Barbara O’Neill, Ph.D., CFP®, AFC®
Distinguished Professor and Extension Financial Management Specialist Emeritus
Rutgers Cooperative Extension
Less than a month remains to take action to reduce your 2022 income taxes. What to do? Consider these 12 year-end tax-planning strategies:
- Tax Loss Harvesting- This strategy involves reviewing the performance of your investments and selling securities (e.g., stock or mutual fund shares) to realize capital losses. Those losses are then netted against taxable gains dollar-for-dollar. If losses exceed gains, losses can offset up to $3,000 of other taxable income.
- Tax-Deferred Investing- Many people change the percentage of their pay contributed to tax-deferred employer retirement savings plans (e.g., 401(k) and 403(b) plans) at year-end. The IRS recently announced an increase in the maximum amount that can be saved from $20,500 in 2022 to $22,500 in 2023.
- Tax-Advantaged Gifting- Stepped-up philanthropy often occurs in December as taxpayers make gifts to both help charities around the holidays and lock in tax write-offs. To receive a tax benefit, taxpayers typically need to use strategies such as bunching itemized deductions (to exceed the standard deduction), donating appreciated securities, making a qualified charitable distribution (QCD), and/or setting up a donor advised fund.
- Roth Conversions- Many financial experts recommend doing this in 2022 because stock prices fell, and taxpayers can convert more of traditional account balances to Roth accounts without increasing their tax bill. Lower tax rates are also in effect through 2025. Income taxes on converted amounts are due for the tax year that assets were converted.
- Required Minimum Distributions- Taxpayers age 72+ must take withdrawals for 2022 RMDs by year-end. Allow time for account custodians to process the paperwork. The IRS tax penalty for not taking RMDs, or not doing the calculation correctly, is 50% of the amount that should have been taken but was not.
- Defer Income- Income is taxable when received, not when it is earned. It may make sense, taxwise, to defer income to 2023 and, thereby, defer paying taxes until they are due in April 2024. Common situations where this occurs are freelancers delaying invoices sent to clients and workers asking employers to delay payment of year-end bonuses.
- Review FSA Balances- Flexible Spending Account rules typically state that before-tax dollar (i.e., money not taxed) deposits must be spent by year-end (i.e., use it or lose it). However, the IRS permits employers to offer a grace period to March 15 of the following year. Check the rules for your FSA and schedule health-related services as needed.
- Review Tax Withholding- The end of each tax year is a good time to review the adequacy of tax withholding and/or quarterly estimated tax payments. The online IRS Tax Withholding Estimator is a good tool to assist with calculations. Some people also like to prepare a mock-up (estimate) of their current year's taxes with tax data on hand.
- Review Life Events- As part of a tax withholding review and preliminary mock-up tax return, life events are a major factor to consider. Examples of events that affect household income and resulting tax payments are marriage, divorce, birth of a child, unemployment, a new job, addition of "side hustle" income, and retirement.
- Review "Safe Harbor" Numbers- Safe harbor rules protect taxpayers from an IRS underpayment penalty. Generally, penalties are waived if taxpayers owe less than $1,000 in taxes or pay (via employer tax withholding or estimated payments) at least 90% of the current year's tax or 100% of the previous year's tax (110% for higher incomes).
- Check Your Marginal Tax Bracket- Rutgers Cooperative Extension has lists of marginal tax brackets going back over a decade. Knowing this information can help with financial planning decisions such as whether to choose a taxable or tax-exempt investment and to know what tax rate to use in online financial calculators.
- Avoid Tax Triggers- A benefit of end-of-year planning is the ability to forecast potential future income that could trigger tax traps such as reaching the income ranges for Medicare income-related monthly adjustment amount (IRMAA) premiums, taxation of Social Security benefits, or the net investment income tax (NIIT).
In summary, review the tax-reduction strategies listed above and consider those that apply to your personal financial situation. Reach out for professional assistance as needed. The window for proactive action for 2022 taxes is closing.