The 2022 midterm election brought many surprises, but its effect on tax planning is less unexpected. Both before and after Nov. 8, taxpayers were likely to face a quiet few years before the tax landscape potentially shifts in a more substantial way.
With Republicans taking control of the House of Representatives and Democrats holding the Senate and the White House, it is unlikely that Americans will see any major tax legislation in the short term. The outgoing Congress could still pass the retirement bill popularly known as “SECURE Act 2.0” in its lame duck session; the bill has attracted bipartisan support and could make it through the Senate to President Joe Biden’s desk in the next few weeks. If it does, the new law will increase the age to trigger required minimum distributions for retirement accounts from 72 to 75. It will also increase retirement account contribution limits for older workers and encourage smaller employers to automatically enroll employees in workplace retirement plans.
Any other lame-duck tax legislation, if it appears at all, will likely come attached to a broader government spending agreement. One such potential tweak is an extension of the CARES Act’s option to take up to $300 in charitable donations ($600 for married couples filing jointly) as an “above-the-line” deduction, meaning taxpayers can benefit even if they don’t itemize their deductions. This benefit was in place for tax years 2020 and 2021, but under current rules, it does not apply to tax year 2022. If lawmakers pass a temporary extension to push budgeting questions into next year, this change and other tax tweaks are unlikely to materialize.
Even with no major tax updates on the horizon, taxpayers can still make useful moves before the end of the year.
Look Ahead When Tax Planning
A major component of tax planning, especially at year-end, is making an educated guess about your future tax situation. While income tax brackets are unlikely to change for the next few years, your personal circumstances could shift your income or your potential deductions significantly.
If you expect your income to rise due to raises, promotions or other factors, you may want to accelerate income to the extent you can. If you are self-employed, bill for completed work sooner rather than later to recognize that income in 2022. Some employees may be able to ask for a promised bonus in late December rather than early January, though such flexibility will depend on your organization. If you have nonqualified stock options, exercising them can accelerate income to a year when you expect to occupy a lower tax bracket. You may also want to consider deferring deductions. This strategy may be especially attractive if you live in a high-tax state. The cap on deducting state and local taxes will disappear at the end of 2025 unless lawmakers renew it, so deferring deductions you can control, such as large charitable donations, may help you get more benefit from them.
On the other hand, you may expect to occupy a lower tax bracket in the near future. This could be because you received a major bonus that temporarily raised your income; you expect to face significant medical bills in the upcoming year; or you are approaching retirement, to name a few examples. In this case, accelerating deductions to the extent you can may make sense. Deferring income is also good, though it can be more challenging, especially for traditional employees.
With a relatively high standard deduction in place – $12,950 for single filers and $25,900 for married joint filers in 2022, rising in 2023 to $13,850 and $27,700 respectively — bunching deductions makes it more likely you can benefit from itemizing them in a higher-income year. For many people, the deductions easiest to control are charitable contributions. You can deduct up to 60% of your adjusted gross income for cash donations, and up to 30% of AGI for gifts of anything else. Giving appreciated assets also allows you to avoid capital gains tax, stretching a gift further. If you don’t have a particular recipient in mind, donor-advised funds can be a useful option. And taxpayers subject to required minimum distributions can give RMDs from an individual retirement account directly to charitable organizations, up to $100,000 annually. These gifts are not deductible, but they can satisfy RMD requirements without creating taxable income.
In addition to charitable contributions, there are a few other deductions you may be able to accelerate. If you pay estimated state income tax, the fourth quarter payment is due Jan. 15; you could, however, pay it in December. Similarly, you could pay property tax bills that are due in early 2023 a few weeks early. Some individuals may be able to accelerate medical bills in order to hit the threshold for deducting such expenses (7.5% of AGI as of 2022). However, bear in mind that the services must be complete in the year of the deduction; you cannot, for example, prepay for your child’s braces and deduct the full amount if the orthodontia won’t be completed until the following year.
If your income varies significantly — often the case for self-employed individuals, for example — alternating between accelerating and deferring deductions can help you to take advantage of itemizing in some years while relying on the standard deduction in others.
Capital Gains And Losses
Capital gains tax rates remain low by historical standards. A married couple with income up to $83,350, or an individual with income up to $41,675, has a long-term capital gains tax rate of zero in 2022. A married couple with income up to $517,200 or an individual with income up to $459,750 still only faces rates up to 15% on long-term capital gains. If Congress doesn’t act, these rates are likely to increase at the end of 2025, giving investors a good reason to consider harvesting capital gains sooner if they have incentive to do so — for example, anticipating a rise in income over the next few years.
Given the stock market’s volatile performance in 2022, more investors may be facing capital losses this year. While no one is thrilled about investment losses, they do open up an opportunity for tax planning. If the assets that have lost value are in taxable accounts, harvesting those losses offers a tax benefit. You can use capital losses to offset capital gains, and also to offset an additional $3,000 of other income in a given year. If your losses exceed your capital gains and the additional $3,000, you can carry them forward to use in the future.
