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Preparing Yourself for Year-End Tax Planning

Categories: Insights |
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7 minutes

“Opportunity is missed by most people because it is dressed in overalls and looks like work.”

Even though Thomas Edison wasn’t talking about taxes when he made that statement, he might as well have been.

Year-end tax planning can feel overwhelming when trying to decipher a complex and confusing tax code. What you’re examining and reviewing may not look like tax-saving opportunities (especially without the overalls). But when you take a closer look at benefits the tax code offers, there are endless opportunities to uncover.

The end of the year is a great time to see what tax-saving opportunities may exist for you as you have a clearer picture than earlier in the year of what your income situation is expected to look like. With a completely different economic environment facing us right now than in years past, planning has become more important than ever.

Retirement Plans & Required Minimum Distributions

2022 has been an important year for inherited retirement accounts.

The IRS finally released its initial interpretation of the SECURE Act, which was originally signed into law back in 2019. This bill changed the rules for retirement accounts, including traditional IRAs as well as Roth IRAs. One of the most significant rule changes pertains to inherited IRAs.

The SECURE Act requires that most non-spouse beneficiaries who inherited an IRA liquidate the account by the end of the 10th year after the death of the account owner. Depending on the age of the original account owner, annual distributions may be required for the beneficiary. This added complexity came as a surprise as it was just introduced earlier this year…over two years after the bill was signed into law!

However, in October of 2022, the IRS issued some temporary relief that would NOT require these distributions to be taken for 2021 or 2022. These distributions are required to be taken beginning in 2023.

While it could be advantageous to hold off on taking distributions to allow the account to grow tax-free, it may be worth considering taking a distribution if you are expected to be in a lower tax bracket this year. Tax rates are expected to increase in 2026, so taking advantage of the historically low tax rates now may be more beneficial than deferring any distributions. Spreading out these withdrawals may help keep you out of a higher tax bracket and, as a result, reduce the overall tax burden of these distributions.

While planning for the current year is important, it can also be beneficial to plan for the future with year-end tax planning. Congress is currently working through another bill being referred to as the SECURE Act 2.0. This legislation would look to make additional modifications to retirement account rules by expanding access to millions more Americans, increasing the age for required minimum distributions (again) and several other beneficial changes.

Portfolio Strategies

It’s been a wild ride for the stock market this year. Although the recent pullback in stocks has negatively impacted portfolios over the year, there are plenty of opportunities that can be taken advantage of to manage your taxes.

Tax Loss Harvesting

In a down market, one key strategy is known as tax loss harvesting. This is the practice of selling securities in your portfolio currently valued at a loss and using those funds to purchase a very similar security. Be careful though! If you repurchase the same security or one that is substantially identical, the Internal Revenue Service may disallow that loss, defeating the entire purpose.

Taking a loss in your portfolio allows you to offset any capital gains that may have been realized during the year. If your losses exceed your gains, you may be able to offset other types of income up to $3,000 a year ($1,500 if you are single) and any losses that you are not able to use can be carried forward indefinitely. If you are expected to be in a high tax bracket this year or next, look to see if harvesting losses in your portfolio would be advantageous for you during year-end tax planning.

Portfolio Income

Have you checked in on your portfolio lately? Just like an annual physical exam at the doctor, checking in on your financial portfolio during the year can be equally important.

Your portfolio can play a large part in year-end tax planning, as it can produce income in the form of interest or dividends. Certain dividends, known as capital gain dividends, generally arise from mutual funds and are required to be paid out by the fund before the end of the year.

When an investor sells out of a mutual fund, the fund manager needs to figure out a way to pay the investor for redeeming their shares. Mutual fund managers may need to sell some of the securities held in the fund to raise cash so they can reimburse the investor. Selling these securities could produce capital gains that then need to be paid out to the remaining shareholders. With the volatility in the market this year, these distributions have become quite unpredictable and could result in an unpleasant taxable event.

Tax Benefits of Charitable Giving

The holiday season is quickly approaching and so is the time that most Americans make charitable contributions. Charitable giving can strengthen your personal values, help protect the causes you love, and can even provide you with potential tax benefits.

The tax code is riddled with provisions for all types of charitable contributions. Below are just three examples of how charitable giving can help reduce your taxes.

