With 2022 over halfway through and while there is still sufficient time to act and implement new strategies, now may be an ideal time to focus on tax planning for the remainder of the year. Although many of the most direct impacts of the COVID-19 crisis have faded into the rearview mirror, many lingering effects along with several international events have led to supply chain issues and an inflationary environment in 2022. Since income may not rise at the same rate as expenses, income tax savings can plug the difference.
With the introduction of the Inflation Reduction Act in the U.S. Senate, it seems as though President Biden’s tax plan is beginning to come into focus, as we wrote about in this recent Alert. While current drafts do not contain changes to tax rates, if any tax legislation does pass, higher tax rates for both individual and corporate taxpayers are possible. Of course, the upcoming midterm elections will most certainly weigh heavily on whether any legislation moves forward or not.
For now, this is a good time to get a handle on what your 2022 income might look like so that, if legislation is passed, we will be able to project the impact on your business or personal tax situation. Here are some ideas, from conventional to advanced, to think about over the remaining days of summer.
Consider Adjusting Your Tax Withholding or Estimated Payments
Revise and Review Your W-4
If you had a balance due (tax and/or underpayment penalties and interest) with your 2021 federal tax return, you may want to revise your Form W-4 to ensure the amount withheld is sufficient and accurate enough for your specific circumstances. When major life events occur, such as buying a home, getting married or divorced, or retiring or changing jobs, revising your W-4 is particularly prudent. If you have not reviewed your withholding recently, you should consider a 2022 tax projection. We often perform tax modeling and planning on a quarterly basis for our clients.
Evaluate Your Quarterly Estimated Tax Payments
If you remit estimated tax payments throughout the year, it’s important to take a closer look at your tax situation for 2022 to make sure that you are not underpaying or overpaying. Again, it is prudent to use periodic tax modeling to manage your tax obligations without underpaying your taxes and being hit with costly underpayment of tax penalties or overpaying and providing the IRS with an interest-free loan.
Plan to Accelerate or Defer Income
If you expect your income to be higher in 2022 than in 2023 and/or expect to be in a higher tax bracket in 2022, it may be beneficial to defer receipt of the income until 2023. For self-employed taxpayers operating on the cash method, such deferral can be achieved by delaying the 2022 year-end billing process to your clients so that payments are not received until 2023. This strategy, while advantageous if done correctly, takes careful planning to ensure that you do not inadvertently find yourself subject to a higher tax bracket in those subsequent years.
Conversely, it may be beneficial to accelerate the receipt of income into 2022. For example, if you expect to have a significant increase in income in 2023 or if you have an abundance of offsetting deductions or tax credits available in 2022 that will not be available in future years, it may be wise to accelerate the receipt of income. A few ways this acceleration can be achieved would be to request having any bonuses paid prior to the end of 2022, or to make a taxable withdrawal from your IRA (assuming you have attained age 59½ and would not be subject to additional penalties). Be careful, however, as accelerating income to the current year will not always be beneficial, even if you expect to be in a higher bracket next year, as deductions and credits often have differing limitations regardless of overall taxable income. For example, the Section 199A qualified business income deduction begins to phase out at $340,100 for married taxpayers filing jointly ($170,050 for single filers). Thus, an acceleration of income into 2022 could cause you to cross that threshold and reduce a deduction that otherwise would have been received.
Utilize Tax-Smart Investment Strategies
Gains from the sale of an investment held for more than one year (as well as dividends on certain stocks) are generally taxed at preferential capital gains rates. Those rates are zero percent, 15 percent and 20 percent for most investments. The applicable rate depends on your taxable income. For example, the zero percent rate applies if your 2022 taxable income does not exceed $83,350 (for joint filers), $55,800 (for heads of household) or $41,675 (for other individuals). The 20 percent tax rate does not kick in until your taxable income exceeds $517,200 (for joint filers), $488,500 (for heads of household), $258,600 (for married filing separately) or $459,750 (for other individuals).
If your taxable income hovers around these threshold amounts, there are ways to reduce your income to take advantage of a lower capital gains rate. For example, you could make deductible IRA contributions or reduce taxable wages by deferring bonuses or contributing to employer retirement plans. If you are over the age of 72, instead of taking your required minimum distributions, contributing to a qualified charity with a direct distribution from your IRA is also a good way to lower income.
Gift Investments to Younger Generations
If your income is too high to benefit from the zero percent or 15 percent rates, try gifting investments (such as appreciated stock or mutual fund shares) to children, grandchildren or other loved ones. If these individuals are in the zero percent or 15 percent capital gains tax bracket when they later sell the investments, any gain will be taxed at the lower rates if you and your loved one owned the investments for more than one year. Dividends from any gifted stock also may qualify for the lower rate. However, beware of the “kiddie tax,” which applies to all children under age 18 and most children age 18 or ages 19-23 who are full-time students. It may limit your opportunity to take advantage of this strategy. Also, keep an eye on the news and any potential legislative changes―you want to beware of any potential rate increases heading into 2023.
