Tax-filing season may be months away, but certain tax matters are best considered before the calendar year ends. The IRS’s much publicized hiring of tens of thousands of new agents means that this could be a particularly bad year to make a tax misstep.
Here are five details that tax expert Maryann Reyes, CPA, believes are worth knowing along with the strategies worth considering in the final months of 2022…
This could be the right time for a Roth conversion. You probably already know the basics about Roth conversions—assets from a traditional IRA, 401(k) or similar tax-deferred retirement plan often can be transferred to a Roth IRA so that future investment growth and withdrawals will be income tax–free.
Main downside of Roth conversions: The converted assets are taxed as ordinary income in the year of the conversion. That can produce a hefty tax bill this year—but waiting to convert these assets could make that tax hit even larger. One reason for that: This year’s stock market losses. Example: If the value of the traditional IRA you’re converting slid from $100,000 to $80,000 in 2022, that’s $20,000 less that will be taxed as ordinary income this year.
What’s more, there’s a growing consensus among tax professionals that income tax rates are likely to climb in the coming years, as the government passes along the bill for its recent spending.
Upside of converting this year: It locks in today’s relatively low tax rates. Of course, what matters here is your own current and future tax rates, not the overall rates—if you expect to land in a significantly lower tax bracket next year because your income will be substantially lower than it is this year, the smart move likely is to postpone a Roth conversion until early 2023 or beyond.
Worth noting: Don’t convert assets that you might need to tap in the near future—penalties often apply when assets are removed from a Roth less than five years after a conversion. Also, Roth conversions are treated as taxable income, so they can temporarily affect access to and rates charged for means-tested programs—your Medicare premiums might increase for a year or your ACA subsidies might be reduced, for example.
Stock market losses could create tax-loss harvesting opportunities. The stock market’s 2022 struggles have left many people with investments in their portfolios that are worth less than what they paid for them. One option: Before 2022 ends, sell some of these underwater securities. The resulting capital loss could reduce your tax bill by offsetting capital gains…or by offsetting taxable income.
Whether this strategy is wise depends in part on the tax rate you would have had to pay on the income or capital gains being offset. Long-term capital losses generally offset long-term capital gains, which typically are taxed at 15%…though high earners pay 20%.
Example: If a $10,000 capital loss is used to offset a $10,000 long-term capital gain, that would shave $1,500 or $2,000 off the tax bill. But if you have taxable income of $83,350 or less if married and filing jointly—or $41,675 or less if single—your long-term capital gains tax rate is 0%. Tax-loss harvesting has no tax upside if the loss offsets an untaxed capital gain.
If you are in a “net loss position” for the year—that is, your capital losses exceed your capital gains—up to $3,000 of the losses can be used to offset ordinary income. Income tax rates range from 10% to 37%, so realizing that $3,000 net loss could deliver a tax savings of anywhere between $300 and $1,110, depending on your tax bracket, and potentially state tax savings as well. Any additional losses realized can be carried over to offset capital gains or income in future years.
Worth noting: Tax-loss harvesting must be done by selling underwater investments from taxable accounts, not from tax-advantaged retirement accounts. If you do sell a security for tax-loss harvesting purposes, be sure not to repurchase the same security or a “substantially identical” security in any of your accounts in the 30 days before or after the sale, or “wash sale” rules prohibit deducting the capital loss.
You can be more generous with your heirs starting this year—without also giving a gift to tax collectors. The annual gift-tax exclusion increased from $15,000 to $16,000 this year. Taxpayers can give up to that amount to anyone they wish to without generating any taxes in the process and without using up a portion of their lifetime gift- and estate-tax exemption.
Giving large annual gifts to future heirs can be a useful strategy for people who have large estates. Estate taxes haven’t been a major concern for many families lately—as of 2022, the lifetime gift- and estate-tax exemption is a sizable $12.06 million, high enough that only extremely wealthy families face estate taxes. But that exemption currently is slated to fall to $5.49 million in 2025, and there’s no guarantee that it won’t be slashed further as the government seeks to increase tax revenue in the coming years.
Giving financial gifts to heirs during your lifetime removes money from your estate so it won’t face estate taxes later. That $16,000 annual exclusion might not seem substantial enough to make a meaningful dent in a multimillion-dollar estate, but it can add up quickly.
Example: A married couple with three married children and seven grandchildren could together give a total of $32,000 each calendar year—that’s $16,000 from each partner to each of their grown children, sons- and-daughters-in-law and grandchildren—removing more than $400,000 per year from their estate. Of course, they should do this only if they have the financial resources to make these gifts without endangering their own retirement.
Inflation will alter tax brackets—eventually. Income tax brackets and many other components of the tax code are indexed to keep pace with inflation. That indexing theoretically means people shouldn’t get pushed into higher tax brackets or miss out on means-tested tax credits because they received raises that merely kept pace with inflation.
The inflation adjustments for 2022 were based on the inflation that occurred from September 2020 through August 2021, which is before the recent post-pandemic inflation really took off. Result: Tax brackets and other tax code details increased by only a little more than 3% for 2022.
Inflation adjustments are more substantial for the 2023 tax year. Example: The 15% tax rate on long-term capital gains that kicked in at $83,350 in 2022 for married couples filing jointly will start at $89,250, an increase of 7.08%. But unfortunately some aspects of the tax code don’t keep pace with inflation at all. Examples: The size of the capital loss that can be used to offset earned income has been stuck at $3,000 since 1978…the threshold for the 3.8% net investment income tax is fixed at $200,000 for singles and $250,000 for married couples…and Social Security benefits are taxable at 50% if you make between $32,000 and $44,000 for married couples filing jointly…and at 85% for income above $44,000. For individuals, the thresholds are $25,000 and $34,000. These have been the thresholds ever since those taxes were introduced decades ago. Many people will be hit with these taxes this year even though their incomes didn’t actually rise on an inflation-adjusted basis.
A key figure used to calculate required minimum distributions (RMDs) has changed. If you’re 72 or older, you probably already know that IRS rules require you to take distributions from your tax-deferred retirement accounts each year. You probably also know that the deadline for those distributions generally is December 31—though it’s April 1 in the first year that RMDs are required—and that the penalties for missing these deadlines can be onerous.
But you may not be aware that a key detail used in the calculation of RMDs has been altered starting this year. The size of the RMDs that account holders are required to take is based in part on how many years of life that account owner is estimated to have left, and those life-expectancy figures were adjusted starting this year to account for lengthening American lifespans.
Example: A 72-year-old previously had to use a 25.6-year distribution period in RMD calculations but now can use a 27.4-year distribution period. (COVID recently shortened American lifespans, but these adjustments were made based on pre-pandemic lifespan data.)
If you calculate your own RMDs rather than rely on figures provided by your investment companies, confirm that you’re using up-to-date 2022 distribution tables.