Written by: Sylwia Nazar, CPA, MST
As year-end approaches, you are inevitably thinking about taxes. Below are some general tax planning strategies that may help to reduce your 2022 tax liability. Contact us to help with your specific situation.
Convert your Traditional IRA to a Roth IRA
A down market may be the time for converting a traditional IRA to a Roth IRA. Roth IRA earnings grow tax-free, withdrawals are tax-free, and Roth IRAs don’t have minimum distribution requirements (RMD’s) to primary beneficiaries.
If you expect to be in the same or a higher tax bracket in retirement, depending on your circumstances and age, the long-term economics can outweigh any conversion tax you’ll pay now.
There are some hidden tax ramifications, so it’s a good idea to check with us to see if a conversion makes sense.
Contribute to a Retirement Plan
For 2022, there are plans where you can contribute much higher amounts than regular IRA’s.
A SEP IRA is an employer-sponsored retirement plan that can be set up by sole proprietors, LLCs, partnerships, and corporations. A SEP IRA can be set up after year end and must be funded by the due date of your tax return (including extensions). You can contribute up to 25% of your compensation or $61,000, whichever is less.
A Solo 401(k) is an additional option when there are no employees. Same contribution limits, however, a Solo 401(k), whether Roth or regular, must be established before year-end. The deadline for funding is when you file your tax return (including extensions).
Limits may be even higher if you are older than 50.
Let us help you decide which type of plan is right for you.
…Looking for even higher contribution limits – have you considered a Defined Benefit Plan
A defined benefit plan is an employer-sponsored plan that pays targeted retirement benefits. Tax deductible funding amounts are based on the desired benefit level. For 2022, the annual targeted benefit for an employee cannot exceed the lesser of 100% of their average compensation for their highest earning three consecutive calendar years or $245,000. An actuary is required for calculations and the plan must be established before year-end. The deadline for funding is when you file your tax return (including extensions).
Year End Gifting
For 2022, the estate tax exemption is $12,060,000 and it will rise to $12,920,000 in 2023. This may be a good time for wealthy individuals to be proactive and make lifetime gifts using some or even all of their exemption amount. The current estate tax exemption will revert to approximately $5,000,000 in 2026, assuming Congress doesn’t extend it.
You can also make annual gifts of up to $16,000 per person in 2022 and $17,000 per person in 2023 without filing a gift tax return. Don’t underestimate the power of annual exclusion gifts: a married couple with four children and six grandchildren could make gifts of $320,000 in 2022 ($16,000 per spouse, per donee, multiplied by ten donees) without utilizing a single dollar of their lifetime exemption.
Direct payments of tuition or medical expenses are NOT treated as gifts. Grandparents, take note.
S-Corp Shareholders – Year-End Bonuses vs Distributions
If your S Corporation fared well this year, you may be looking to distribute some of those profits. The question is how you should be paying yourself, as compensation vs a distribution.
Assuming you are already paying yourself reasonable compensation, you may want to consider taking profits as a distribution. Unlike bonuses, distributions aren’t subject to payroll taxes.
Beware this could have an impact on your qualified business income deduction (QBI).
This decision has many moving parts. Let us help simplify your decision.
Thinking of Purchasing a New Business Asset
100% bonus depreciation is still available through 12/31/2022 for assets placed in service by the end of the year. Starting in 2023, the bonus depreciation deduction will be reduced to 80%, and then by 20% annually until it disappears in 2027. Consider purchasing assets and placing them in service before year-end to take advantage of this deduction.
Make a Qualified Charitable Distribution
A qualified charitable distribution (QCD) allows each individual who is 70½ years old or older to donate up to $100,000 to one or more charities directly from a taxable IRA. Yes, spouses are treated separately. The qualified charitable distributions can satisfy all or a portion of the account holder’s RMD without having the distribution counted as taxable income. This makes charitable contributions “tax deductible” when you do not itemize deductions.
Consider Bunching Charitable Contributions
Bunching your charitable contributions may be a way to get some tax benefit if you are no longer itemizing deductions. For example, if you usually donate $3,000 per year to your favorite charity, instead consider donating $12,000 (3 years at once) which may allow you to itemize deductions and receive some tax benefit.
An alternative is to use a donor advised fund where you contribute the tax-deductible dollars currently but can decide later which charities you would like to give to.
Fund a 529 Plan
A 529 plan provides a tax-advantaged opportunity to save for education. Contributions to a 529 plan are not tax deductible on your federal return but may be deductible on your state income tax return (Illinois allows such a deduction). The money grows tax-deferred and if withdrawn later for qualified education expenses (tuition, room, board) becomes tax-free.
You can pre-fund a 529 plan with up to $80,000 in 2022 ($160,000 for a couple) without using any of your estate tax exemption but remember any amount over $16,000 and we will need to prepare a gift tax return.
Illinois residents may pick up a free tax deduction just by “filtering” education payments through an Illinois 529 plan. Let us explain how.
Considering the Purchase of an Electric Vehicle
The Clean Vehicle Tax Credit is worth up to $7,500 for new all-electric and hybrid plug-in cars.
Beginning in 2023, the price of vans, SUVs, and pickup trucks cannot exceed $80,000 to qualify. Other vehicles will be capped at $55,000. The U.S. Department of Energy maintains a list of eligible vehicles.
Beware of income limits – single taxpayers cannot have modified adjusted gross income over $150,000 ($300,000 for joint filers). Also, Vehicles need to meet other qualifications to be eligible, including final assembly in the U.S.
If you’re looking for ways to reduce your tax liability before the end of the year, Friedman + Huey is here to help. Give us a call today so we can discuss your specific situation and devise a plan to help you keep more money in your pocket.