Things to Learn From a Tax Return

 

With less than five months remaining in 2024, now is the time to begin serious tax planning for your 2024 income tax return. I recently attended a webinar with some tips for financial advisors about reviewing clients’ tax returns. The advice also applies to taxpayers themselves.

 

Below are my take-aways from this presentation:

 

Review a Draft Return- It is wise to review a draft of your annual tax return before it is submitted. My tax preparer provides me with a draft paper copy to take home and review before my taxes are submitted to the IRS. Not only does this provide an opportunity to catch possible errors and omissions, but it also provides valuable insights about household finances and a source of questions about tax calculations and future tax planning for my second visit.

 

Beware QCD Reporting Errors- The problem is that 1099-R forms for retirement plan withdrawals only show the gross distribution amount and not the amount that taxpayers age 70.5+ elect to donate to a qualified charity via a qualified charitable distribution (QCD). Tax rules state that the letters “QCD” should be placed on the 1040 form line (4b) for “IRA Distributions” to explain the difference between the gross amount and taxable amount, but some tax preparers forget to do this and then taxpayers have to file an amended return .

 

Stay Away From SALY- SALY is an acronym for “Same as Last Year.” When it comes to income taxes, rarely are household finances exactly the same from one year to the next. Tax laws change and people’s lives change (birth of a child, marriage, retirement, widowhood, the start of required minimum distributions [RMDs]), which necessitates future tax projections.

 

Know Your Effective Tax Rate- Effective tax rates are useful for calculating tax withholding and understanding the totality of your income tax payments. Simply look at your 2023 tax return and divide your total tax owed by taxable income. For example, if you pay $16,000 of tax on a $100,000 taxable income, the effective tax rate is 16%, even though single and married filing jointly tax filers would be in the 22% marginal tax bracket (the tax rate on your last dollar of income) in 2024.

 

Watch Out for State Tax Non-Conformities- I now live in a state (Florida) where there is no income tax but, for Money Talk readers who do, it is important to know where your state tax rules diverge from federal tax rules. Otherwise, you could overlook valuable tax deductions (e.g., medical expenses and write-offs for college savings plan contributions).

 

Accelerate Carefully- Consider accelerating income in early retirement years (before RMDs), during years with lower-than-normal income, and in the last year of filing a joint tax return (before single taxpayer status applies). Consider accelerating deductions (e.g., bunching itemized deductions in one year) when you realize large capital gains, have a high-earning year, or are near “tripwires” for tax on Social Security, IRMAA Medicare premiums, and the net investment income tax. IRMAA is not a tax, per se, but it is a drag on your bottom line.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

Year-End Tax Moves to Save Money

 As the year winds down so, too, does your opportunity to take proactive steps to reduce 2023 income tax due in April 2024 and, perhaps, taxes due in future years as well.  Below are some money-saving tax planning strategies to consider. Seek professional advice as needed.

Early RMD Withdrawals- The “financial gap years” between age 59½ and 73 (or 75 if born in 1960 or later) are when there are no longer penalties for withdrawals from tax-deferred accounts but required minimum distributions are not yet mandatory. Sometimes it makes sense to pay taxes voluntarily at a lower tax rate during gap years to save on taxes later at a higher tax rate.

 

Draft Tax Return- A draft tax return with “best estimates” of taxable income and tax write-offs is the first step in a year-end tax review. By early December 2023, income and tax withholding should be pretty predictable and tax-saving strategies taken so far (e.g., tax-deferred retirement plan contributions and charitable gifting) are already accounted for.

 

Year-to-Year Comparison- Once a draft 2023 tax return is prepared, compare it to 2022. Look for big changes in income and expenses that will affect taxes owed. Example: savers earned about 0.25% interest in 2022 vs. 4.5%+ with online banks and money market funds in 2023. On large account balances, this could result in a big difference of thousands of dollars of additional taxable income (e.g., $250,000 x .0025 = $625 versus $250,000 x .045 = $11,250).

 

Tax-Loss Harvesting- This is where investors proactively take a loss on the sale of securities to offset realized capital gains. If losses exceed gains, up to $3,000 can be claimed against other taxable income and any losses beyond that carried forward to future tax years. Securities held for a year and a day or longer are taxed at long-term capital gains rates (versus ordinary income rates for short-term gains) so it is important to review their holding period before selling.

 

Tax Bracket Planning- The objective is to control your marginal tax bracket to avoid paying taxes at a higher rate. For example, if you are near the top of the income range for the 12% tax bracket, you want to try to avoid slipping into the 22% tax bracket, which is a big jump. Knowing where you stand can inform tax-reducing strategies such as Roth IRA conversions, deferring income from 2023 to 2024, increasing retirement plan contributions, and “bunching” itemized deductions such as charitable contributions and property taxes due in early 2024.

