As calendar year 2022 comes to a close, it is a good time for taxpayers and their advisors to start thinking of planning moves that will help lower their tax bill for this year and possibly the next.
This year, we have seen significant financial uncertainty and an inflation rate not seen since the 1980s, which led to the passing of the Inflation Reduction Act of 2022. Even as the economy continues to change, the standard year-end approach of deferring income and accelerating deductions will continue to provide the best results for most taxpayers.
Our office can help you prepare an effective strategy tailored to your unique circumstances while considering what changes may lie ahead. The earlier we get started, the greater the potential maximization of benefits. We have compiled a checklist of actions that may help you save tax dollars if you act before year-end. Not all actions will apply in your situation, but you (or a family member) will likely benefit from many of them. We can narrow down the specific actions you can take, and once we meet with you, we can construct a detailed plan. Please review the following list and contact us at your earliest convenience, so that we can advise you on which tax-saving strategies may be beneficial to you.
- Medical Expenses – Itemizing taxpayers can deduct certain unreimbursed medical expenses that exceed 7.5% of 2022 adjusted gross income (AGI). For those exceeding this threshold, it may be beneficial to accelerate additional medical expenses into the tax year 2022.
- State and Local Taxes – The itemized deduction for taxes is still capped at $10,000; this includes income taxes paid to state governments, state and local real property taxes, and state and local personal property taxes (such as driver’s license fees). Taxes paid for property held for investment are still deductible in full and do not fall within the $10,000 overall limitation.
- Donor-Advised Funds (DAF) – This is a charitable giving vehicle administered by a public charity created to manage charitable donations on behalf of organizations, families, or individuals. A donor-advised fund allows the taxpayer to receive an immediate tax deduction with the benefit of not having to immediately decide which charities to support. Although the taxpayer surrenders ownership of the assets contributed to the donor-advised fund, he/she retains advisory privileges over how the assets are invested and distributed to charities.
- Bunching Deductions – Taxpayers who are close to the threshold for itemizing deductions, as opposed to taking the standard deduction, may consider bunching expenses in certain years. Consider the timing of payments for medical expenses, charitable contributions, and extra mortgage payments to exceed the standard deduction threshold.
Retirement Account Planning
- Individuals of 70-1/2 years or older may exclude from gross income qualified charitable distributions (QCDs) from IRAs of up to $100,000 per year. If excluded from income, the charitable donation will not count toward the individual’s itemized deductions. As such, this strategy is especially useful for taxpayers who do not normally itemize.
- Individuals afraid of outliving their IRA funds or who want to reduce their RMDs can consider investing in a qualified longevity annuity contract (QLAC), which is a deferred annuity funded by a qualified retirement plan.
- Taxpayers whose dependent children have earned income may want to consider making a Roth IRA contribution on their behalf. Doing so will not result in an immediate benefit, but the funds will grow tax-free until their child’s eventual retirement.
- Even if a taxpayer’s traditional IRA contributions do not qualify for a deduction, they may want to consider making nondeductible contributions and immediately convert them to a Roth IRA (the backdoor Roth strategy).
Real Estate Planning
- Cost Segregation Studies – Real property, such as a rental building, is separated into a non-depreciable land component and a depreciable building component. The building component is depreciated over 27.5 years if residential real estate and 39 years for commercial property. A cost segregation study can be performed to break up the building component into segments with shorter useful lives allowing for accelerated depreciation. Studies may be performed for properties placed in services in prior years by filing Form 3115, also known as the Application for Change in Accounting Method. Any increase to prior year depreciation may be recognized in the current year.
- Like-Kind Exchanges – Taxpayers selling appreciated rental real estate may want to consider transferring their equity into a larger, more profitable property using a like-kind exchange. For taxpayers uninterested in managing a rental property, a professionally-managed Delaware Statutory Trust (DST) can be considered instead.
Net Investment Income Tax
A 3.8% surtax applies to the lesser of (1) net investment income or (2) the excess of modified adjusted gross income (MAGI) over the threshold.
Modified Adjusted Gross Income Thresholds
|Married Filing Jointly||$250,000|
|Married Filing Separately||$125,000|
|Head of Household||$200,000|
|Widow(er) with Dependent Child||$250,000|
MAGI is Adjusted Gross Income (AGI) increased by the amount excluded from income as foreign earned income (net of the deductions and exclusions disallowed with respect to the foreign earned income). The 3.8% surtax applies to gross income from interest, dividends, annuities, royalties, and rents unless those items are derived in the ordinary course of a trade or business to which the tax does not apply. The tax also applies to income generated from a trade or business if it is a passive activity of the taxpayer. Hence, the tax does not apply to active businesses conducted by a sole proprietor, partnership, or S corporation. Investment income does not include any amount subject to the self-employment tax and does not include amounts distributed from retirement plans. As year-end nears, taxpayers may want to consider actions including:
- Reducing MAGI by electing installment sale treatment to recognize capital gains over several years.
