Financial decisions you make between now and the end of the
year can have a significant effect on how much tax you have to pay next April.
This is particularly true if you're saving for retirement, itemize deductions,
or hold investments outside a retirement account.
But time is running short. It will be too late to cut your
tax bill using most of the tips we've assembled below after we ring in the new
year. So check out our list right away and get cracking!
Check Your Withholding
If you were hit with a big tax bill this year because you
didn't have enough money withheld from your paycheck, you may be able to take
steps between now and year-end to avoid another April surprise. Use the IRS's
Tax Withholding Estimator(opens in new tab) as soon as you can to determine
whether you should file a new Form W-4 with your employer and increase the
amount of taxes withheld from your paycheck before the end of the year. You'll
need your most recent pay stub and a copy of your 2021 tax return to help
estimate your 2022 income. If it looks like you're going to owe money when you
file your next tax return, the IRS tool will tell you how much "extra
withholding" you should put down on Line 4(c) of Form W-4(opens in new
tab) to catch you up on withholding for the year. Then, early next year,
complete another W-4 for withholding in 2023.
In general, you don't have to worry about a penalty if you
owe less than $1,000 after subtracting withholdings and credits, or if you paid
at least 90% of the amount of tax due for the current year or 100% of taxes due
the previous year, whichever is smaller.
Consider Paying 2023 Bills Now
Unless your finances have changed significantly, you
probably have a pretty good idea whether you'll itemize or claim the standard
deduction when you file your 2022 tax return. If you plan to itemize — or
you're close to the threshold — now is a good time to prepay deductible
expenses, such as mortgage payments and state taxes due in January. Other moves
to make by New Year's Eve:
Review your medical bills. If you have enough unreimbursed
medical expenses, you may be able to deduct them. You can only deduct
unreimbursed medical expenses that exceed 7.5% of your adjusted gross income.
That puts this tax break out of reach for most taxpayers, but if you had
extraordinarily high medical expenses this year — due to a major illness or a
chronic condition, such as long Covid, for example — you may qualify.
And there's still time to schedule appointments and
procedures that will increase the amount of your deductible expenses. The list
of eligible expenses includes dental and vision care, which may not be covered
by your insurance. For the complete rundown, go to IRS Publication 502(opens in
new tab).
Pay property taxes early. Itemizers can deduct up to $10,000
in state and local taxes. If you haven't maxed out for the year and your
municipality allows it, pay the property tax bill due in January in December so
you can deduct it from your 2022 taxes.
Prepay tuition. If you're the parent of a college student,
you may be able to lower your 2022 tax bill by prepaying the first quarter
tuition bill — and you don't need to itemize to claim this tax break. The American
Opportunity Tax Credit, which you can take for students who are in their first
four years of undergraduate study, is worth up to $2,500 for each qualifying
student. Married couples filing jointly with modified adjusted joint income of
up to $160,000 can claim the full credit, while those with a MAGI of up to
$180,000 can claim a partial amount.
Likewise, if you're planning to take a class next year to
boost your own career, consider prepaying the January bill before December 31
so you can claim the Lifetime Learning Credit on your 2022 tax return. The
credit is worth up to 20% of your out-of-pocket costs for tuition, fees and
books, up to a maximum of $2,000. It's not limited to undergraduate expenses, and
you don't have to be a full-time student. As with the American Opportunity Tax
Credit, married couples filing jointly with MAGI of up to $160,000 can claim
the full credit, while those with a MAGI of up to $180,000 can claim a partial
credit.
Contribute to a 529 Plan or ABLE Account
Stashing money in a 529 plan before year-end won't reduce
your federal tax bill, but it could lower your state tax tab. More than 30
states allow you to deduct at least a portion of 529 plan contributions from
state income taxes. In most states, you must contribute to your own state's
plan to get the tax deduction, but several states allow you to deduct
contributions to any state's plan. Check out your own state's rules at
savingforcollege.com(opens in new tab). Many states allow grandparents and
others to contribute to your child's plan, and a few will allow them to deduct
those contributions, too.
