As 2022 comes to an end, it’s important for taxpayers to make sure they’ve taken advantage of planning options available this year.
A good first step in an effective year-end strategy is determining your expected 2022 and 2023 marginal tax rate. In general, if your marginal tax rate is expected to stay the same or decrease in 2023, you should consider deferring income and accelerating deductions. If it’s going to increase, it may make sense to accelerate income and defer deductions.
Of course, you should consider the timing of significant income events, such as the sale of a business, real estate or other investments, a significant work bonus or retirement — and determine if the following taxes apply:
- Net Investment Income Tax, a 3.8% tax on investment income, such as interest, dividends and capital gains, for taxpayers with the following gross income: $250,000 for married couple filing jointly, $125,000 for married couple filing separately and $200,000 for all others.
- Additional Medicare Tax, a 0.9% tax on wages and self-employment income in excess of the gross income detailed above.
- Alternative Minimum Tax, which requires some taxpayers to calculate their tax liability under ordinary income tax rules and the AMT and then pay whichever amount is the highest.
Tax rate stays same or decreases
Taxpayers who expect their marginal income tax rate to stay the same or decrease in 2023 should consider increasing their charitable contributions this year. Remember, excess charitable contributions not deductible in the current year may be carried forward for five years, so check for charitable contribution carry-forwards from previous years and whether you can fully utilize these and 2022 carry-forwards.
You also may want to consider setting up a donor adviser fund, which allows you to “bunch” charitable deductions into one year and spread contributions to a charity over several years.
Individuals older than 70½ should consider distributions to charities from an IRA since these distributions are tax-free up to $100,000 per year.
Other considerations if the marginal income tax rate is expected to be the same or drop in 2023 include:
- Defer the sale of capital gain assets
- Sell investments with unrealized losses to offset capital gains or utilize the $3,000-per-year offset against ordinary income
- Exercise nonqualified stock options in 2023 instead of this year
- Elect the installment method to report gain on qualifying sales
- Buy mutual fund shares after the record date for a shareholder distribution, particularly the large year-end capital gain distribution that many funds make
- Review the ability to defer income and accelerate deductions of the business if you own a pass-through business, such as an S corporation, partnership or limited liability company
- Consider whether you have expiring net operating loss
- Prepay deductible expenses that have economically accrued before the end of the year, such as property taxes, but consider the $10,000 maximum deduction for state and local taxes and the impact of the AMT.
Tax rate increases
Taxpayers who expect their marginal tax rate to go up in 2023 should consider:
- Deferring charitable contributions
- Exercising nonqualified stock options
- Accelerating bonuses
- Electing out of installment sale treatment
- Deferring the payment of deductible expenses, such as property taxes
- Accelerating recognition of income of closely held pass-through businesses
Family gifting opportunities
Individuals may make annual exclusion gifts of up to $16,000 to as many people as they choose without reducing the donor’s lifetime estate/gift tax exemption. This exemption will increase to $17,000 in 2023. Tuition paid to educational institutions and medical expenses paid directly to a health care provider are not counted against this limit.
You can also “superfund” a 529 plan by electing to contribute five years of annual exclusion gifts to a plan in one year. These contributions can be taken into account ratably over a five-year period, allowing a gift of $80,000 made in 2022 to qualify for annual exclusions.
There’s a lot to consider when it comes to year-end tax planning. With the right planning and a sound strategy, you can leverage the opportunities that make the most sense for you today and into the future.
Jay A. Kennedy is an attorney at Warner Norcross + Judd LLP, where he focuses on tax planning for businesses, nonprofits and individuals. He can be reached at firstname.lastname@example.org.