- Selling investments currently held at a loss to offset capital gains.
- Switching investments to tax-exempt investments.
Alternative Minimum Tax
Like the NII tax, the Alternative Minimum Tax (AMT) also requires personalized attention. There are steps that taxpayers subject to AMT can take to reduce its effect on their tax liability. For instance, taxpayers can attempt to eliminate certain tax preferences. With state and local tax deductions still capped at $10,000, we are expecting most taxpayers will not be subject to AMT.
Additional Medicare Tax
The 0.9% additional Medicare tax may also require higher-income earners to take year-end actions. It applies to individuals for whom the sum of their employment wages and their self-employment income is in excess of an unindexed threshold amount. The threshold amounts are:
Income Threshold for Additional Medicare Tax
|Married Filing Jointly||$250,000|
|Married Filing Separately||$125,000|
|Head of Household||$200,000|
|Widow(er) with Dependent Child||$200,000|
There could be situations where an employee may need to have more taxes withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he or she would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000. If you feel you do not have enough income tax withholding to cover this tax, you may request that your employer process additional withholding from your income.
The annual exclusion for gifts increased to $16,000 in 2022. Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift taxes. The exclusion applies to gifts of up to $16,000 made in 2022 to each of an unlimited number of individuals. You cannot carry over unused exclusions from one year to the next. The transfers may also save family income taxes where income-earning property is gifted to family members in lower income tax brackets who are not subject to the kiddie tax. It may be advantageous to consider making gifts above the exclusion for high-net-worth individuals that may be affected by a possible decrease in the estate and gift tax exemption.
Complex Trusts and Estates
There is a special election available for estates and complex trusts for distributions made to a beneficiary within 65 days following the end of a tax year. The fiduciary can elect to treat any such distribution or part of a distribution as having been made in the prior year. The effect of this election is that the deduction for the distribution can be taken by the estate or trust in the year before the distribution was made. However, the beneficiary receiving the distribution must also be taxed on the distribution in the year before the distribution was received.
The amount covered by the 65-day election is limited to the greater of:
- The amount of the estate’s or trust’s income; or
- The estate’s or trust’s DNI, reduced by amounts paid or required to be distributed during the tax year, other than amounts subject to the 65-day election.
This election is made on Form 1041. Once made, the election is irrevocable, but is binding only for that year. The 65-day election is not available for accumulation distributions.
- Residential Clean Energy Credit – A nonrefundable tax credit is available to an individual for residential energy-efficient property. The credit is claimed in the year the qualifying property is placed in service and equals 30 percent of eligible costs. Projects completed after December 31, 2022, will be eligible for a credit for tax year 2023.
- Clean Vehicle Credit – The Inflation Reduction Act of 2022 made significant changes to the Qualified Plug-in Electric Drive Motor Vehicle Credit, now known as the Clean Vehicle Credit. The changes took effect on August 16, 2022, and included an additional requirement for the final assembly of the vehicle to take place in North America. A tax credit of up to $7,500 is available for automobiles that meet this requirement. If a “written binding contract” was established before August 16, then the old rules will still apply, even if the vehicle is placed in service after the cutoff date. Electric cars from Tesla, General Motors, and Toyota are still not eligible for a credit for the remainder of 2022. However, certain models from these automakers may be eligible beginning January 1, 2023, if they meet the final assembly test.
Limitation on Excess Business Losses for Noncorporate Taxpayers:
Noncorporate taxpayers are not allowed to deduct excess business losses for tax years beginning in 2021 through 2026. An excess business loss is defined as the excess if any, of (1) the taxpayer’s aggregate business deductions for the year over (2) the sum of the taxpayer’s aggregate business gross income or gain plus an amount adjusted for inflation ($540,000 for married filing joint returns and $270,000 for any other status). Any disallowed excess business losses will be characterized as a net operating loss carryover to subsequent years.
These are just some of the year-end steps that can be taken to save taxes. By contacting us, we can tailor a plan that will work best for you.
KROST CPAs & Consultants
About the Author
David Ha, CPA, Manager
David Ha is a Tax Manager in the tax department at KROST. David has been in the public accounting profession for over a decade and came from private accounting. His areas of expertise include tax planning and compliance for high-net-worth individuals, partnerships, and corporations. He services clients in various industries including but not limited to cannabis, restaurant, real estate, professional services, and financial services industries. » Full Bio