The holiday season isn’t exactly a time when taxes are top-of-mind. But there are important federal tax moves you can make in these final days of 2022 that could save you a lot of money come April.
Tax planning is especially important in a year when Americans are already being squeezed by the highest inflation in a generation and may not even have a fat tax refund to look forward to in 2023. The IRS warned last week that refunds may be smaller next year.
With that in mind, here are some suggestions for getting an early jump on sheltering your money and maximizing your refund:
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Should I sell losing stocks at the end of the year?
Uncle Sam provides a little comfort during years like 2022 when stock and bond prices dropped sharply. Capital losses can offset taxable gains. Any net losses beyond that can reduce ordinary income up to $3,000 annually. That $3,000 figure hasn’t risen in many years and represents a modest consolation prize for investors who got banged up this year, though losses beyond that can carry forward for use in future years.
Short-term losses first are applied against short-term gains and long-term losses against long-term gains. Investments are considered long-term if held for more than one year.
This tax break applies to gains and losses held in taxable accounts. Losses within Individual Retirement Accounts, workplace 401(k) plans and other tax-sheltered accounts aren’t eligible for it.
“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, head of wealth planning and advice at J.P. Morgan Wealth Management.
However, if you sell a stock or other asset at a loss, you won’t be able to claim the tax deduction if you or a spouse purchased the same security or one that is substantially similar 30 days before or after the sale. So for instance, if you sold shares of AMC at a loss but purchased their preferred stock traded under the APE ticker 30 days before or after the sale, you wouldn’t be able to claim the deduction. This is known as a wash sale.
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 window, said Frank. That way you can maintain a similar level of exposure to an asset class or sector. If you are considering doing that, then it’s worthwhile to consult a tax specialist to ensure you’ll still qualify for the deduction, he added.
2022 standard and itemized deductions
Several years ago, Congress made the standard deduction more generous but also made it harder for taxpayers to itemize deductions instead. Property taxes, state and local taxes, mortgage interest and charitable donations are among the main itemized deductions you can take, but you’d need to have more than $12,950 of such expenses to make it worthwhile if single, or $25,900 if a married couple. Otherwise, taking the standard deduction makes more sense. In 2021, taxpayers taking the standard deduction also could claim a deduction on charity donations worth up to $300 for singles or $600 for married couples, but that provision has expired.
Charitable contributions are typically the deductions over which most people have more control, noted Kelsey Clair, a tax strategist and certified public accountant at Baird Wealth Strategies, in a recent webinar. That is, you have leeway to decide how much to donate and to which nonprofit groups in a given year.
For people close to those $12,950 or $25,900 thresholds, it might pay to bunch deductions to qualify for itemizing at least every other year or so. One way to do that is to donate extra money to charities one year, then cut back the next.
Importantly the thresholds will increase next year, which is why you should consider making any routine donations before the end of the year, said Richard Lavina, CEO and founder of Taxfyle, a tax software designed for small businesses.
The same concept applies to small business owners. Try to pay for as many tax-deductible business expenses such as utility bills and office supplies or other equipment before the end of the year so you can deduct them from your taxable business income, Lavina, a certified public accountant, said.
Donate IRA money to charity
If you have IRA money that you don’t need for living expenses and are at least 70½ years old, there’s another charity-oriented tax break to consider. This one involves withdrawing some of your IRA money and donating it directly to one or more qualified charities. It’s known as a qualified charitable distribution or QCD.
You wouldn’t receive a donation deduction on your gift, as you otherwise might, but the money withdrawn from your IRA also wouldn’t be included in your adjusted gross income. That can help you avoid higher Medicare premiums, shelter more of your Social Security benefits from taxes and provide other benefits, Clair noted. The donation also can count toward any required minimum distribution, or RMD, you must take.
Worth noting: Interested taxpayers can donate up to $100,000 a year in this manner.
Check that you didn’t underpay taxes
It’s good to end each year knowing that you haven’t substantially underpaid your tax obligations, so as not to trigger interest and possible penalties when you file a return later.
Thus, it’s smart to run some numbers before year-end to make sure you haven’t been withholding too little on job income, from retirement-account withdrawals and so on. In some cases, you might want to make an estimated tax payment before year-end.
The basic rule is that you can avoid a penalty if you pay at least 90% of your current-year tax obligation, though that number can be difficult to estimate, Clair noted. Another option is to pay at least 100% of your prior-year tax bill, for 2021, though that rises to 110% if your adjusted gross income tops $150,000. A penalty also wouldn’t apply if you owe less than $1,000.
Converting 401(k) and more to Roth IRAs
Many tax and investment advisers suggest moving some of your 401(k) or traditional IRA money into a Roth IRA if you can afford to do so. Withdrawals from Roths generally aren’t taxed, and there are no annual required minimum distributions to meet with these accounts. They can continue to build up in value over time, tax-free.
“The potential for higher ordinary income tax rates in the near future increases the value of the benefits,” noted Wells Fargo in a comprehensive year-end tax planning guide.
Those are the main benefits, and they’re certainly enticing. But there are drawbacks too. One is that the amount that you transfer over or convert will be taxable in the year made, which can have a big impact on your finances now.
Also, you’d want to use money in other accounts to pay the taxes, and a lot of people don’t have tens or hundreds of thousands of dollars lying around. Plus, you no longer can “recharacterize” or cancel a conversion – an option that was available in the past.
Then again, converting makes more sense when account values are depressed, as in 2022. As such, now might be a good time to consider this move.
Contributing: Medora Lee
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