If you engage in tax-loss selling, you should be aware of “wash sale” rules. If you sell an investment to generate a capital loss, you cannot repurchase that investment (or one that is “substantially identical”) within 30 days of the sale. Otherwise, the capital loss will be disallowed and you will lose the tax benefit of selling the asset. Note that these rules only apply to capital losses, not capital gains.
Roth IRA Conversions
Another strategy that may have a wider appeal in 2022 is converting a traditional IRA to a Roth IRA. Since conversions are taxable events, it is generally a good idea to convert just enough not to push yourself into a higher tax bracket for the year, assuming this tracks with other long-term financial planning goals. Falling stock prices may let you convert a larger percentage of your traditional IRA without major effects on your income tax bill for the year.
Roth accounts don’t require annual withdrawals, providing more flexibility in retirement. And since you’ve already paid tax on the contributions, withdrawals are income tax-free. Investment returns can, over time, help counter inflation’s effect on your savings — a concern that is newly top-of-mind for many retirement savers.
Inflation’s Effect On Tax Planning
The return of inflation at levels not seen in decades means that dollar thresholds for a variety of tax purposes are changing more dramatically than some taxpayers are used to. Some of these include:
- The standard deduction for tax year 2022 is up $400 compared to 2021 ($800 for married couples filing jointly). It will rise another $900 to $13,850 for single taxpayers ($1,800 to $27,700 for married couples filing jointly) in 2023.
- Income tax brackets are slightly wider in 2022 than they were in 2021, and will become wider still for 2023.
- The annual gift tax exclusion is $16,000 for an individual in 2022, and $17,000 in 2023; for married couples, the exclusions are $32,000 and $34,000.
- Contributions for health savings accounts in 2022 are allowed up to $3,650 for individuals under 55; this limit will rise to $3,850 in 2023. (In both years, individuals 55 and older may make an additional catch-up contribution up to $1,000.) Bear in mind that you have until April 2023 to make contributions for tax year 2022.
It is also worthwhile to check your withholdings, especially since the penalty for underpaying your federal income tax has risen to 6%, and will potentially reach 7% in January 2023. The Internal Revenue Service offers a calculator to help determine whether you are on track. On the other hand, if you are set to receive a large refund, consider scaling back your withholdings. This reduces the possibility that IRS delays or errors could slow your refund down in favor of getting more money back in your pocket.
Year-End Tax Planning For Retirement Accounts
Whether you are retired or saving for retirement, tax diversification can offer you extra flexibility. Keeping some of your savings in taxable, pretax and after-tax accounts allows you to adjust contributions or withdrawals (to a point) depending on the year. For example, workers experiencing a low-income year can contribute to Roth IRAs with after-tax dollars taxed at relatively lower amounts. Workers having high-income years may want to bump up their traditional IRA contributions to take advantage of the immediate deduction. Also remember that you can contribute to an IRA until the income tax deadline the following spring, while 401(k) contributions must be made by year-end.
Savers should try to reach their maximum contribution limits for the year, if they are able. At a minimum, make sure you are contributing enough to secure any matching your employer offers. In 2022, the limit is $20,500 for traditional 401(k) plans for workers under 50, and $27,000 for workers over 50. These will increase to $22,500 and $30,000, respectively, for 2023. Roth 401(k)s have the same limits; note that if you have multiple 401(k) accounts, the limit applies to all of them, not to each separately.
If you have earned income, you can contribute up to $6,000 annually to a traditional IRA, with an extra $1,000 in catch-up contributions for savers 50 and older. The base limit will rise for $6,500 for tax year 2023. Note that if you are covered by a retirement plan at work, your IRA contributions may only be partially deductible or nondeductible depending on your adjusted gross income. Roth IRAs have the same contribution limits as traditional IRAs, but whether you can contribute to a Roth IRA at all is restricted by income.
As I mentioned earlier in this article, catch-up contributions for older savers may increase if Congress passes “SECURE 2.0.” Regardless, take advantage of the benefits available to you. If you are already retired, year-end is also a good time to make sure you have taken any RMDs to which you may be subject, since penalties for not taking required distributions can be steep.
No one can predict the future. However, a split Congress is as close as most taxpayers get to an assurance that they can rely on the current tax environment, even as market conditions and inflation remain unsettled.
While the next few years may be quiet, change is coming: A variety of tax thresholds, including the federal income tax brackets, will revert to previous levels in 2026 if lawmakers don’t act to extend provisions in the Tax Cuts and Jobs Act. This means that it’s also a good time to consider moves that may not need to happen before the end of 2022, but that you want to complete before the end of 2025. For example, the lifetime exemption for the federal estate and gift tax is currently high — $12.92 million per person for 2023 — making this a potentially good time to set up lifetime gifts or otherwise reduce the size of your taxable estate.
Tax planning should be a year-round activity. But even in a relatively quiet year, taxpayers who take stock before New Year’s Day have a special opportunity to take advantage of current conditions and set themselves up for a prosperous 2023.