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Year-End Tax Planning Strategies

| 12/21/22 2:03 PM
8 minute read 

With year end rapidly approaching, there is still time to implement tax saving strategies to lower your 2022 taxes. Current focus should be on deferring 2022 income into the following year and accelerating deductions for 2023 into the current year. This is often referred to as the “normal approach” to year-end tax planning.

One recent legislation update relates to individuals turning 72 in 2023, and expecting to begin their Required Minimum Distributions (RMDs), Congress may give you an additional deferral. Text of the proposed “Consolidated Appropriations Act, 2023” which contains the SECURE Act 2.0 legislation, has proposed that for individuals turning 72 in 2023 may wait until turning 73 to begin RMDs. Please keep this in mind as you think through your planning.

A framework for year-end tax planning

In order to ensure that the normal approach is appropriate, a multi-year income tax projection should be prepared for 2022 and 2023. This will give you an idea of what your projected marginal tax rates might be for each year, and also help you identify the income and deduction items that you can either accelerate into 2022 or defer into 2023. 

Keep in mind the following high-level guidelines when working with multiple tax years:

Year-End Tax Planning Strategies

Income deferral ideas 

Now that we have provided a framework for creating a tax planning projection, we would like to share some actual ideas for deferring and/or reducing your income. Here is our eleven-item check list of ideas to consider:

  1. Defer interest income on idle cash. One example of this is to purchase a short-term CD that matures in 2023. Purchasing a Treasury Bill will also produce a similar result with the interest being paid on this security at maturity. The interest income on these two cash holdings will not be taxed until 2023. In addition, the Treasury interest will, in general, not be taxed by your state.
  2. Convert pass-through entity interest from taxable to tax-exempt. This is often overlooked by many entrepreneurs, but to the extent you control the flow-through entity, consider moving any idle cash/working capital into a tax-free money market account or similar short-term, but tax-free instrument. In addition, the CD and Treasury Bill strategies previously mentioned are options as well.
  3. Postpone recognition of “cash basis” income items. If you are self-employed and/or operate your business on the cash basis method of accounting, consider delaying (within reason) billing invoices for 2022 until the end of the year so the income payment comes to you next year.
  4. Contribute to an IRA. Contributing to an IRA is another option for reducing your income for 2022 (assuming you meet certain criteria). In this arrangement you have until April 15th of 2023 to actually make the contribution and still reduce your 2022 income. The maximum contribution is $6,000 plus and additional $1,000 if you are 50 years old or older.
  5. Contribute the maximum to your 401(k). The maximum contribution for this year is $20,500 ($27,000 if age 50 or older). If not taking full advantage of the maximum contribution, then at least make sure you are contributing enough to receive the full match by your employer.
  6. Defer your first required minimum distribution (“RMD”) if reaching 72 this year. If your 72nd birthday was in 2022, then you have a 2022 RMD. Consider deferring your first RMD into 2023 since you have until April 1st of the year following the year you turn 72 to take your first RMD. Consider the impact of “doubling up” on IRA distributions in 2023 since your 2023 distribution will also need to be made in 2023. Again, understanding your projected taxable income for 2022 and 2023 will help you make this timing decision.
  7. Review retirement distributions containing employer stock. Consider taking a lump-sum distribution of your employer stock in retirement (after 59 ½) versus rolling into an IRA. You will pay tax on your cost basis of these shares upon distribution, but the net unrealized appreciation in the stock will not be taxed until you sell these shares. In addition, this “net unrealized appreciation” strategy allows you to pay tax on the appreciation at the long-term capital gains rate upon sale.
  8. Maximize the use of flexible spending accounts and/or Health Savings Accounts (HSA). Assuming your employer provides these options, they are a great way to pay for medical expenses and lower your income. Plus, the HSA will allow for growth in a tax-sheltered environment. Maximum 2022 contributions to a Health Savings Account are $7,300 for family coverage and $3,650 for individual coverage, and an additional $1,000 contribution if you are 55 or older.
  9. Direct RMD to charity. If 70 ½ or older, you may be able to distribute up to $100,000 of your required minimum distribution to a qualified charity. This transfer must be direct to the charity from your IRA and will not be included in income, but does count towards your required distribution amount. 
  10. Consider life insurance/annuity. If you have maximized tax-deferred savings in all other vehicles available to you, then consider utilizing insurance products. The cash balances (and/or investments) inside life insurance or an annuity grow on a tax deferred basis.
  11. Shift income to children. Consider shifting some income to children who are in a lower tax bracket. For example, if you own stock that pays a dividend, one option might be to gift that stock to your children. The dividends will then be taxed to your children rather than you. You can make a tax-free gift of up to $16,000 per recipient in 2022 without incurring federal gift tax. Caution: Beware of the kiddie tax rules. Under these rules, for children under age 18, (or full-time students under age 24), who don't earn more than one-half of their financial support, any unearned income over $2,300 is taxed at the parents' marginal tax rates. 