Time Your Investment Sales
As you evaluate investments, be mindful of your holding period and consider the tax impact of selling appreciated positions before the end of the year, specifically for 2022. Although the current tax bill does not contain any changes to the capital gains tax rate, there is still the potential for long-term capital gains rates to increase to 39.6 percent for taxpayers making over $1 million, as prior plans contemplated. Combined with the net investment income tax (NIIT) of 3.8 percent, affected taxpayers could see a 43.4 percent marginal long-term capital gains rate, which is quite an increase from the current combined rate of 23.8 percent.
Harvest Tax Losses
Generally, at the end of the year, taxpayers take note of their gains (if any). If their income is particularly high for the year, they may sell certain securities at a loss in order to reduce their tax for the year, an activity known as tax-loss harvesting. Capital losses may be fully deducted against capital gains and offset up to an additional $3,000 of ordinary income ($1,500 for a married individual filing separately), with any excess carried over indefinitely. However, this year, selling securities that have declined in value may need to wait until 2023 to offset the potential higher tax rate resulting from any potential legislative changes. Conversely, harvesting gains can offset losses and generate tax-free gains.
Invest in Opportunity Zones
If you have a high amount of capital gains in 2022, these gains can be deferred if they are reinvested within 180 days into a qualified opportunity fund (QOF). This gain is deferred until the investment is sold or December 31, 2026, whichever is earlier. In addition, if the assets are held in the QOF for at least 10 years, the taxpayer will pay no gains on the appreciation of the QOF investment itself.
All states have communities that now qualify. Besides investing in a fund, one can also take advantage of this opportunity by establishing a business in the qualified opportunity zone or by investing in qualified opportunity zone property.
Employ a Sound Deduction and Credit Strategy
Generally, it is best to itemize your deductions if your personal expenses, such as mortgage interest, charitable contributions, medical expenses and taxes, exceed the standard deduction. For 2022, joint filers can enjoy a standard deduction of $25,900. The standard deduction for heads of household is $19,400, and single taxpayers (including married taxpayers filing separately) can claim a standard deduction of $12,950.
Bunch Itemized Deductions for Maximum Impact
To maximize the benefits of the standard deduction and itemized deductions, consider adjusting the timing of deductible expenses―i.e., “bunching”―so that they are higher in one year and lower the following year. This can be accomplished by paying deductible expenses in 2022, such as mortgage interest due in January 2023, estimated tax payments due in early 2023 for state purposes (keeping in mind the state tax deduction limitation), or doubling up on charitable contributions every other year. For 2022, medical expenses, including amounts paid as health insurance premiums, long-term care insurance premiums and dental insurance premiums, are deductible only to the extent that the total medical and dental expenses exceed 7.5 percent of adjusted gross income (AGI) for all taxpayers. Bunching medical and dental expenses in one calendar year can help maximize your allowable deduction.
Evaluate Charitable Contributions Options
For high-income earners, charitable contributions are a common way to generate greater tax savings. In many instances, the topic around charitable contributions can be accomplished through a donor-advised fund. Also known as charitable gift funds or philanthropic funds, donor-advised funds allow donors to make a charitable contribution to a specific public charity or community foundation that uses the assets to establish a separate fund. Taxpayers can claim the charitable tax deduction in the year they fund the donor-advised fund and schedule grants over the next two years or other multiyear periods. This is particularly useful for taxpayers engaged in a bunching strategy, as discussed above. For older taxpayers (over age 70½) who will not itemize in 2022 but still want to make contributions, a qualified charitable distribution (QCD) from an IRA is a great way to give to charity. Making a direct contribution from the IRA to the charitable organization has the added value of not increasing the taxpayer’s AGI, which can decrease the amount of Social Security benefits that are taxable, as well as affecting other favorable tax provisions that phase out based on AGI.
Contribute to a Health Savings Account
Contributing to a health savings account (HSA) offers three significant tax benefits: It allows you to deduct your contributions, lets you make withdrawals without paying any tax and allows your money to grow tax-free. For these reasons, HSAs are one of the most popular tax reduction strategies.
Track Energy Tax Credits
Tax incentives are available to taxpayers who install certain energy efficient property, such as solar electric property, solar water heaters, geothermal heat pumps, small wind turbines and fuel cell property. A credit is available for a percentage of the expenditures incurred for such property. However, it is worth nothing that the credit for residential energy efficient property (such as windows, door, insulation and roofs) expired at the end of 2021.
