With year-end rapidly approaching, it’s time to consider moves that will lower your 2022 tax bill and hopefully position you for tax savings in future years too. This column is Part 1 of our two-part list of suggested year-end strategies.
While the fates of the economy and the stock market remain uncertain, it now appears that there won’t be any significant tax increases that will take effect this year or next year.
Assuming that turns out to be true, the year-end tax planning environment is much better than it was at this time last year, when there was a smorgasbord of tax change proposals on the table.
With those thoughts in mind, here are some year-end tax planning ideas to consider:
Game the standard deduction
The Tax Cuts and Jobs Act (TCJA) almost doubled the standard deduction amounts. For 2022, the basic standard deduction allowances are:
$12,950 if you are single or use married filing separate status.
$25,900 if you and your spouse file jointly.
$19,400 if you are a head of household.
Slightly higher standard deductions are allowed for those who are 65 or older or blind.
Here’s the plan. If your total itemizable deductions for this year will be close to your standard deduction allowance, consider making enough additional expenditures for itemized deduction items before year-end to exceed the standard deduction. Those expenditures will lower this year’s tax bill.
Next year, your standard deduction will be quite a bit bigger thanks to an inflation adjustment, and you can claim the bigger allowance if you don’t itemize next year. The projected standard deductions for 2023 are $13,850, $27,700, and $20,800, respectively.
The easiest deductible expense to prepay is included in your house payment that’s due on Jan. 1. Accelerating that payment into this year will give you 13 months’ worth of itemized home mortgage interest deductions in 2022. Although the TCJA put new limits on these deductions, you’re probably unaffected. But ask your tax adviser to be sure.
Next up on the prepayment menu are state and local income and property taxes that are due early next year. Prepaying those bills before year-end can decrease your 2022 federal income tax bill, because your itemized deductions total will be that much higher. However, the TCJA decreased the maximum amount you can deduct for state and local taxes to $10,000 or $5,000 if you use married filing separate status. So, beware of that limitation.
Warning: The state and local tax prepayment drill can be a bad idea if you will owe the dreaded alternative minimum tax (AMT) for this year. That’s because write-offs for state and local income and property taxes are completely disallowed under the AMT rules. Therefore, prepaying those expenses may do little or no tax-saving good if you will be in the AMT zone. Thankfully, changes included in the TCJA took millions of taxpayers out of AMT danger, but not everybody. Ask your tax adviser if you’re in the clear for this year or not.
Consider making bigger charitable donations this year and smaller donations next year to compensate. That could cause your itemized deductions to exceed your standard deduction this year.
Finally, consider accelerating elective medical procedures, dental work, and expenditures for vision care. You can deduct medical expenses to the extent they exceed 7.5% of your adjusted gross income (AGI) if you itemize.
Carefully manage gains and losses
If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The federal income tax rate on net long-term capital gains recognized this year is “only” 15% for most folks, although it can reach the maximum 20% rate at high income levels. The add-on 3.8% net investment income tax (NIIT) can also bite at higher income levels. So, the true maximum rate for high-income individuals is 23.8%: The advertised 20% top rate plus 3.8% for the unadvertised NIIT.
If you have some loser investments that you would like to unload (who doesn’t these days), biting the bullet and triggering the resulting capital losses this year would shelter capital gains from other sales this year. In particular, sheltering short-term capital gains with capital losses is a tax-smart move because net short-terms gains will otherwise be taxed at your higher ordinary income rate of up to 37%, plus another 3.8% if the NIIT bites. Ouch!
If selling some losers would cause your 2022 capital losses to exceed your 2022 capital gains, the result would be a net capital loss for the year. No problem! That net capital loss can be used to shelter up to $3,000 of 2022 income from salaries, bonuses, self-employment income, interest income, royalties, and whatever else ($1,500 if you use married filing separate status).
Any excess net capital loss is carried forward to next year and beyond. In fact, having a capital loss carryover could turn out to be a really good deal. The carryover can be used to shelter both short-term gains and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years, because you won’t have to hold appreciated securities for over a year to get a lower tax rate. You’ll pay 0% to the extent you can shelter gains with your loss carryover.
Important point: If you sold a home earlier this year for a taxable gain, as some people did when real-estate values were peaking, you can use that to offset some or all of that gain with capital losses from selling loser securities. Good!
The bottom line
This column only covers the most basic year-end tax planning strategies for individual taxpayers. Stay tuned for Part Two of our menu of strategies, coming soon.