Ongoing rising interest rates, inflation, and market volatility make year-end tax planning essential for individuals looking to reduce the amount of taxes paid over time.
The following article will highlight key considerations for individuals with regard to federal tax planning. It is important for individuals to also consider state and foreign tax tips. We recommend consulting with a trusted advisor when making decisions around taxes. The tips presented here are based on federal laws in effect at the time of publication.
Optimizing the Timeline
A common way of minimizing taxes involves analyzing the marginal tax rates of the current and upcoming year and timing income and deductions around such. Ideally, income should be received in the year with the lower marginal tax rate and deductible expenses should be paid in the year with the higher marginal tax rate.
Some key actions that may reduce or defer taxes include:
- Delaying closing capital gain transactions until after year end or structuring 2022 transactions as installment sales so that gain is deferred past 2022 (also see Long Term Capital Gains, below).
- Considering whether to trigger capital losses before the end of 2022 to offset 2022 capital gains.
- Delaying interest or dividend payments from closely held corporations to individual business-owner taxpayers.
- Deferring commission income by closing sales in early 2023 instead of late 2022.
- Accelerating deductions for expenses such as mortgage interest and charitable donations (including donations of appreciated property) into 2022 (subject to AGI limitations).
- Evaluating whether non-business bad debts are worthless by the end of 2022 and should be recognized as a short-term capital loss.
- Shifting investments to municipal bonds or investments that do not pay dividends to reduce taxable income in future years.
For those taxpayers anticipating being in a higher tax bracket for 2023, can take some actions in 2022 to shift taxable income so that it is taxed at a lower rate.
These considerations include:
- Accelerating capital gains into 2022 or deferring capital losses until 2023.
- Electing out of the installment sale method for 2022 installment sales.
- Deferring deductions such as large charitable contributions to 2023.
Long-term capital gains (and qualified dividends) are subject to a lower tax rate than other types of income. Investors should consider the following when planning for capital gains:
- Holding capital assets for more than a year (more than three years for assets attributable to carried interests) so that the gain upon disposition qualifies for the lower long-term capital gains rate.
- Considering long-term deferral strategies for capital gains such as reinvesting capital gains into designated qualified opportunity zones.
- Investing in, and holding, “qualified small business stock” for at least five years.
- Donating appreciated property to a qualified charity to avoid long term capital gains tax (also see Charitable Contributions, below).
Key Points to Remember:
Social Security Tax
The Old-Age, Survivors, and Disability Insurance (OASDI) program is funded by contributions from employees and employers through FICA tax. The FICA tax rate for both employees and employers is 6.2% of the employee's gross pay, but only on wages up to $147,000 for 2022 and $160,200 for 2023. Employers, employees, and self-employed persons also pay a tax for Medicare/Medicaid hospitalization insurance (HI), which is part of the FICA tax, but is not capped by the OASDI wage base. The HI payroll tax is 2.9%, which applies to earned income only.
Retirement Plan Contributions
- The maximum amount of elective contributions that an employee can make in 2022 to a 401(k) or 403(b) plan is $20,500 ($27,000 if age 50 or over and the plan allows “catch up” contributions). For 2023, these limits are $22,500 and $30,000, respectively.
- The SECURE Act changes the age for required minimum distributions (RMDs) from tax-qualified retirement plans and IRAs from age 70½ to age 72 for individuals born on or after July 1, 1949. Generally, the first RMD for such individuals is due by April 1 of the year after the year in which they turn 72.
- Individuals age 70½ or older can donate up to $100,000 to a qualified charity directly from a taxable IRA.
- Small businesses can contribute the lesser of (i) 25% of employees’ salaries or (ii) an annual maximum set by the IRS each year to a Simplified Employee Pension (SEP) plan by the extended due date of the employer’s federal income tax return for the year that the contribution is made. The maximum SEP contribution for 2022 is $61,000. The maximum SEP contribution for 2023 is $66,000. The calculation of the 25% limit for self-employed individuals is based on net self-employment income, which is calculated after the reduction in income from the SEP contribution (as well as for other things, such as self-employment taxes).
Limitation on Deductions of State and Local Taxes
For individual taxpayers who itemize their deductions, the Tax Cuts and Jobs Act introduced a $10,000 limit on deductions of state and local taxes paid during the year ($5,000 for married individuals filing separately). The limitation applies to taxable years beginning on or after December 31, 2017 and before January 1, 2026. Various states have enacted new rules that allow owners of pass-through entities to avoid the SALT deduction limitation in certain cases.
Charitable Contributions
Cash contributions made to qualifying charitable organizations, including donor-advised funds, in 2022 and 2023 will be subject to a 60% AGI limitation. The limitations for cash contributions continue to be 30% of AGI for contributions to non-operating private foundations. Tax planning around charitable contributions may include:
- Creating and funding a private foundation, donor-advised fund, or charitable remainder trust.
- Donating appreciated property to a qualified charity to avoid long-term capital gains tax.
Estate and Gift Taxes
For gifts made in 2022, the gift tax annual exclusion is $16,000 and for 2023 is $17,000. For 2022, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $12,060,000 per person. For 2023, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $12,920,000. All outright gifts to a spouse who is a U.S. citizen are free of federal gift tax. However, for 2022 and 2023, only the first $164,000 and $175,000, respectively, of gifts to a non-U.S. citizen spouse is excluded from the total amount of taxable gifts for the year. Tax planning strategies may include:
- Making annual exclusion gifts.
- Making larger gifts to the next generation, either outright or in trust.
- Creating a Spousal Lifetime Access Trust (SLAT) or a Grantor Retained Annuity Trust (GRAT) or selling assets to an Intentionally Defective Grantor Trust (IDGT).
Net Operating Losses and Excess Business Loss Limitation
Net operating losses (NOLs) generated in 2022 are limited to 80% of taxable income and are not permitted to be carried back. Any unused NOLs are carried forward subject to the 80% of taxable income limitation in carryforward years.
A non-corporate taxpayer may deduct net business losses of up to $270,000 ($540,000 for joint filers) in 2022. The limitation is $289,000 ($578,000 for joint filers) for 2023. A disallowed excess business loss (EBL) is treated as an NOL carryforward in the subsequent year, subject to the NOL rules. With the passage of the Inflation Reduction Act, the EBL limitation has been extended through the end of 2028.
For questions on how each of these considerations may impact you, please contact our tax team today.