Utilize 529 Plans for Education Savings
A 529 plan is a tax-advantaged savings plan that allows you to save for future education expenses. These plans often come in the form of prepaid tuition plans, which either allow you to lock in tuition at a current cost or allow you to establish an investment account that can grow tax-deferred. For such tax-deferred investment accounts, as long as distributions are used to pay qualified expenses, the principal and earnings can be used income tax-free. Qualified expenses include up to $10,000 in tuition and fees for grades K-12, and an even greater amount of postsecondary education expenses such as tuition, room and board, and books. Many states, including Pennsylvania, allow for a deduction or credit for contributions to a 529 plan, though many states restrict which plan you can contribute to and still receive the deduction or credit.
Plan for Retirement
Maximize Pre-Tax Retirement Contributions
Maximizing the contribution amounts made to your respective retirement plan(s) is generally a great way to both save more money for retirement, and many retirement plan contributions are also deductible at the time of contribution. Be sure to maximize both your regular contributions as well as any “catch-up contributions” if you are 50 years old or over. Below, please find a chart of maximum retirement contributions in 2022 (additional limitations apply as well).
Contributions to a traditional IRA are deductible up to the current limit of $6,000. A $1,000 catch-up contribution is allowed for any taxpayers 50 or older by the end of 2022. Contributions to a Roth IRA are nondeductible, but they grow tax-free within the account and are not subject to income tax when finally distributed. Taxpayers can also complete a Roth IRA conversion in which a traditional IRA is rolled over into a Roth IRA. While such a conversion may trigger a taxable event, once in the Roth IRA, both the principal and earnings will be tax-free on distribution.
Report Virtual Currency Transactions
Virtual currencies (also known as cryptocurrencies), such as Bitcoin, Ethereum and Tether, have been rapidly increasing in popularity over the past decade. Virtual currency may now be used to pay for goods or services, or held for investment. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value. In some environments, it operates as a substitute for “real” fiat currency, but for federal tax purposes, virtual currency is treated like property. Virtual currencies can therefore be classified as business property, investment property or personal property, depending on how they are used or obtained.
If you receive virtual currency as payment for services rendered, the value of the virtual currency received would be considered taxable income and will be subject to both income and Social Security taxes, just like wages or self-employment income paid in dollars would be. Using virtual currency to obtain cash or purchase goods would be a recognizable transaction, just like a sale would be. Usually, your basis in virtual currency is the fair market value (FMV) of the currency on the date it is received or purchased. If the FMV of property (or cash) you receive for the virtual currency exceeds your adjusted basis in the currency, you will have a taxable gain. A loss will occur if the FMV is less than your basis. For a more detailed discussion of the tax treatment of virtual currency, see our related Alert.
One strategy to reduce your 2022 tax liability on virtual currency transactions is to use the “highest in, first out” (HIFO) accounting method. This method would allow you to specifically identify which units you are transferring in the transaction, the ones with the highest basis, and apply that basis to the sale or exchange transaction. This will require you to keep detailed records of all virtual currency purchases to substantiate your basis on sale. If you do not keep detailed records, the IRS will default to the “first in, first out” (FIFO) method, which may result in a larger gain in 2022. Using the HIFO method of detailed transactions will help us better reduce your 2022 tax liability and defer the higher gain on lower basis units to a future tax year.
Prepare for the Next Natural Disaster
No matter what the situation may be, there is no perfect way to plan for a natural disaster or for the occurrence of property damage. Hurricane season is here!
In 2021, the Federal Emergency Management Agency (FEMA) declared major disasters following hurricanes, tropical storms, tornados, severe storms, straight-line winds, flooding, landslides and mudslides, wildfires and winter storms. Given the impact these events can have on individuals, organizations and businesses, now is the time to make or update an emergency plan. We have provided guidance on how to help taxpayers prepare and plan for the unexpected.
Taxpayers should place any original documents such as tax returns, birth certificates, deeds, titles and insurance policies inside waterproof containers in a secure space. Duplicates of these documents should be kept with a trusted person outside the taxpayer’s area or in a bank safe deposit box. Scanning them for backup storage on electronic media such as a flash drive is another option that provides security and portability.
Document Valuables and Equipment
Current photos or videos of a home’s contents can help support claims for insurance or tax benefits after a disaster. All property, especially expensive and high value items, should be recorded. The IRS provides disaster-loss workbooks in Publication 584 that can help individuals and businesses compile lists of belongings or business equipment, or for simpler and faster guidance, request our record retention document, which is always provided to clients with the delivery of their tax returns.
Utilize Portability Election to Minimize Estate Tax
Upon the death of a spouse, the deceased’s assets usually pass to the surviving spouse, tax-free. In addition, if the deceased spouse files an estate tax return, the spouse can pass on any unused estate exclusion on to the surviving spouse―but importantly, the estate tax return must be filed! Most taxpayers never contemplate filing an estate tax return, as their estates are well below the estate exclusion (currently $12,060,000 per person). However, when the Tax Cuts and Jobs Act expires in 2026, the exclusion amount is set to fall back to around $6 million. President Biden has also proposed reducing the exclusion even further to $3.5 million. So, more and more middle income and upper middle income families with small businesses and significant retirement assets may be affected by the estate tax in the near future.
