Judge Learned Hand once wrote, may so arrange his affairs that his taxes shall be as low as possible. But how might you go about doing that, especially as you think about your 2022 tax return?
Here, according to tax experts, are some strategies and tactics to consider:
1. Roth IRA ConversionDistributing some or all of the money in your traditional IRA into a Roth IRA will increase your tax burden in the short term. That’s because the distribution will be taxed as ordinary income. But doing full or partial Roth IRA conversions in 2022 might lower your overall burden over the course of your retirement.
What’s more, given that the Standard & Poor’s 500 index was down 21% as of this writing, now is a good time to do a Roth IRA conversion, according to Ted Sarenski, a wealth manager (CPA, CFP, PFS, and AEP) at Sage View Advisory. The reason? One would have a lower tax bill now than had one done a Roth IRA conversion when the market was trading at all-time highs.
“With the market down 20%, moving money out of taxable to tax-free is like buying at a sale,” said Sarenski. “The eventual recovery of the investment moved will be in the tax-free account.”
For her part, Kelley Long, the founder of Financial Bliss with Kelley Long, said “not only is a down market a good time to maximize the long-term tax savings but with tax rates set to go up automatically in 2025, taking a longer view may be necessary for the next couple years to intentionally incur tax in some instances.”
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Graphic: 7 Strategies to Take Now to Lower Your Tax Bill Later
2. Max Out How Much You’re Contributing to Your 401(k)Maxing out how much you’re contributing to your 401(k) will lower your 2022 tax bill, according to Sarenski. That is because the money contributed to a 401(k) reduces your current taxable income. Plus, there’s another benefit. With the market down you’re not only lowering your tax bill, but you’re investing “at the 20% sales price.,” said Sarenski.
Of note, the contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is $20,500 in 2022, and those age 50 and older can contribute an additional $6,500.
Sarenski also said workers should take advantage of other pre-tax employee benefits, such as dependent care benefits, medical reimbursement, and education benefits.
Long also recommends making sure you’re on track to contribute the maximum amount to your HSA, if eligible. The maximum contribution amounts for 2022 are $3,650 for self-only and $7,300 for families. The annual “catch-up” contribution amount for individuals age 55 or older is $1,000.
3. Open a Retirement AccountSole proprietor business owners who have not yet established a retirement savings account consider opening a SEP-IRA or solo-401(k), said Long. SEP contributions, she noted, can be made after Dec. 31, 2022, but 401(k) contributions must be made during the calendar year. “So getting that set up asap can get those contributions going too,” she said.
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Read: Tax Benefits of Retirement Accounts: Comparing 401(k)s, 403(b)s, and IRAs.
4. Contribute to a 529 PlanSarenski also recommends contributing to Section 529 plans for children and grandchildren. According to Intuit TurboTax, contributions to a 529 plan are not tax-deductible for your federal taxes although some states provide a state tax deduction for contributions.
5. Tax-loss HarvestingWith markets down, Sarenski also recommends exploring selling investments that have lost value from what you paid for them as a way to reduce the amount you’ll owe during tax season. This strategy is called tax-loss harvesting.
CPA Bio’s| More About Our Tax ExpertsTed Sarenski, CFP®, PFS, Wealth AdvisorGenerally, according to Intuit TurboTax, realized losses can offset any capital gains from selling securities. Plus, such losses can usually also offset up to $3,000 in other income.
And any losses that can’t be used in the current tax year can be carried forward to offset capital gains in future tax years. “It’s a great time to reposition a portfolio at no or low tax cost,” said Sarenski.
Long, for her part, said those using tax-loss harvesting should be mindful of something called the wash-sale rule. A wash sale occurs, according to Investor.gov, when you sell or trade securities at a loss and within 30 days before or after the sale you:
Buy substantially identical securities,Acquire substantially identical securities in a fully taxable trade, orAcquire a contract or option to buy substantially identical securities.Internal Revenue Service rules prohibit you from deducting losses related to ‘wash sales’. For more information about wash sales, read IRS Publication 550, Investment Income and Expenses (Including Capital Gains and Losses).
Of note, Nate Wenner, a senior financial adviser with Wipfli Financial Advisors LLC, said tax-loss harvesting is not the same as capitulating and selling out of holdings when their prices are low. “This is replacing them with other securities whose values have also gone down,” he said. “Both the original investment and the replacement investment, viewed in the context of an investor’s larger diversified portfolio, will recover at some point. Maybe soon, maybe not for some time. But by acting now, opportunistically, you can capture a tax loss while still having your portfolio positioned well for the future recovery.”
6. Reposition Interest-bearing InvestmentsAccording to Sarenski, interest-bearing investments such as certificates of deposit (CDs), could be moved into short-term U.S. Treasury securities. Typically, interest income earned on certificates of deposit is subject to state and federal income tax while Income from bonds issued by the federal government and its agencies, including Treasury securities, is generally exempt from state and local taxes.
Moving money from CDs to Treasury securities also reduces the risk of one’s fixed-income investments, according to Sarenski. Treasury securities have no call risk and virtually no liquidity, event or credit, and default risk, according to Finra. CDs are widely regarded as low-risk investments, according to Zacks. But the standard deposit insurance amount is $250,000 per depositor, according to the Federal Deposit Insurance Corporation.
7. Other Tactics to Lower Tax BillsIf you’re 70 ½ and older, charitable inclined, and you have a traditional IRA, Sarenski recommends using a qualified charitable distribution (QCD). A QCD is a direct transfer of funds from your IRA, payable directly to a qualified charity, as described by Internal Revenue Service (IRS). The maximum annual amount that can qualify for a QCD is $100,000. Of note, the QCD doesn’t reduce your tax bill, but it is excluded from your taxable income.
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Editor’s Note: Reviewed for tax accuracy by a TurboTax CPA expert. TurboTax is the exclusive partner of TheStreet’s tax content.