Ideas for accelerating deductions

Another reason for preparing a projection, is to understand where your projected itemized deductions are in relation to the standard deduction. As shown in the table below, the standard deduction has increased significantly to a level where many taxpayers are utilizing the standard deduction because it has become a higher amount than their itemized deductions.

Here are a handful of ideas for accelerating deductions to help reduce your taxable income:

  1. Accelerate deductible tax payments. Three examples of state tax payments for consideration that you could consider making by December 31st:
    • Pay the second installment of real estate taxes (normally due in April)
    • Increase your payroll withholdings to pay for state income taxes (versus paying balance in April)
    • Make 4th quarter state estimated tax payments (versus paying January 15th)
    • Please note that state and local taxes are limited to $10,000 annually on a federal basis, so make sure that you don’t accelerate a tax payment without any benefit.
  2. Maximize home mortgage interest deduction. Consider making your January 2023 payment by December 31, 2022.
  3. Make tax-efficient charitable gifts. For example, donate appreciated securities that you have held for more than a year. Alternatively, if you have securities with a loss, sell those to recognize the loss and then donate the proceeds. You can also “pre-fund” future charitable gifts by contributing to a donor advised fund, charitable remainder trust or private foundation. A credit card may be used to make a charitable contribution as well if you are short on cash or want to earn frequent flyer miles.
  4. Establish proper timing of deductions. Make sure that payments are delivered on or before December 31st to ensure they are 2022 deductions. 
  5. “Bunch” itemized deductions. If your itemized deductions fall short of certain thresholds to give you any benefit, consider “bunching” them into alternative tax years to force them over the thresholds. For example, medical expenses are only deductible to the extent they exceed 7.5% of your adjusted gross income. Timing or “bunching” your medical expenses into one year allows a better likelihood they will exceed this 7.5% threshold.

Tips for your investments

Taking proactive steps with your investments between now and year-end may have a big impact on 2022 taxes. With that in mind, here are some tax tips for consideration:

  1. Re-consider Municipal Bonds. Given your tax bracket and increased yields, Municipal Bonds (“Muni’s”) may now make sense in your portfolio, whereas a few months ago they may not have made an attractive choice. Remember, Muni interest may be double tax-free if the bonds you purchase are from your state of residency.
  2. Take a look at Treasuries. Increased yields (which are guaranteed by the federal government) have become attractive recently – especially coupled with the fact that most states do not tax interest on U.S. Government obligations.
  3. Evaluate location. Evaluate the holdings in your portfolio to understand whether they are properly located between your taxable and retirement accounts. Less tax-efficient investments (e.g., emerging market or small capitalization equity mutual funds) with higher turnover maybe better “located” in your retirement accounts.
  4. Get ahead with tax loss harvesting. Tax loss harvesting has become an important aspect of managing your investments. Here are some quick tips for year-end tax loss harvesting:
    • Incorporate capital gains distributions from mutual funds. Understand the magnitude of your capital gain distributions from any mutual funds and make sure you harvest enough capital losses to offset these gains as well. Consider whether it makes sense to sell a mutual fund before the distribution is paid.
    • Beware of the wash sale rule. If you purchase the same, or a "substantially identical" investment within 30 days before or after the sale of the security generating a loss, you will void the loss. “Substantially identical” may be tricky since there is no formal definition provided by the Internal Revenue Service.
    • Use losses against ordinary income. Up to $3,000 in net capital losses can be used against other ordinary income (e.g., wages, taxable interest, IRA distributions, etc.) in any given year.
    • Don’t be afraid to generate more losses than you need this year. You can carry over the excess (above the $3,000 previously mentioned) into future years, and they won’t expire until you do.
    • Specifically identify. Use the specific identification method of selling your investments to control the desired tax result. If you are selling less than an entire position and some of your lots have gains and losses (i.e., they were bought at different times), then be sure to specifically identify and sell the lots with losses.
    • Opportunity Zones. Still have a gain after all of this? You can utilize an Opportunity Zone investment and defer your federal gains into this vehicle. Be sure to consult with your tax and investment advisors before investing to ensure it’s right for you.

While we have provided many tax planning ideas that you can take advantage of between now and year-end, please note that we have not included every tax planning idea that may be available to you, and not every idea may be appropriate for your situation. We encourage you to begin planning as soon as possible to take advantage of your available opportunities.

IMPORTANT DISCLOSURE INFORMATION    

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by First Foundation Advisors), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from First Foundation Advisors. Please remember that if you are a First Foundation client, it remains your responsibility to advise First Foundation, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. First Foundation Advisors is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the First Foundation Advisors’ current written disclosure statement discussing our advisory services and fees is available for review upon request, or at firstfoundationinc.com.  Please Note: First Foundation Advisors does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to First Foundation Advisors’ web site or incorporated herein, and takes no responsibility therefore. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. There is no guarantee that a tax-managed strategy will result in increased after-tax returns. Results will differ based on an individual investor’s circumstances.

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