If someone in your family has special needs, you can
contribute up to $16,000 this year to an ABLE account, which allows people with
qualifying disabilities to save money without jeopardizing government benefits
(ABLE account beneficiaries can contribute more to their own account). You
don't have to invest in your own state's plan, but if you're a resident of one
of the states that do offer a tax break for ABLE accounts, you can deduct your
contribution. Michigan, for example, allows residents who contribute to its
ABLE account to deduct up to $5,000 (or $10,000 for a married couple). For more
information, go to the ABLE National Resource Center's website(opens in new
tab).
Reap the Tax Harvest
The tax code allows you to sell investments that have fallen
below your purchase price and use the resulting loss to offset capital gains in
taxable accounts. That's a compelling reason to consider jettisoning your
losing positions. Investments that you've held for a year or less are taxed as
ordinary income, but investments you've held longer are taxed at the long-term
capital gains rate, which ranges from 0% to 23.8% (including the 3.8% surtax on
net investment income).
After matching short-term losses against short-term gains,
and long-term losses against long-term gains, any excess losses can be used to
offset the opposite kind of gain. If you still wind up with an overall net
capital loss, you can use up to $3,000 of that loss to offset ordinary income
and roll the rest over to the following year. Note that once you sell an asset
at a loss, the "wash-sale" rule requires you to wait 30 days before
reinvesting in it or buying a substantially identical investment.
For 2022, lower-income investors (i.e., with income less
than $41,675 for single filers and $83,350 for joint filers) pay no capital
gains tax on investments held for more than a year. If that's the case, it may
make sense to sell winning investments tax-free and reinvest (no need to wait
30 days), effectively resetting the odometer on future gains.
Also note that mutual funds are required to pay out to their
shareholders any gains realized from the sale of stocks or bonds during the
year. If you own the fund in a taxable account, you must pay taxes on these
distributions when you file your tax return, even if you reinvest them. Given
the poor performance of the stock market this year, you may not think this will
be a problem. But some funds were still sitting on large gains from 2021 and
may have been forced to sell some of those winners to meet investor outflows.
As a result, you could get hit with a capital gains distribution even if your
fund lost money this year.
If you do get hit with a distribution, review your portfolio
to see if you have any mutual funds, stocks or bonds that have declined in
value since you purchased them. Selling them before year-end will provide
losses to offset your gains. Mutual funds typically publish an estimate of
their capital gains distributions in November or December, along with the date
of the distribution. Estimates are on a per-share basis, so if you figure out
how many shares you have, you can gauge the size of your distribution.
Interested in buying a fund before the end of the year?
Check its website first. If the fund plans to make a capital gains
distribution, postpone your purchase until after the distribution date. Otherwise,
you'll have to pay taxes on gains racked up before you got on board.
Max Out Your Employer's Retirement Savings Plan
As the year comes to a close, you may be able to squeeze a
little more money from each paycheck for your retirement savings. You can
contribute up to $20,500 to a 401(k), 403(b) or federal Thrift Savings Plan in
2022, plus $6,500 in catch-up contributions if you're 50 or older.
Pretax contributions will lower your take-home pay and
reduce your tax bill. If your employer offers a Roth 401(k), you can make
contributions that won't lower your taxable income now but that can be
withdrawn tax-free in retirement. If your employer offers both types of plans,
you can direct new contributions to the Roth 401(k) rather than the pretax
401(k) at any time.
Contact your 401(k) administrator or your employer's human
resources department ASAP to find out how much you're on track to contribute to
your 401(k) by the end of the year and to ask about the steps you need to take
to boost your contributions. The earlier you make the change, the better:
401(k) contributions are made through payroll deduction. If you're contributing
on your own to a traditional or Roth IRA for 2022, you have until April 18,
2023.