 

Fourth Quarter Estimate- The last opportunity to apply tax payments toward expected 2023 tax liability and avoid an under-withholding penalty is a fourth quarter estimated tax payment due January 16, 2024. By early January, all information for a tax return should be known, including mutual fund dividend/capital gain distributions that are passed through to investors.

 

For additional year-end tax-saving strategies, consult with a tax advisor or financial planner and/or review this publication from Intuit.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

Ten Tax Planning Tips for 2022

Now that 2021 income tax season has been over for a month and the dust has settled, it is time to start some serious tax planning for 2022. Planning now provides seven months to take action and/or implement changes to avoid a stressful “tax scramble” at the end of the year. In an earlier blog post, I described 12 tax planning topics for 2022.

 

In this post, I continue the conversation with ten tax planning tips for 2022 (in no particular order) for readers to consider:

¨    Plan for Tax Benefits That Go Away- On a recent webinar, I heard stories about dramatic increases in 2021 tax refunds for families with children resulting from the expanded child tax credit and child and dependent care credit. “Normal” tax rules apply in 2022, however, which may require a withholding change for many families to avoid getting a smaller refund, or owing tax, in 2023. To do this, file a new W-4 form or make larger estimated payments.

 

¨    Determine Your 2022 “Safe Harbor”- The safe harbor rule is an “income tax get-out-of-jail-free card” to avoid an IRS under-withholding tax penalty. It works like this: withhold 100% (110% with an adjusted gross income or AGI more than $150,000) of tax owed for the previous year (i.e., 2021) or 90% of current year (2022) tax liability using a W-4 form at work for job-related income tax withholding; withholding for Social Security, a pension, and required minimum distributions through account custodians; and/or quarterly estimated payments using IRS Form 1040-ES.

¨    Improve Your Tax Records- If disorganized records were a problem for 2021 taxes due in 2022, set up a better system. Since there is no longer a non-itemizer’s charitable deduction in 2022 and only about 10% of tax filers itemize, you’ll probably have fewer receipts to save. Common filing methods include file folders, a large envelope, and a designated desk drawer. To err on the side of caution in the event of an audit, experts advise keeping tax records for at least six years.

 

¨    Set Up Spreadsheets- Taxpayers with recurring income and/or expenses (freelancers, landlords, Airbnb and VRBO hosts, employees with side hustles, etc.) should consider purchasing software or setting up a simple Excel spreadsheet to aggregate their business income and expenses throughout the year.

 

¨    Ramp Up Retirement Savings- Consider increasing retirement savings in a tax-deferred employer retirement savings plan (e.g., 401(k), 403(b), and traditional IRA). Saving even 1% more of pay can make a difference in later life. There are online calculators like this one than can show you what you could save. Also consider some savings in taxable and/or tax-free accounts so you have tax diversification (i.e., assets that are taxed in different ways).

 

¨    Beware Roth IRAs- There’s nothing wrong with Roth IRAs. They are a great retirement savings tool. However, if your 2022 income could be close to the limits to make contributions ($144,000 for individuals and $214,000 for couples filing jointly in 2022), it may be best to wait until early 2023 when your actual income is known. Otherwise, you may need to do an excess contributions withdrawal and pay tax on any money that an early contribution earned.

 

¨    Consider a SEP- With millions of Americans quitting jobs during the last year and many becoming part-time freelancers or full-time entrepreneurs, a simplified employee pension (SEP) can be a great retirement savings option. Depending on business income, SEPs often have higher contribution limits than IRAs. The deadline for making 2022 SEP contributions is the tax filing deadline in April 2023. Take time now to research potential account custodians.

 

¨    Plan for IRMAA- Older adults on Medicare should project their 2022 income as best they can, although it is difficult to know now what taxable mutual fund distributions or self-employment earnings might be. If income appears to be on track to trigger an income-related monthly adjusted amount (IRMAA) Medicare surcharge, it may be wise not to aggravate the situation with taxable capital gains and Roth IRA conversions. Seek professional advice, if needed.

 

¨    Determine “Bunching” Potential- Bunching is a legal tax minimization strategy where taxpayers aggregate sufficient tax-deductible items to exceed the standard deduction for their age and tax filing status. The 2022 standard deduction is $12,950 for individuals ($14,700 age 65+) and $25,900 for married filing jointly ($28,700 if both spouses are age 65+). An example of a bunching strategy is combining three deductible items: state income and local property taxes up to the $10,000 cap; unreimbursed medical expenses for an elective procedure, and charitable donations.

