Tax Planning Strategies Now and Into the Future

There is still time before year-end to capitalize on some tried and true tax planning strategies. These planning ideas will also be great in a week, month or year.

• Increase contributions to 401(k) plan — Annual contribution is limited to $20,500.  Taxpayers that are 50 or over are eligible to make an additional catch-up contribution of $6,500.
• Maximize SEP-IRA retirement account contributions — For a self-employed individual, contributions are limited to 25% of the net earnings from self-employment, not including contributions for oneself, up to $61,000 for 2022.  And the best part?  If the taxpayer extends the filing of their tax return, they will have until October 16, 2023 to fully fund their contribution!
• Fund health savings accounts — Limited to $3,650 for an individual and $7,300 for families.  An additional $1,000 catch up contribution is permitted taxpayers 55 or older.
• Use your entire $5,000 dependent care flexible spending account — If funds are used to cover qualified childcare costs, the first $5,000 is exempt from tax.
• Fund education plans — There is no federal deduction for funding Section 529 plans, but some states offer income tax deductions for these contributions.

Roth IRA conversions

Many retirement account values decrease in 2022, presenting an opportunity for taxpayers to consider converting their traditional IRA to a Roth IRA.  When a traditional IRA is converted to a Roth IRA, the converted amount is taxable in the year of the conversion.  The resulting Roth IRA can subsequently grow tax free.

It will be necessary for taxpayers to have sufficient cash outside of the retirement accounts to cover the resulting tax bill.  You could also use some of the planning strategies discussed above to help mitigate the increased income from the Roth conversion, or consider spreading the conversion over multiple tax years to more efficiently use graduated tax rates.

Minimize capital gains / tax loss harvesting

Along the same lines as above, taxpayers might be sitting on capital losses due to dips in the stock market.  Capital losses can be used to offset current year capital gains plus up to $3,000 of other income.  Any additional losses can be carried forward to future tax years.

Taxpayers need to be aware of the wash sale rules, which prohibit the acquisition of identical stock or securities within 30 days of the sale of the disposed stock or securities at a loss.  If this occurs, the loss is not recognized, but is instead included in the cost basis of the security.

Opportunity zones

Qualified opportunity zones have attracted attention as a valuable tax planning tool since their introduction in the Tax Cuts and Jobs Act of 2017.  And despite recent headlines focusing on the inflationary environment and high interest rates, investments in qualified opportunity zones may still be a haven for taxpayers seeking to mitigate income tax liabilities.  As a reminder, the primary incentives of the opportunity zone program include:

• Deferred recognition of an otherwise recognized capital gain until December 31, 2026 or earlier if the qualified opportunity fund investment is sold before this date
• Permanent exclusion of gain recognized on the disposition of the qualified opportunity fund investment or its underlying assets. The exclusion is only available if the investment is held for 10 years.

There are many rules related to qualified opportunity zones, including contribution deadlines, types of assets held in qualified opportunity funds, etc.  We have covered opportunity zones extensively on this blog, thanks to Brian Duren.  The last post titled “Opportunity Zones in 2022: End of Penalty Relief, Rising Interest Rates, and Year-End Reminders” is a good place to get up to speed. 

Multi-year tax planning

Traditional tax planning emphasizes the deferral of income and the acceleration of deductions.  There may be times when the opposite of that is true.  Consider a plan that uses multiple tax years to find the least amount of cumulative tax.

