There’s More To Year-End Taxes Than Harvesting 2022’s Losses

Year-end planning for 2022 has to account for three tax acts—the Tax Cuts and Jobs Act of 2017, the SECURE Act and the CARES Act. These three pieces of legislation offer clients five standout opportunities to lower their income for tax purposes.

  1. The first opportunity deals with required minimum distributions, which start when clients turn 72. The tried-and-true Roth conversion is still in play. But there’s also another strategy that’s a little less publicized: It involves giving up to $100,000 from an IRA account with required minimum distributions to a qualified charity by December 31 in order to reduce 2022 income.

This qualified charitable distribution is available to both spouses from their separately owned or inherited IRAs, for a total of $200,000, and the contribution can exceed the required minimum distribution. This strategy, however, cannot be used with a donor-advised fund or private foundation.

  1. The next opportunity comes from the CARES Act. This legislation’s itemized deductions allowed fully deductible charitable deductions in 2020 and 2020. But for 2022, the clock has been turned back, and the rules are now the same as they were before Covid-19: Itemized deductions are once again limited to 60% of adjusted gross income (AGI) for cash gifts and to 30% of long-term capital gain on property given to public charities. For gifts to grant-making private foundations, there’s a limit of 30% of AGI for cash gifts and a 20% limit on gifted long-term capital gains.

However, a planning opportunity has arisen in the ordering of donations, since the pre-Covid ordering rules remain suspended. Say that a client has $1 million in AGI. This means they can take advantage of the larger 60% of deduction on AGI, for a $600,000 total, even if not all the contributions were cash to a qualified public charity. For this to be possible, the taxpayer must elect to have the “percentage limitation suspension” apply to their qualified contributions.

For example, if this client wants to make a $300,000 donation of appreciated long-term securities to a private foundation and also wants to take the maximum deduction possible for public charities giving as well, it’s possible to hit that $600,000 maximum with the two combined.

The client would first make the private foundation donation of $300,000, which is $100,000 over the 20% limit. That $100,000 can be carried forward to 2023, leaving $200,000 as the private foundation donation for 2022. If the client then elects the limitation suspension, they can also make a $400,000 cash donation to a qualifying charity ($200,000 for the private foundation plus $400,000 in a qualifying contribution equals a $600,000 allowance for qualifying contributions). The total 2022 charitable deduction would be $600,000.

  1. The third opportunity, bunching donations and front-loading a contribution, will remain very popular this year. For a married couple donating $30,000 a year for five years, with a $10,000 real estate deduction for state and local taxes, the total deduction would be $200,000. However, if they front-load those charitable contributions and donate $150,000 in the first year followed by nothing the next four years, the client’s total deductions would end up being $272,000, as they would elect the standard deduction for those four years instead of itemizing.

“By bunching it, you are able to utilize more of the charitable contribution over those years. A $72,000 increase in deductions with somebody who is in the 35% to 37% tax rate, that ends up being a $26,000 tax benefit,” she said. “So it is real money.”

If the clients aren’t comfortable donating for a five-year period in a single year, they can double-up contributions for a two-year period and still benefit. For example, the couple would donate $60,000 in year one, and nothing in year two, and their itemized deductions in year one would be $70,000 (including the real estate tax deduction), while they’d take the standard $28,000 deduction in year two.

“Over the two years, that’s $98,000 versus the $80,000 if they made level contributions each year,” she said. “That would give them $18,000 more in deductions, which is over $6,000 of tax savings.”

  1. A fourth opportunity is the still-in-play backdoor Roth conversion. While much attention has been given to retirees converting large IRA balances to a Roth to avoid required minimum distributions, this strategy can also be used every year with a client’s Roth IRA contribution.

For 2022, a client can make a traditional Roth contribution of $6,000 or $7,000 if they are age 50 or older, invested in a vehicle that shouldn’t have much value fluctuation. Then shortly after the contribution, and before the value changes, the traditional IRA can be converted to a Roth with no related tax cost since there was no growth in value. The client gets the contribution deduction in 2022, and the Roth grows with all its benefits.

  1. The fifth opportunity is for clients who have made estimated tax payments based on safe harbor rules who may not need to make the fourth quarter payment if they had losses this year,

A lot of year-end planning is about housekeeping, thinking about the compliance.Last year a lot of clients did have large capital gains, and so they may have based their estimated tax payments and other items based on 2021, but 2022 is not turning out that way.

Some other tax considerations in mind:

  • Clients who make pass-through entity tax payments to their state, where a deduction might be allowed at the federal level, may have a large federal deduction in 2022.
  • Stock options should be reviewed so the clients can decide whether to exercise them or disqualify them, considering all the various losses that might be in play.
  • Tax-loss harvesting will be top of mind for many investors.
  • And all clients should maximize contributions to tax-deferred accounts—such as IRAs, 401(k)s, HSAs, etc.