 

¨    Tax-Saving Actions- Now is the time to do research, seek professional advice, and determine “process steps” for strategies to reduce your taxes in 2022 or beyond. Five examples are tax-loss harvesting, Roth IRA conversions, qualified charitable contributions (age 70½ +), setting up a donor advised fund, and increased contributions to a tax-deferred retirement savings plan, health savings account or HSA (if eligible), or flexible spending account or FSA (if available).

This post provides general personal finance information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 

 

Twelve Tax Planning Topics for 2022

 The 2021 income tax season will soon be in the history books. With income tax calculations still fresh in our heads, this is a great time to do some tax planning for 2022. Here are 12 tax topics to consider:

 

Itemized Deductions- Only about 10% of taxpayers can itemize since the Tax Cuts and Jobs Act went into effect in 2018. Absent catastrophic medical bills or a natural disaster declared by the U.S. President, most people can’t itemize without a plan. To itemize deductions in 2022, single taxpayers must have allowable deductions greater than $12,950 and married couples filing jointly must exceed $25,900 ($28,700 for a couple with both spouses age 65+).

 

Charitable Gifts- Nobody wants to have large medical bills or property losses, income and property taxes are SALT capped at $10,000, and it takes a pricey house with a large mortgage to exceed the standard deduct with deductible interest. This leaves charitable donations as a path to itemizing. Strategies to garner a tax benefit for charitable gifts to qualified charities include “bunching” deductions into one tax year and setting up and funding a donor advised fund.

 

Changed Income- A change in household income this year- up or down- will affect income taxes. Income changes can result from a number of life events including changing jobs, adding or ending “side hustle” freelance work, adding a spouse to the labor force, retiring, getting married or divorced, having a baby, and more.

 

Changed Number of Dependents- A change in family size and/or number of allowable dependents also affects income taxes. For example, parents can gain or lose the child tax credit. Changes can occur as a result of adding a child(ren) as a result of birth or adoption and losing eligibility when children “age out.” Specific rules for claiming dependents apply.

 

Tax Bracket Projections- Once you project 2022 income, you can project your marginal tax bracket and tax rate (the percentage of tax assessed on your last dollar of earnings). In 2022, there are seven tax rates for each filing status (single, married filing jointly, head of household, and married filing separately). Pay particular attention if your projected income is close to a “breakpoint” for the next highest tax bracket so you can take proactive steps to stay below that number.

 

Tax-Deferred Investing- One way to avoid a higher tax bracket is to increase tax-deductible contributions to an employer retirement plan (e.g., 401(k), 403(b), 457, TSP). Contributions are subtracted from gross income, which reduces adjusted gross income (AGI) and taxable income. Sometimes, saving just 1% more of pay can make a big difference on taxes due.

 

Changed Tax Withholding- If there are major changes in income and number of dependents, tax withholding is likely out of whack. Payroll tax withholding and/or quarterly estimated payments may need to be adjusted. A good resource to synchronize expected income with required tax payments is the IRS Tax Withholding Estimator.

 

Safe Harbor Rule- A previous year tax return (e.g., 2021 for 2022) is also a useful tax withholding resource because it shows your most recent tax bill. Under the IRS safe harbor rule, if you withhold 100% of tax owed the prior year (110% with adjusted gross income over $150,000), you can avoid an underpayment penalty for insufficient tax withholding. The takeaway, therefore, is to withhold and/or send quarterly payments at least equal to this amount.

 

Older Adult Tax Concerns- Two key tax planning concerns for older adults are required minimum distributions (RMDs) that increase taxable ordinary income and Income-Related Monthly Adjustment Amount (IRMAA) surcharges on standard Medicare Part B premiums. Often, RMDs trigger IRMAA, which is based on modified AGI or MAGI from two years prior. Taxpayers close to five IRMAA trigger amounts may want to take steps to defer or reduce taxable income.

 

State Income Tax Check-Up- State tax rules can vary from federal tax rules. For example, you may qualify to deduct medical expenses on a state income tax return while you cannot on a federal return. If so, save those receipts for health insurance premiums and copays. In addition, like federal taxes, make sure that state income tax withholding is on track.

 

Roth IRA Conversions- Taxpayers concerned about rising tax rates (their own or the government’s) might want to convert money in a traditional IRA to a tax-free Roth IRA before tax rates are set to rise in 2026. Since traditional IRA withdrawals are taxable, consider making small, partial conversions over several years (e.g., 2022, 2023, 2024, and 2025).

 

Simplify and Organize- The end of tax filing season is a good time to answer the question “Is there a better way to organize my tax records?” Some people use digitized (scanned) records while others use file folders or envelopes. The important thing is to find a system that works for you to make 2022 tax filing season as stress-free as possible in 2023.

 

This post provides general personal finance information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.