TAx Plannning Strategies

 The following highlights tax planning strategies 

Year-end planning does not occur in a vacuum and is certainly impacted by the changing tax environment. 

Overview of General Goals and Objectives of Year-end Tax Planning

Individual Planning

Capital Gain (Loss) Harvesting

A common strategy regarding investment portfolios as you near the end of the year is to consider selling loss positions to offset incurred or planned capital gains before year end. Keep in mind the “wash sale rules” when reviewing year-end capital gains and dividends. Wash sales are sales of stock or securities in which losses are realized but not recognized for tax purposes because the seller acquires substantially identical stock or securities within 30 days before or after the sale. Non-recognition, however, applies only to losses; gains are recognized in full.

Qualified Opportunity Funds (QOFs)

If you have substantial capital gains, investments of eligible gains in QOFs remain a strategy, but we have not seen much traction in this area. This approach temporarily defers taxable events until the earlier of an inclusion event or December 31, 2026. This is an effective approach if you don’t have enough deductions or credits to offset your gains until a later time or you anticipate that the tax rates could decrease in a later year. Also, the longer you hold the assets in the QOF, the more advantageous your investment is treated for tax purposes.

Sale of Principal Residence

If you have or will sell your principal residence , an exclusion of up to $250,000 ($500,000 for married filing jointly taxpayers) applies to the gains from the sale of a principal residence. To be eligible for the exclusion, the residence must have been owned and occupied as your principal residence for at least two of the five years preceding the sale. If a taxpayer only satisfies a portion of the two-year ownership and use requirement, the exclusion amount is reduced (pro-rata basis). If you want to sell your principal residence but decide to wait because of unfavorable market conditions, you can rent the residence for up to three years after the date you move out and still qualify for the exclusion. Any gain attributable to prior year depreciation claimed during the rental period will be taxed at a maximum 25 percent rate. Note, that the same rate contingencies apply as in the capital gains section.

Converting a Traditional IRA to a Roth IRA

Considering whether to convert your traditional IRA to a Roth IRA is a tax planning strategy that can allow future distributions from the Roth IRA to be tax free. The taxpayer will have to pay tax on the converted funds, but once the money is in the Roth, all future earnings are tax free. Present and future tax rates, as well as the remaining number of years before planned distributions, are key in your decision on whether a Roth conversion makes sense. This is an effective strategy if your income is too high to invest in a Roth IRA as well.

If you expect the tax rate you will pay in retirement to remain the same or increase, then switching to a Roth IRA may pay off in regard to taxes. If your tax rate in retirement will be lower, the tax-free Roth distributions during retirement may not be advantageous. Also, you do not need to convert the entire amount to a Roth at one time. The money can be moved in increments over time, spacing out the tax hit. Recent legislative proposals have been made to limit the ability to perform Roth conversions, but actual changes are uncertain at this point. BMSS can assist with analyses of alternatives in this area, including the tax impact as well as the other differences between traditional and Roth IRAs

Contributing to your 401(k)

For 2022, the contribution limit is $20,500 ($27,000 for individuals age 50 or older). Amounts you defer and pay into your 401(k) plan are generally pretax, meaning they are not subject to federal income tax or payroll taxes. The exception to the pre-tax treatment is contributions to a Roth 401(k) plan if available from your employer. The IRS   contribution limits for 2023 will be $22,500 ($30,000 for individuals age 50 or older).

Simplified Employee Pension Plans

A Simplified Employee Pension (SEP) plan allows employers to contribute to traditional IRAs set up for employees. Employers can contribute up to 25 percent of the employee’s annual salary (up to an annual maximum set by the IRS each year.) The maximum SEP contribution for 2022 is $61,000 and the contribution must be made by the extended due date of the employer’s return.

Child and Dependent Care Credit

Taxpayers who incur expenses to care for children under age 13 (or for an incapacitated dependent or spouse) to work or look for work can claim a credit for those expenses. The credit is calculated as a percentage of the expenses incurred, up to a maximum of $3,000 for taxpayers with one qualifying child or dependent and $6,000 for taxpayers with two or more qualifying children or dependents. A qualifying individual for the child and dependent care credit includes the following:

• A dependent qualifying child is      under age 13 when care is provided, or
• A spouse, who is physically or      mentally incapable of self-care, lived with you for more than half of the      year.

Child Tax Credit (CTC)

Taxpayers are allowed an income tax credit of $2,000 for each qualifying child age 17 and younger t the end of the calendar year. The child tax credit is refundable, up to $1,500 for some taxpayers. 