If you aren't on track to max out your retirement account
for the year, adding money from a year-end bonus can be a great way to boost
your contributions without affecting your regular take-home pay. Rules vary,
and some plans don't allow participants to contribute their bonus. Also make
sure that you don't cross the annual contribution limit. You have until the
tax-filing deadline to withdraw any extra contribution and the earnings on it,
which will both be taxable. If you don't take it out, the excess contribution
will be taxable now and you'll have to pay taxes on it again when you finally
withdraw the money.
Use Your Side Hustle to Boost Retirement Savings
If you have self-employment or freelance income, open a solo
401(k) plan. You must open it by December 31, although you have until April 18,
2023, to contribute and take a tax deduction for 2022. You can contribute up to
$20,500 ($27,000 if you're 50 or older) to a solo 401(k), minus any
contributions you've made to a 9-to-5 employer's 401(k) for the year. You can
also contribute up to 20% of your net self-employment income to the plan.
Contributions to the solo 401(k) can total $61,000 in 2022 (or $67,500 if 50 or
older), but they can't exceed your self-employed income for the year.
Another option is to open a Simplified Employee Pension
(SEP) account. However, if you have just a little freelance income, you can
contribute more money to a solo 401(k). SEP contributions are limited to 25% of
net self-employment income, up to $61,000.
Open a Donor-Advised Fund
Putting your money or other assets, such as stocks or
personal property, in a donor-advised fund allows you to deduct the entire
contribution in the year you make it and decide later how you want to dole out
grants to charities of your choice. You can open a donor-advised fund at
financial-services firms such as Fidelity Charitable(opens in new tab) or
Schwab Charitable(opens in new tab) or at community foundations. Contributing
one lump sum this year may help lift your deductions above the standard
deduction amount and allow you to itemize.
Max Out Charitable Donations (and Declutter)
If you itemize, donating clothes, kitchenware or furniture
you no longer need can boost your deductions while helping a worthy cause.
You'll base your deduction on the donated item's "fair market value"
(or what it might sell for at a thrift or consignment shop) — you can use
online tools such as TurboTax's ItsDeductible tool(opens in new tab) to
estimate this value. You will need a written acknowledgment from the
organization if you are claiming a contribution of $250 or more (consider
snapping a photo of the donation for your records). For donated items valued at
more than $5,000 (art, antiques, etc.), plan on providing a written appraisal.
For the 2022 tax year, you can deduct cash donations of up to 60% of your
adjusted gross income.
Transfer IRA Money to Charity
Taxpayers who are 70½ or older can transfer up to $100,000
from a traditional IRA tax-free to charity each year, as long as they transfer
the money to the charity directly.
This is a nice benefit for IRA owners who are 72 or older,
because the distribution counts as your required minimum distribution. In
addition, a "qualified charitable distribution" will reduce the size
of your IRA, which will reduce future required withdrawals, and your tax bill
too. Plus, the transfer could help keep your income below the threshold at
which you're subject to the Medicare high-income surcharge as well as hold down
the percentage of your Social Security benefits subject to tax.
If you decide to make a QCD, do it well in advance of New
Year's Eve. To qualify for the tax break, the money has to be out of the account
and the check needs to be cashed by the charity by December 31.
Consider a Roth Conversion
Consider converting some money from a traditional IRA to a
Roth IRA this year, up to the top end of your income tax bracket, especially if
you believe your taxes may go up in the future. You'll pay taxes on the
conversion (minus any portion that represents nondeductible IRA contributions),
but the money will grow tax-free in the Roth after that. Converting your entire
traditional IRA balance can bump you up to a higher tax bracket, but you can
spread conversions over several years.
Be careful about making a large conversion if you're within
two years of signing up for Medicare — you'll have to pay extra for Medicare
Part B if your adjusted gross income (plus tax-exempt interest income) is more
than a certain amount. For example, if your 2020 income was $91,000 or more if
you're single, or $182,000 or more if you're married filing jointly, your 2022
Medicare Part B costs are higher. Your last tax return on file determines your
Medicare premiums, so a 2022 conversion could affect 2024 premiums.
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