2022 Year-End Tax Planning: Three Popular Ways to Reduce Taxable Income

Director of Tax and Accounting, Michael Malc, CPA
11-02-2022

2022 Year-End Tax Planning: Three Popular Ways to Reduce Taxable Income

As we enter the month of November and anticipate the upcoming holiday season, clients should be mindful that they only have two more months to take advantage of any sort of tax planning to reduce or postpone recognition of income for the 2022 tax year. There are three popular avenues that can be taken to lower taxable income and ultimately your tax liability: retirement account contributions, tax loss harvesting, and charitable donations including qualified charitable distributions (QCD) from retirement accounts.

RETIREMENT ACCOUNT
Retirement account contributions, specifically contributions to 401ks, are due by December 31, 2022. For the 2022 tax year, the maximum contribution amount is $20,500 with a $6,500 catch-up amount for contributors over the age of 50. Contributions to traditional IRAs and Roth IRAs/back door Roth IRAs can be made up until April 17th, 2023. The maximum contribution limits for those are $6,000, with an extra $1,000 for those over 50 for a total of $7,000. Keep in mind that contributions to ROTH IRA accounts are not tax-deferred, but a good tool to limit tax expenses after retirement. For those that are Self-Employed or have their own side business and file a Schedule C, contributions to a SEP IRA can be made up until April 17th, 2023, unless an extension to file on October 16th, 2023 has been made. The contribution limit for a SEP IRA is the lower of either 25% of salary wages (special calculation for sole proprietors) or $61,000. Putting money into retirement accounts is a great way to minimize current taxable income since that income will only be taxable upon distribution during retirement.

TAX LOSS HARVESTING
You may have heard your financial advisor mention a concept called tax loss harvesting as a way to minimize taxes. The idea is, that by selling low-performing stocks that have caused losses, the losses can be utilized to offset taxable capital gains in the current year or be carried forward to next year to offset gains then. Short-term and long-term losses can offset short-term and long-term gains. If after netting it all there is still a short-term or long-term loss of more than $3,000, then $3,000 of loss can offset ordinary income, like wage income, and the rest can be carried forward to the next year or until it is used up. The carryforward losses would retain their short or long-term designation to offset gains in the future.

CHARITABLE CONTRIBUTIONS
Finally, charitable contributions in the form of cash or long-term appreciated securities are a nice way to reduce taxes. With the passing of the Tax Cuts and Jobs Act in 2017, the amount of eligible charitable deductions rose from 50% of adjusted growth income (AGI) to 60% of adjusted growth income. Donations of appreciated securities are typically capped at 30% of adjusted growth income.

A lesser-known form of charitable deduction that is great for taxpayers who have already started taking out Required Minimum Distributions from their IRA accounts is the Qualified Charitable Distribution (QCD). The QCD rules allow a taxpayer to make a direct charitable contribution to a qualified charitable organization of up to $100,000 from their RMD and effectively reduce their recognized income for that year. Note that QCDs cannot be made to a donor-advised fund (DAF account).

As an example of how the QCD works, if a taxpayer’s RMD was $300,000, then without making a QCD, the entire $300,000 would be subject to ordinary income tax rates. If the taxpayer decided to do a QCD of $100,000, then only $200,000 of retirement income would be recognized and taxed on the tax return. This deduction is better than a regular charitable donation as it directly affects AGI. A lower AGI can mean less social security income is taxable, less income is subject to the net investment income tax, and even a lower threshold with which to base deductible medical expenses on.
One point to keep in mind is that the QCD can only be taken as a deduction of income against income that would otherwise be taxable. This means o say that any portion of an IRA distribution that would be considered non-taxable, i.e. in a case where one has a basis in the account (from making a non-deductible IRA contribution in a prior year), then the QCD would be limited to offsetting the taxable portion only. The non-taxable distribution would still be non-taxable, it just wouldn’t be considered a QCD. The non-taxable amount could still be given to charity if desired, however, it would be reported as an itemized deduction subject to the 60% limitation of AGI.

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Please consult with your investment adviser and tax professional for more guidance and assistance.