2022 Year-End Tax Planning Tips for Individuals and Small Businesses
Each year we strategize with our clients on ways to save and reduce taxes. Below are some things to consider for your own year-end planning.
Individual Planning Tips
Determine your capital gains/losses. Consider selling assets in taxable accounts that have unrealized losses before the end of the year to offset capital gains and offset up to $3,000 of ordinary income.
Consider your vacation home. Because the passive loss rules are so restrictive, you should consider personally using vacation rental property enough to qualify it as a second residence. Use by a family member also generally qualifies as personal use. This approach may enable you to deduct all of the mortgage interest as qualified residence interest. Keep in mind, however, that this may cause you to forfeit deductions for the personal-use portion of other routine expenses such as repairs, maintenance, homeowner’s fees, and insurance.
Consider exchanges of like-kind properties. Exchanges of like-kind property are not limited to transactions directly between two parties. If you cannot reach agreement with an exchange candidate, you may benefit from a multiparty exchange – that is, a transaction in which you dispose of your real property to one person and acquire your new real property from someone else. This option may be a possible solution that may satisfy all parties’ objectives and still allow you to achieve tax deferral.
Account for family credits. If your employer offers a dependent care assistance program, you should consider using this benefit. You may exclude from gross income up to $5,000 ($2,500 if you are married and filing separately) per year under an employer-provided program. While these amounts will reduce the expenses eligible for the childcare credit, the reimbursement plan usually provides better savings. The employer plan is free from Social Security and income taxes.
Account for education planning. You may find it feasible to transfer income-producing property to your children under certain circumstances once they are old enough to no longer be subject to the kiddie tax rules. Income accruing to them will be taxed at their presumably lower rate. In many cases, you can successfully reduce your family’s overall tax liability by giving income-producing assets to such older children.
Account for retirement planning. Some individuals make the maximum nondeductible contributions to a traditional IRA and convert the IRA to a Roth RIA the next day. In this case there is generally no income to include (assuming the individual has no other IRAs with deductible contributions). This makes the conversion tax-free; all additional interest or other earnings will fall under the Roth IRA rules and not be subject to tax on distribution. If you have money in an IRA, are under age 59 1/2, and need cash, consider using the substantially equal payment exception. Bu using this “life annuity” option, you can arrange for equal, periodic withdrawals to be made at least annually and avoid penalties for early withdrawal. The withdrawal amount is based on life expectancy and actual or projected IRA earnings. Withdrawals will be subject to income tax but not the 10 percent early withdrawal penalty. However, the same rules do not apply to a Roth IRA. Penalty-free distributions may also be made for certain “hardships” such as paying for health insurance premiums if you’ve been unemployed for at least 12 consecutive weeks, covering unreimbursed medical expenses in excess of 7.5 percent of AGI (10 percent if under age 65), paying qualified higher education expenses, and purchasing your first home (but limited to $10,000). The distribution will still be subject to tax but you won’t be subject to the 10 percent penalty tax as long as you qualify under one of the hardship exceptions.
If you are divorced and receive alimony, you can make an IRA contribution even if all your income is from taxable alimony.
Consider making some Roth(K) contributions to the 401(k) plan. Roth(k) contributions are taxed as contributed, but related earnings are never taxed if they’re held in a Roth(k) for at least five years and distributed only after age 59 1/2. The amounts can be rolled over from a Roth(k) into a Roth IRA at distribution and held until needed. As noted above, Roth IRAs do not have required minimum distributions during the owner’s lifetime.
Make maximum contributions to your 401(k). For contributions made with pretax dollars, you save taxes now and accumulate tax-deferred retirement savings. If the plan allows, you may withdraw contributions to a 401(k) plan when you terminate your employment or if you face a financial hardship, as defined in stringent IRS regulations. If you withdraw funds before age 59 1/2, you generally will be subject to a 10 percent penalty tax in addition to ordinary income tax. On termination, you can direct the plan administrator to roll over the amount to an IRA or a new employer’s plan without paying any tax at the time of the rollover, allowing further tax deferral until you need to take distributions.
If you need a loan and have money invested in your company’s 401(k) or 403(b) plan, you may be able to borrow against your savings. Although loan conditions vary according to plans, the interest rates tend to be lower than for other consumer loans, and the interest you pay goes back into your account in the retirement plan. In most cases, the interest you pay is nondeductible.
Make your estimated payments. You can reduce or eliminate an underpayment of estimated tax penalty by making an additional payment at any time during the year. Alternatively, you can request that your employer withhold additional tax from your wages for the remainder of the year. Any additional withholding tax will be treated as having been paid equally throughout the year for purposes of determining the underpayment penalty. If you choose this option, your increased withholding will continue until you notify your employer to revise the amount.
Consider gifting to charity. Evaluate both your tax and philanthropic goals when making charitable contributions. Although contributions to public charities have a higher deductibility limitation than contributions to private foundations, contributions to a private foundation may afford you greater control over the use of the funds.
Alternatively, you may consider establishing a “donor-advised fund” through a local community foundation, or a charity affiliated with a mutual fund, investment firm, or bank. The public charity sponsoring the donor-advised fund owns and controls the fund, but you are able to advise the charity on how you would prefer the funds to be invested and/or distributed.