  • Itemized Deductions – Taxpayers who itemize deductions can deduct charitable contributions from income that would otherwise be taxed. If you anticipate a large tax bill this spring, consider bunching charitable contributions. Combining multiple years’ worth of charitable contributions into one single tax year can produce a larger deduction. This strategy can also be used to exceed the annual standard deduction threshold, providing you with a greater tax savings by itemizing.
  • Qualified Charitable Distributions (QCDs) – If you are required to take a distribution from your IRA this year, you may be eligible to make a qualified charitable distribution. The tax code allows taxpayers over the age of 70.5 to distribute funds from their IRA directly to a public charity of their choice. Qualified charitable distributions tend to be one of the most favorable giving strategies available. Not only can these distributions help satisfy all or a part of your required minimum distributions, but you also do not need to recognize income on the portion that is given directly to charity.
  • Temporary Allowance: Over the past two years, Congress passed a temporary rule that allowed taxpayers to receive a charitable deduction even if they claimed the standard deduction. For 2021 the deduction was limited to $600 for married filers and $300 for single filers.  Although this special allowance has not yet been extended for the 2022 tax year, there is a possibility that Congress may pass this tax extender by the end of the year.

Roth IRA Conversions

A Roth conversion can be an effective strategy for managing taxes during retirement. A Roth conversion involves moving funds held in a traditional IRA to a Roth IRA. This transfer is considered a taxable event as the funds are shifting from a before-tax retirement account to an after-tax retirement account.

So why would you choose to pay taxes now rather than later?

To start, a Roth IRA is funded with after-tax dollars so any distributions that you take may be completely free of income tax. This tax-free distribution also applies to any heirs that eventually inherit the account as well.

Unlike Roth IRAs, traditional IRAs require account owners who reach age 72 to take annual withdrawals. These required minimum distributions are considered taxable income and can impact the tax bracket that you fall into. By completing a Roth conversion, you can pay the taxes on those transferred funds now and enjoy tax-free distributions later in life without worrying about the impact of required minimum distributions.

The recent decline in the stock market can create an even better opportunity for a Roth conversion. In fact, Roth conversions can be most beneficial when stocks are down as you are able to convert more shares at the same cost. With tax rates still at a historical low, this is just another added benefit to converting right now as part of year-end tax planning.

Other Recent Tax Developments to Consider

  • The Inflation Reduction Act. This bill included several energy-efficient tax incentives for both individuals and businesses. The bill also extended popular Affordable Care Act premium reductions and capped yearly Medicare Part D out-of-pocket costs at $2,000, beginning in 2025.
  • Student loan forgiveness of up to $20,000, per borrower.  President Biden signed an executive order over the summer that would forgive some federal student loan debt for qualifying individuals.  While this forgiveness is not considered a taxable event for federal purposes, it may be taxable in your resident state.

Midterm Elections & Future Tax Policy

With the 2022 midterm elections behind us, we have a better sense of what to expect over the next two years. Control of Congress will now be split with Republicans winning the House of Representatives and Democrats holding onto the Senate. With a divided Congress we are not likely to see major tax hikes or tax cuts over the next couple of years. Although, we can expect the two parties to work together to pass smaller measures that attract bipartisan support, such as the pending retirement plan reform, referred to as the SECURE Act 2.0. 

The next substantial change to the tax code is expected to occur beginning in 2026 when several provisions of the Tax Cuts and Jobs Act of 2017 are set to expire. Households can expect to see tax rates revert to their higher 2017 levels, adjusted for inflation of course. The higher federal estate exemption is also set to be cut in half at that point as well. While we may still be a few years away from these changes taking effect, it’s important to keep them in mind to help you plan for your future with year-end tax planning.

Future Planning

Let’s face it, many people would rather plan for a vacation than think about their taxes. But with this economic environment that we are currently facing, it’s important to consider the opportunities available right now. Everyone has a situation unique to them, and certain opportunities may be better for some than others. That’s why it is important to consult with a wealth advisor to help take advantage of the strategies that make the most sense for you. There are only a few weeks left in the year to plan accordingly, so act fast! You can get in touch with advisors from Domani Wealth anytime by calling 855-555-5455 or emailing info@domaniwealth.com.

Important Disclosure

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 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 article serves as the receipt of, or as a substitute for, personalized investment advice from Domani. A copy of Domani’s current written disclosure brochure discussing our advisory services and fees continues to remain available upon request.

PLEASE SEE ADDITIONAL IMPORTANT DISCLOSURE INFORMATION

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