In order to elect the portability of the exclusion, the estate tax return generally must be filed within nine months of the decedent’s date of death, or 15 months if a valid extension was filed. In 2017, the IRS extended this window to two years from the date of death, and just last month, the IRS further extended it to five years. If a loved one passed in the past five years, you may wish to reevaluate whether an estate tax return may be necessary.
Plan for Businesses Deductions
Purchase New Assets
The deduction limit for purchases of new or used equipment or machinery has increased for 2022. Under Section 179, the cost of such purchases can be deducted up to $1,080,000, subject to certain income limitations. As an alternative, businesses can elect to utilize the 100 percent first-year bonus depreciation, which is not subject to any income limitations (this rule is currently set to reduce to 80 percent in 2023).
If you set up a qualified retirement plan for your business, you can make deductible contributions for 2022 while also allowing the earnings in the plan to grow tax-free until the funds are withdrawn. Of course, which retirement plan is the best for your business will depend on the individual facts and circumstances of your business, including your level of income and whether you have employees. The different plans available include defined benefit, defined contribution, one-person 401(k), simplified employee pension (SEP) and SIMPLE IRAs. Each type of plan has advantages and disadvantages that we will gladly discuss with you to determine which plan is the right fit for your business.
While several plans have a maximum contribution amount of $61,000 for 2022, defined benefit plans can provide an annual benefit up to the lesser of $245,000 or 100 percent of compensation for the three highest years, which can create large tax deductions. Another benefit of making contributions to a qualified retirement plan is that employer portion of the contributions can sometimes be made as late as October 16, 2023.
In addition to making current-year deductions, certain small businesses are also eligible for two different tax credits. One credit helps to recoup some of the administrative expenses of setting up the plan, while the other benefits plans which include an auto-enrollment feature.
Employ Family Members
If a small business employs a family member as a bona fide employee, the taxpayer can deduct the wages and benefits, including medical benefits, paid to the employee on Schedule C or F as a business expense. In addition, wages paid to your child under age 18 are not subject to federal employment taxes, will be deductible at your normally higher marginal tax rate, are taxable at the child’s usually lower marginal tax rate and can be offset by up to $12,950 (your child’s maximum standard deduction). However, in order to be considered a bona fide employee, basic business practices, such as keeping time reports, filing payroll returns and basing pay on the actual work performed, need to be followed.
Track Business Meal Expenses
Historically, business meal expenses have been limited to a deduction of 50 percent of the total cost. For 2022, however, such meals are again allowed a 100 percent deduction. The food must be provided by a restaurant, as the change is largely to encourage patronage of such establishments, many of which were adversely impacted by the COVID-19 pandemic. Businesses selling pre-packaged food or facilities on the employer's premises that furnishes meals to the employees are not considered restaurants for the definition of this deduction and remain subject to the 50 percent limitation.
Maximize Your QBI Deduction
While business income from pass-through entities is usually taxed at the ordinary individual tax rates of the owners or shareholders, taxpayers who receive qualified business income (QBI) from a trade or business through a partnership, limited liability company, S corporation and/or sole proprietorship may be entitled to a 20 percent deduction, subject to certain phaseouts and income restrictions. If you are close to an income threshold, reducing your income through deductions or income deferral may increase the amount of the deduction available to you. Further, if you increase the amount of wages paid or property placed in service by the business, you may also increase the amount of the deduction.
Evaluate Your State Tax Exposure from Telecommuting
In a post-COVID remote work environment, virtually every state has taken the position that having an employee present within a state creates nexus and will potentially subject the employer to business registrations, employee withholding, registered agent requirements and/or business tax filings.
As such, each state where you have an employee working remotely must be closely examined, as every state has different methods for apportioning taxable income, sourcing revenue, minimum factor presence standards and other registration requirements. We have conducted many such assessments and would be pleased to assist.
Many of the most restrictive aspects of the COVID-19 pandemic have long faded, as many of us have returned to our schools, offices and leisure activities. However, the impact of the pandemic on the world economy and tax landscape remains significant and, at times, unpredictable. This, coupled with rising inflation, could result in ongoing federal stimulus initiatives as well as continued attempts by the current administration to enact their desired tax policy changes, which may have a material impact on the tax landscape going forward. Despite (or perhaps due to) the economic and political turmoil, there are numerous tax planning opportunities available to taxpayers. The time to act on those opportunities is now, while there is ample time to devise and enact a strong tax planning and savings strategy.