Consider gifting property. A gift of appreciated property (including company stock) that has been held for more than one year generally can provide a double benefit: you obtain a charitable contribution deduction equal to the property’s FMV on the date of the contribution, and the gain is not taxable income. In the case of publicly traded stock that you currently hold and in which you want to continue investing, consider making a donation of that stock rather than equivalent amount of cash. If you make a charitable contribution of appreciated stock and use the cash that you otherwise could have contributed to purchase replacement stock, you will have the same charitable contribution deduction and get a stepped-up basis in the replacement stock, thus potentially reducing your taxable gain on the new stock when you eventually sell it.
Business Planning Tips
Account for QBI deductions. The 20 percent deduction is not allowed in computing AGI; instead, it is allowed as a deduction that reduces taxable income. Thus, the deduction does not affect limitations based on AGI. The deduction is available to taxpayers that itemize deductions as well as those that do not.
Account for restricted stocks. If you receive restricted stock of a start-up company or other property with a relatively low value and an expectation of growth, consider making a section 83(b) election. This approach may be advantageous as it allows you to recognize ordinary compensation income on a relatively low value up front and plan for future appreciation to be taxed at more favorable capital gains rates. Keep in mind that a section 83(b) election must generally be filed within 30 days of transfer of the stock.
Compile business expenses. Keep a daily log of business mileage and expenses to keep track of expenses related to business use of an automobile. Although such logs are not required, they can be helpful if you are asked to substantiate deductions related to the business use of that automobile. The IRS considers written records more favorably than oral testimony and favors records compiled at the time of the business use over evidence constructed later.
Implement an automobile use policy. As an employer, you can satisfy the substantiation requirements applicable to automobiles by initiating and implementing a written policy statement prohibiting personal use of employer-provided vehicles. Alternatively, employees can use their own cars and turn in expense vouchers for reimbursement. If either method is used, make certain that your substantiation requirements are clear and enforced.
Accelerate deductions for cash basis taxpayers. If you are a sole proprietor or your business operates on a cash basis for tax purposes, consider paying out typical accrued expenses such as bonuses, vacation pay, etc. This will allow the deduction to be taken in the 2022 tax year which reduces taxable income when rates are potentially more favorable.
Pass-through entity taxes. If your business operates as a partnership or S-Corporation, consider making an election to pay Pass-Through Entity Taxes in states where the tax can be paid. These entity level taxes serve as a way to circumvent the SALT deduction limitation at the Federal level by reducing taxable income distributed to partners/shareholders.
Meals and entertainment. As part of the Consolidated Appropriations Act (2021), the meals and entertainment deduction was increased to 100% for food and beverages purchased at restaurants. Consider using restaurants for purposes of client entertainment and business development to utilize the full 100% deduction and aid small business affected by COVID-19 which ends after 2022.
Accelerated depreciation. For assets placed in service in 2022, consider electing bonus depreciation under Section 168(k). This could potentially result in a 100% tax deduction of the cost of the qualified business property. Beginning in 2023, there will be a 20% reduction of this benefit each year until fully phased out in 2027.
State nexus. Just because your business is based in one state does not prohibit the state nexus laws in others. If you have employees, office locations, or are conducting business across state lines, consider whether or not you should be filing and paying tax within those states.
Entity selection. C corporation losses do not flow through to shareholders. Instead, C corporation losses may have little value from a federal income tax perspective until the corporation starts to generate income against which it can apply the losses. Some start-ups that expect to be unprofitable for some time may find S corporation or tax partnership status more attractive from a federal income perspective, so long as the owners’ ability to use the losses is not limited (for example, by basis limitations, at-risk rules, passive activity loss rules, or excess business loss rules).Determining whether C corporation status or flow-through status makes more sense in a particular situation often may require modeling the results of each status, based upon projections and assumptions regarding income, losses, deductions, distributions, credits, timing of stock sales or liquidations, future disposition transactions, and other facts. Negative tax consequences can be associated with a conversion from C corporation to flow-through status; thus, the initial choice of whether to be a C corporation or flow-through can be important. The limits on an S corporation’s capital structure can make S corporation status unattractive in some situations. For example, because all shares of an S corporation’s stock must have the same economic rights, an S corporation cannot provide for special allocations to different owners as a means of attracting capital. It also cannot get equity infusions from ineligible shareholders, such as banks, corporations, partnerships, and nonresident aliens and cannot obtain capital from the public markets because of the limitation on the number and type of shareholders. Further, an S corporation needs to work with its legal counsel in drafting its governing documents to minimize the chance that a future event (such as a stock transfer) will cause the eligibility requirements not to be met. Businesses that want to be taxed as flow-through entities but have concerns may want to consider being partnerships instead.
S corporations also are subject to some of the tax rules that govern C corporations, such as rules for reorganizations and acquisitions. In fact, an S corporation is one of the kinds of “targets” that can be acquired in a section 338(h)(10) or a section 336(e) transaction. These transactions involve stock purchases that are treated as taxable asset purchases for federal income tax purposes. Some acquirers like to use these transactions to be able to “step up” the basis of a target’s assets to value when actual asset acquisitions are not practical or possible. Some business owners may view the possibility of being able to sell their businesses in such transactions in the future as an advantage of S corporation status.
