails taking a portion of your IRA funds and donating them directly to one or more qualified charities. A qualified charitable distribution, or QCD, is what it is.
You would not receive a tax deduction for your gift, but the money withdrawn from your IRA would not be included in your adjusted gross income. Clair explained that this can help you avoid higher Medicare premiums, shield more of your Social Security benefits from taxes, and provide other benefits. The donation may also be applied to any required minimum distribution, or RMD, that you must take.
Make sure you haven’t underpaid your taxes.
It’s a good idea to end each year knowing that you haven’t significantly underpaid your tax obligations in order to avoid interest and penalties when you file a return later.
As a result, it’s a good idea to run some numbers before the end of the year to ensure you haven’t been withholding too little on job income, retirement-account withdrawals, and so on. In some cases, you may want to make an estimated tax payment before the end of the fiscal year.
The basic rule is that you can avoid a penalty if you pay at least 90% of your current-year tax obligation, though Clair notes that this figure can be difficult to estimate. Another option is to pay at least 100% of your prior-year tax bill for 2021, with the amount increasing to 110% if your adjusted gross income exceeds $150,000. If you owe less than $1,000, there will be no penalty.
Converting 401(k)s and other retirement accounts to Roth IRAs
Many tax and investment advisors recommend transferring some of your 401(k) or traditional IRA funds to a Roth IRA if you can afford it. Withdrawals from Roths are generally not taxed, and these accounts have no annual required minimum distributions to meet. They can continue to grow in value tax-free over time.
“The possibility of higher ordinary income tax rates in the near future raises the value of the benefits,” Wells Fargo noted in a comprehensive year-end tax planning guide.
