With less than six weeks before the end of 2022, I thought my readers would be interested in actions they could take before yearend to reduce their income tax bill. Once the calendar flips to 2023, all the 2022 tax reduction strategies will disappear. Most tax breaks fall into two categories, tax benefits for everyone, and deductions for business owners. (In this article, I will refer collectively to self-employed farmers, ranchers, and business owners as FRB.)
First, let’s look at tax breaks available to every taxpayer. Most people in this category live off their wages, retirement, or investments.
- Charitably inclined retirees should consider a Qualified Charitable Distribution (QCD). Required minimum distributions (RMD) up to $100,000 per year can avoid tax if you instruct your IRA custodian to issue a check directly to your favorite charity before the end of the year. This strategy qualifies as an RMD but is also excludable from taxable income. (However, you do not get to double dip and also claim a charitable contribution deduction.)
- If you are considering the sale of appreciated assets or investments, many people in the middle class can take advantage of the 0% capital gain rate, if their taxable income falls below the 22% tax bracket threshold (Single $41,775, Head of Household $55,900, or Married Filing Jointly (MFJ) $83,550 for the 2022 tax year). For example, if your 2022 total MFJ income was expected to be $100,000, you could sell a long-term capital asset for a gain of up to $9,450 and not pay any capital gains tax on that gain. (Income $100,000 – standard deduction $25,900 = $74,100 of taxable income, which is $9,450 less than the $83,550 threshold.) Therefore, you can pocket the gain of $9,450 tax free.
- In contrast, if your nonqualified investments have taken a tumble, consider tax loss harvesting. Sell positions with losses and claim a deductible loss. Here are two caveats. First, the limit for deducting capital losses is $3,000 per year. Second, don’t invest in the same security within 30 days, otherwise it will be disregarded as a wash sale.
- Alternate between the standard and itemized deductions. This works well for Taxpayers who used to itemize (before TCJA doubled the standard deduction) and now miss out by a few thousand dollars. By timing deductible payments like taxes and charitable contributions, some could benefit by itemizing one year, and claiming the standard deduction the next. As a cash basis taxpayer, you get the deduction in the year the deduction is paid.
- One way to lower your “taxes” is to avoid penalties. Specifically, it shouldn’t be too hard to avoid IRS penalties for: 1) late filing, 2) late payment, and 3) underpayment. Late filing penalties can be avoided by either filing your tax return or extension (Form 4868) by April 15. The late payment penalty applies to tax payments received after April 15. The underpayment penalty is similar but applies to tax payments during the year. If you file your 2022 tax return and pay a balance due of up to $1,000 by April 15, 2023, no underpayment penalty will apply. But if you owe more than $1,000 you will owe a penalty. This can happen to wage earners if they receive unexpected income one year. It if more common for FRBs to be subject to the underpayment penalty. Thankfully, there is a safe harbor provision. There will be no underpayment penalty if you have paid 100% of last year’s total tax. (Caution, high-income taxpayers (AGI > $150K) must cover 110% of last year’s total tax.)
- I encourage wealthy taxpayers to check out Conservation Easements (mentioned in a recent article) or Charitable Remainder Trusts before year end.
Last year, the nonitemizer charitable contribution deduction ($300, $600 MFJ) was part of the list above. However, the temporary tax break was not extended to 2022. Therefore, the only way to deduct charitable contributions is to itemize on Schedule A.
Next, are suggestions for FRBs.
An old strategy for FRBs is to purchase assets before the end of the year. Unlike some accountants, I don’t recommend buying an asset to receive a tax break. Why pay for a new machine when your old machine is working well? It never made sense to me to pay $100,000 for a new asset to obtain a refund of $40,000. That said, if your old machine is dying and you plan to replace it soon, then I agree that buying it in December 2022 is better than February 2023 because you will experience the tax benefit sooner. (Please remember the new asset must be placed in service before yearend.)
An FRB can also legally deduct the business portion of many personal expenses. For example, if the FRB uses one room of his home exclusively for business, then a home office deduction can be computed and deducted. There is also a Safe Harbor option which offers the added benefit of not recapturing depreciation when you sell your home.
Do you use your cell phone in your business? If so, then you can deduct the business portion as an expense of the business. Many FRBs deduct 75% to 90% of their monthly cell phone fees. The business use of laptops, computers, and internet can also be deducted. Don’t forget to track and claim the IRS mileage rate of 62.5 cents per mile for last half of 2022.
In summary, I encourage you to implement tax savings strategies before December 31, 2022, when this year becomes a memory.
Aric Schreiner, CPA, PFS, Certified Tax Strategist, helps successful professionals and small business owners strategize to reduce taxes and audit risk.
