7 Tax Planning Tips for the End of the Year.
Tax planning between now and the end of the year can have a significant impact on how much tax you have to pay next April.
Financial decisions you make between now and the end of the year can have a significant effect on how much tax you have to pay next April. But time is running short. It will be too late to cut your tax bill using most of the tips we've assembled below after we ring in the new year.
1) Check Your Withholding
If you were hit with a big tax bill this year because you didn't have enough money withheld from your paycheck, you may be able to take steps between now and year-end to avoid another April surprise. Use the IRS's Tax Withholding Estimator as soon as you can to determine whether you should file a new Form W-4 with your employer and increase the amount of taxes withheld from your paycheck before the end of the year. You'll need your most recent pay stub and a copy of your 2021 tax return to help estimate your 2022 income. If it looks like you're going to owe money when you file your next tax return, the IRS tool will tell you how much "extra withholding" you should put down on Line 4(c) of Form W-4 to catch you up on withholding for the year. Then, early next year, complete another W-4 for withholding in 2023.
In general, you don't have to worry about a penalty if you owe less than $1,000 after subtracting withholdings and credits, or if you paid at least 90% of the amount of tax due for the current year or 100% of taxes due the previous year, whichever is smaller.
2) Consider Paying 2023 Bills Now
Unless your finances have changed significantly, you probably have a pretty good idea whether you'll itemize or claim the standard deduction when you file your 2022 tax return. If you plan to itemize — or you're close to the threshold — now is a good time to prepay deductible expenses, such as mortgage payments and state taxes due in January. Other moves to make by New Year's Eve:
Review your medical bills. If you have enough unreimbursed medical expenses, you may be able to deduct them. You can only deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. That puts this tax break out of reach for most taxpayers, but if you had extraordinarily high medical expenses this year — due to a major illness or a chronic condition, such as long Covid, for example — you may qualify.
And there's still time to schedule appointments and procedures that will increase the amount of your deductible expenses. The list of eligible expenses includes dental and vision care, which may not be covered by your insurance. For the complete rundown, go to IRS Publication 502.
Pay property taxes early. Itemizers can deduct up to $10,000 in state and local taxes. If you haven't maxed out for the year and your municipality allows it, pay the property tax bill due in January in December so you can deduct it from your 2022 taxes.
Prepay tuition. If you're the parent of a college student, you may be able to lower your 2022 tax bill by prepaying the first quarter tuition bill — and you don't need to itemize to claim this tax break. The American Opportunity Tax Credit, which you can take for students who are in their first four years of undergraduate study, is worth up to $2,500 for each qualifying student. Married couples filing jointly with modified adjusted joint income of up to $160,000 can claim the full credit, while those with a MAGI of up to $180,000 can claim a partial amount.
3) Contribute to a 529 Plan or ABLE Account
Stashing money in a 529 plan before year-end won't reduce your federal tax bill, but it could lower your state tax tab. More than 30 states allow you to deduct at least a portion of 529 plan contributions from state income taxes. In most states, you must contribute to your own state's plan to get the tax deduction, but several states allow you to deduct contributions to any state's plan. Check out your own state's rules at savingforcollege.com. Many states allow grandparents and others to contribute to your child's plan, and a few will allow them to deduct those contributions, too.
If someone in your family has special needs, you can contribute up to $16,000 this year to an ABLE account, which allows people with qualifying disabilities to save money without jeopardizing government benefits (ABLE account beneficiaries can contribute more to their own account). You don't have to invest in your own state's plan, but if you're a resident of one of the states that do offer a tax break for ABLE accounts, you can deduct your contribution. Michigan, for example, allows residents who contribute to its ABLE account to deduct up to $5,000 (or $10,000 for a married couple). For more information, go to the ABLE National Resource Center's website.
4) Max Out Your Employer's Retirement Savings Plan
As the year comes to a close, you may be able to squeeze a little more money from each paycheck for your retirement savings. You can contribute up to $20,500 to a 401(k), 403(b) or federal Thrift Savings Plan in 2022, plus $6,500 in catch-up contributions if you're 50 or older.
Pretax contributions will lower your take-home pay and reduce your tax bill. If your employer offers a Roth 401(k), you can make contributions that won't lower your taxable income now but that can be withdrawn tax-free in retirement. If your employer offers both types of plans, you can direct new contributions to the Roth 401(k) rather than the pretax 401(k) at any time.
Contact your 401(k) administrator or your employer's human resources department ASAP to find out how much you're on track to contribute to your 401(k) by the end of the year and to ask about the steps you need to take to boost your contributions. The earlier you make the change, the better: 401(k) contributions are made through payroll deduction. If you're contributing on your own to a traditional or Roth IRA for 2022, you have until April 18, 2023.
If you aren't on track to max out your retirement account for the year, adding money from a year-end bonus can be a great way to boost your contributions without affecting your regular take-home pay. Rules vary, and some plans don't allow participants to contribute their bonus. Also make sure that you don't cross the annual contribution limit. You have until the tax-filing deadline to withdraw any extra contribution and the earnings on it, which will both be taxable. If you don't take it out, the excess contribution will be taxable now and you'll have to pay taxes on it again when you finally withdraw the money.
5) Max Out Charitable Donations (and Declutter)
If you itemize, donating clothes, kitchenware or furniture you no longer need can boost your deductions while helping a worthy cause. You'll base your deduction on the donated item's "fair market value" (or what it might sell for at a thrift or consignment shop) — you can use online tools such as TurboTax's ItsDeductible tool to estimate this value. You will need a written acknowledgment from the organization if you are claiming a contribution of $250 or more (consider snapping a photo of the donation for your records). For donated items valued at more than $5,000 (art, antiques, etc.), plan on providing a written appraisal. For the 2022 tax year, you can deduct cash donations of up to 60% of your adjusted gross income.
6) Transfer IRA Money to Charity
Taxpayers who are 70½ or older can transfer up to $100,000 from a traditional IRA tax-free to charity each year, as long as they transfer the money to the charity directly.
This is a nice benefit for IRA owners who are 72 or older, because the distribution counts as your required minimum distribution. In addition, a "qualified charitable distribution" will reduce the size of your IRA, which will reduce future required withdrawals, and your tax bill too. Plus, the transfer could help keep your income below the threshold at which you're subject to the Medicare high-income surcharge as well as hold down the percentage of your Social Security benefits subject to tax.
If you decide to make a QCD, do it well in advance of New Year's Eve. To qualify for the tax break, the money has to be out of the account and the check needs to be cashed by the charity by December 31.
7) Consider a Roth Conversion
Consider converting some money from a traditional IRA to a Roth IRA this year, up to the top end of your income tax bracket, especially if you believe your taxes may go up in the future. You'll pay taxes on the conversion (minus any portion that represents nondeductible IRA contributions), but the money will grow tax-free in the Roth after that. Converting your entire traditional IRA balance can bump you up to a higher tax bracket, but you can spread conversions over several years.
Be careful about making a large conversion if you're within two years of signing up for Medicare — you'll have to pay extra for Medicare Part B if your adjusted gross income (plus tax-exempt interest income) is more than a certain amount. For example, if your 2020 income was $91,000 or more if you're single, or $182,000 or more if you're married filing jointly, your 2022 Medicare Part B costs are higher. Your last tax return on file determines your Medicare premiums, so a 2022 conversion could affect 2024 premiums.
Have questions about your year-end tax planning for 2022? Call me at 480-513-183, or schedule a time via my calendar, Chat With Charles.
Source: Sandra Block, Kiplingers