American Opportunity Tax Credit (AOTC)

The maximum credit that can be taken is $2,500 per eligible student for the first four years of higher education and up to $1,000 of that amount is refundable. The AOTC is phased out for single taxpayers with incomes ranging from $80,000 to $90,000, and for joint taxpayers with incomes ranging from $160,000 to $180,000.

The Lifetime Learning Credit for Education

The lifetime learning credit is a nonrefundable credit for qualified students and is available for all years of post-secondary education. The maximum credit is $2,000 and is phased out for single taxpayers with incomes ranging from $80,000 to $90,000 and joint taxpayers with incomes ranging from $160,000 to $180,000. 

Coverdell Education Savings Accounts (ESAs) and 529 Plans

ESAs  and 529 Plans are trust or custodial accounts created exclusively to pay the qualified elementary, secondary, and higher education expenses of a single named beneficiary. Annual contributions are limited to $2,000 per beneficiary for ESA and NO annual contribution limit for 529 Plans,  The contributions are not tax-deductible, but the designated beneficiary can receive tax-free distributions to pay qualified education expenses.

Student Loan Interest Deduction

Taxpayers may deduct from gross income, subject to certain conditions, interest payments made on qualified education loans. The deduction is an above-the-line adjustment to income that can be claimed by all individuals, not just those who itemize. The maximum deduction of $2,500 is phased out for high-income taxpayers. Please be sure to keep any 1098-E forms you receive relating to this deduction.

Qualified Business Income Deduction

For tax years beginning after 2017, taxpayers, other than corporations, may be entitled to a deduction of up to 20 percent of their qualified business income.  There are income limitations to the deduction. The deduction may be limited based on whether the taxpayer is engaged in a service type trade or business (such as law, accounting, health, or consulting), by the amount of W-2 wages paid by the trade or business, and/or by the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. 

The Standard Deduction and Itemized Deductions – Individuals

For 2022, the standard deduction is $25,900 for married filing jointly and surviving spouses, $19,400 for head of household, and $12,950 for all other taxpayers. The standard deduction is important for planning the timing of one’s itemized deductions (as discussed further below) as itemized deductions must exceed the standard deduction to maximize the tax value of the deductions. For taxpayers whose personal itemized deductions will not typically exceed the standard deduction each year, they might consider bunching certain deductions that would normally be paid in two or more years into a single tax year. Charitable contributions might be the personal expense that lends itself more easily to this situation, but medical expenses might also be considered for this technique.

Itemized Deductions

• State and local taxes (SALT)      (including personal property and real estate) are limited to $10,000      ($5,000 if married filing separately). 
• The floor for medical expenses      in 2022 is 7.5 percent of AGI.
• For mortgages taken out after      December 14, 2017, only interest on the first $750,000 of mortgage debt is      deductible. For mortgages before December 14, 2017, the mortgage interest  deduction lets you deduct mortgage interest paid on the first $1,000,000  of mortgage debt for a primary or secondary home.
• Interest on home equity loans      is no longer deductible if it is not connected to home improvement      expenses. Interest on home equity loans is subject to the $750,000      mortgage limit (MFJ), or $375,000 for a married taxpayer filing a separate      return.
• Personal casualty losses are      deductible only if they are attributable to a federally declared disaster      and only to the extent the $100 per casualty and 10 percent of AGI limits      are met. Additionally, theft losses are deductible up to the fair market      value of the property, but taxpayers need to prove that all of the      requirements for theft, in their state, occurred to claim theft losses.

Year-End Strategies

Until the clock strikes midnight to ring in the new tax year, it is not too late to plan your 2022 taxes. By simply accelerating expenses, deferring income, or vice versa, you could significantly lower your tax bill without missing out on the money deferred or spent for long. 

Additionally, you could accelerate or defer expenses. 

Other Measures – Adjusting Withholding / Estimated Tax Payments

If you owed money on your 2021 tax return, your withholdings may be too low. You may wish to consider adjusting your withholdings for the remainder of the year to reduce or eliminate a balance due. Furthermore, you can pay estimated tax payments based on your 2021 tax due towards year end. Your total withholdings and estimates paid must equal 100% of your 2021 taxes due (110% if your 2021 AGI exceeded $150,000 for MFJ) to avoid penalties. If you expect your 2022 liability to be less than your 2021 liability, your withholding and /or estimates must exceed 90% of your 2022 actual liability to avoid a penalty for underpayment of estimated taxes.

Reviewing Retirement Plan Beneficiaries

For future planning purposes, avoid unintended consequences by updating beneficiary designations of your 401(k) or 403(b) plans, annuities, pensions, and IRAs to account for life changes such as marriage, divorce, or the death of a spouse or other beneficiary listed. Also, be sure to review the beneficiaries listed in your will and taxable accounts. If you do not have a will, consider drafting one sooner rather than later.