- Individuals can help avoid tax surprises through strategies around retirement plans, flex spending accounts, and education plans.
- Valid methods for potentially increasing tax savings include Roth IRA conversions, opportunity zone investments, and recognizing capital losses.
- Consider a proactive and far-reaching multi-year tax plan to help take advantage of tax brackets, transaction timing, and more.
Seeking tax-planning strategies for individuals?
Taxpayers often seek “magic bullet” tax-savings, but may be better served by consistently applying tax planning basics. Some simple year-end actions repeated over time could yield significant tax benefits.
Tax planning tends to be a “one-size-fits-one” approach. Everyone’s tax situation is different. Some basic strategies — when applied consistently — could have a significant impact.
Throughout the tax code, there are various adjusted gross income limitations and thresholds. With effective planning like the strategies below, taxpayers can help avoid surprises arising from these limitations.
- Increase contributions to 401(k) plan — $20,500 plus an additional $6,500 catch-up contribution for any taxpayers 50 or over.
- Fund health savings accounts — Up to $3,650 for self-only and $7,300 for families. Additional $1,000 catch up contribution is allowed for taxpayers 55 or older.
- Use your entire $5,000 dependent care flexible spending account — If funds are used to cover qualified childcare costs, the $5,000 is exempt from tax.
- Consider “bunching” charitable contributions — If you regularly give to charity but the standard deduction is greater than your itemized deductions, you could put multiple years of charitable contributions into a donor advised fund (DAF). Then you would receive a deduction the year you fund the DAF and would itemize deductions. In subsequent years, you would make charitable contributions from the DAF and use the standard deduction.
- Fund education plans — There is no federal deduction for funding Section 529 plans, but some states offer a state-level income tax deduction for these contributions.
Roth IRA conversions
Many 2022 retirement account values have decreased. However, this decrease presents an opportunity for taxpayers to consider converting their traditional IRA to a Roth IRA. When a traditional IRA is converted to a Roth IRA, the converted amount is taxable in the year of conversion. The resulting Roth IRA can now grow tax free.
It’s necessary for taxpayers to have sufficient cash outside of retirement accounts to cover the resulting tax bill. You could also use some of the planning strategies discussed above to help mitigate the increased income from the Roth conversion, or consider spreading the conversion over multiple tax years to more efficiently use graduated tax rates.
Capturing capital losses
With markets down, the opportunity arises to capture capital losses. Consider selling “underwater” securities to recognize those capital losses.
Capital losses can be used to offset current year capital gains plus up to $3,000 of other income. Any additional losses can be carried forward to future tax years.
Taxpayers need to watch the wash sale rules, which prohibit acquiring substantially identical stock or securities within 30 days of selling stock or securities at a loss. If this occurs, the loss is not recognized in the current tax year but is instead included in the cost basis of the security.
Opportunity zones have been a valuable tax-planning tool for the past several years. Generally, you may contribute to a Qualified Opportunity Zone Fund (QOF) the amount of your capital gains recognized in the current year.
By contributing to a QOF, you defer tax on the reinvested gain until you dispose your QOF investment or December 31, 2026, whichever is earlier. Additionally, if you hold the QOF for at least 10 years, a portion of the post-acquisition appreciation of the QOF may be permanently excluded from taxable income.
There are many rules related to QOFs, including contribution deadlines, types of assets held in QOFs, etc. Consult a tax advisor regarding the specifics and benefits of QOFs.
Multi-year tax planning
Traditional tax planning suggests deferring income and accelerating deductions. There may be times when the opposite of that is true. Consider a plan that uses multiple tax years to find the least cumulative amount of tax.
- Installment sales — When a seller receives payments on a sale transaction over multiple tax years, they recognize the income in the year the principal payment is received, thus spreading the gain over multiple tax years. If you have capital or other losses you can use in the tax year, or significant taxable events in future years, consider opting out of the installment method. Doing so would recognize the income in the year of sale knowing it will be offset, in whole or part, by other losses or more efficiently using the graduated tax brackets.
- Timing of transaction closing — Consider whether accelerating transaction closing in the current tax year or deferring until 2023 could yield the better tax result.
- Interest/dividend payments from closely-held entities — You can control the timing of interest and/or dividend payments from closely-held entities to the tax year that is most beneficial.
- Invest in municipal bonds vs. taxable bonds — The current interest rate environment provides municipal bond investments with very attractive tax-free interest options. Municipal bonds are tax free at the federal level but may be taxable at the state level.
- Use qualified charitable distributions to satisfy required minimum distribution (RMD) requirements — Taxpayers over 70.5 (or age 72 in other circumstances) must take RMDs from their IRAs. Charitably inclined taxpayers may satisfy this requirement by having their IRA custodian contribute directly to a qualified charitable organization. This strategy avoids increasing adjusted gross income by not recognizing the RMD as income. However, you don’t receive a charitable deduction because the income was not recognized.
- Non-business bad debt — If you previously lent money (and lending money is not your primary business) that will not be repaid, you can recognize a short-term capital loss in the year the debt is rendered “completely worthless.”
- Charitable contributions — Satisfy charitable commitments by donating appreciated stock. Generally, you’ll receive a deduction for the fair market value of the stock and avoid paying capital gains on the increase. If the stock value has decreased since it was purchased and you need those proceeds to fund charitable contributions, sell the stock first then donate the cash. You will receive the benefit of the capital loss.
How we can help
Our team of tax professionals can help you throughout the entire tax preparation and planning process so you can file with confidence, knowing you have taken advantage of potential tax opportunities to achieve your specific goals. Contact us to start planning today.