• Invest in municipal bonds vs. taxable bonds — The current interest rate environment provides municipal bond investments with very attractive tax-free interest options. Municipal bonds are tax free at the federal level, taxability at the state level varies by jurisdiction. 
• Charitable contributions — Satisfy charitable commitments by donating appreciated stock. Generally, you’ll receive a deduction for the fair market value of the stock and avoid paying capital gains on the increase. If the stock value has decreased since it was purchased and you need those proceeds to fund charitable contributions, sell the stock first then donate the cash. You will receive the benefit of the capital loss.
• Consider “bunching” charitable contributions — If you regularly give to charity but the standard deduction is greater than your itemized deductions, you could elect to put multiple years of charitable contributions into a donor advised fund (DAF).  You would receive a deduction in the year that you fund the DAF and would itemize deductions.  In subsequent years, you would make charitable contributions from the DAF and use the standard deduction.
• Use qualified charitable distributions to satisfy required minimum distribution (RMD) requirements — Taxpayers over 70.5, or age 72 in certain circumstances, must take RMDs from their IRAs.  Charitably-inclined individuals may satisfy this requirement by having their IRA custodian contribute directly to a qualified charitable organization. This strategy avoids increasing adjusted gross income by not recognizing the RMD as income.  In this case, you wouldn’t receive a charitable deduction because the income was not recognized.
• Utilize the estate and gift tax exemptions — The lifetime estate tax exemption amount is $12.06 million and allows transfers of property to non-spouse beneficiaries during the donor’s lifetime or upon their passing without paying any gift or estate tax.  Taxpayers can also give $16,000 annually per person without any gift-tax consequences.  That is $32,000 for married filing jointly taxpayers! Lori Peterson is great in this space!
• Installment sales — When a seller receives payments on a sale transaction over multiple tax years, the income is recognized in the year the principal payment is received, thus spreading the gain over multiple tax years.  If you have capital or other losses that you can use in the tax year, or significant taxable events in future years, the installment method should be considered. Doing so will recognize the income in the year of sale knowing it will be offset, in whole or part, by other losses or more efficiently using the graduated tax brackets.
• Timing of transaction closing — Consider whether accelerating transaction closing in the current tax year or deferring until 2023 could yield the better tax result.
• Interest/dividend payments from closely-held entities — You can control the timing of interest and/or dividend payments from closely-held entities to the tax year that is most beneficial.
• Non-business bad debt — If you previously lent money that will not be repaid, you can recognize a short-term capital loss in the year the debt is rendered “completely worthless.”  Please note that this would not be applicable if lending money is your primary trade or business.
• Take full advantage of the Qualified Business Income deduction — This deduction, which was created by the Tax Cuts and Jobs Act of 2017, allows non-corporate taxpayers to deduct up to 20% of their qualified business income, plus up to 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income. This is also known as the Section 199A deduction. Taxpayers with projected income at or near the phase-out limits of the deduction ($340,100 for married filing jointly and $170,050 for single) should attempt to reduce their taxable income in order to generate the biggest possible qualified business income deduction.
• Be mindful of the decrease in Federal bonus depreciation effective January 1, 2023 — The 100% Federal bonus depreciation for eligible acquisitions and improvements remains in effect through December 31, 2022.  After that, the Federal bonus depreciation decreases by 20% each year through January 1, 2027.  In other words, qualified assets placed in service on or after January 1, 2023 are eligible for Federal bonus depreciation of 80%.  As a reminder, not all states conform to the Federal treatment of bonus depreciation.
• Perform a cost segregation study — A cost segregation study identifies assets used in a trade or business that can be depreciated at an accelerated rate using a shorter depreciation life.  These assets may be part of newly constructed buildings or existing buildings that have been purchased or renovated.  If the expense of the construction, purchase, or renovation was in a previous year, taxpayers can complete a cost segregation study on a past acquisition or improvement, and take the current year’s deduction for the resulting accelerated depreciation not claimed in prior years.  Mona Stocki and Alison Smidt are always my first phone calls for cost segregation studies.
• Consider accounting method changes — Changing an accounting method may be a great way to reduce taxable income for a given tax year by accelerating deductions into the year or deferring income into a subsequent year. Under the right circumstances, this flexible tax planning strategy could generate immediate tax savings, improved cash flow, and in some cases, provide permanent tax benefits for businesses.

Thanks to Carey Heyman and countless others for their help with this post!