How to be smart about taxes in the year ahead

Bill Cass, CFP®, CPWA®

Bill Cass, CFP®, CPWA®, 04/20/22


With the 2021 tax filing deadline over, it may be time to think about the year ahead.

Preparing for tax season can be time consuming for both taxpayers and advisors as they gather documents, prepare forms, and search for additional information. Many taxpayers put their thoughts about taxes aside once their returns have been filed.

Forgetting about taxes can lead to missed opportunities throughout the year, however. There are likely many strategies and time-sensitive tax provisions that could help with managing taxes more efficiently. Once year-end approaches, certain options may be lost.

A better course of action is to keep taxes in mind and look for potential opportunities throughout the calendar year. For example, taxpayers may be well served by reviewing their 2021 return now to look for opportunities for 2022.

The 1040 form can provide a blueprint for tax-planning strategies

1. Maximize the child tax credit (CTC) form 1040 child tax credit lines
  • Although the expanded or enhanced version of the child tax credit expired at the end of 2021, a maximum tax credit of $2,000 is still available for each qualifying child. The credit is subject to income phaseouts beginning at a modified adjusted gross income (MAGI) of $200,000 for single filers, and $400,000 for married couples filing jointly. There is also a $500 tax credit available for other dependents (same MAGI phaseouts apply) including dependents over the age of 18.
  • Taxpayers may want to manage their income throughout the year (deferring income through retirement plan contributions, for example) to make maximum use of the CTC
2. Taxes on investment income (lines 2 and 3) qualified dividends line
  • Depending on the marginal tax bracket and other investment-related factors, does it make sense to consider tax-free municipal bonds that may provide a higher tax-equivalent yield?
  • Taxpayers may also want to explore opportunities to benefit from lower tax rates on investment income generated through qualified dividends
3. Taxes on retirement income (lines 4, 5, and 6)

retirement income

  • For those age 70½, IRA distributions to qualified charities through qualified charitable distributions (QCDs) are tax free. This could be a good option to satisfy philanthropic goals while avoiding taxes on IRA withdrawals. For details, read, "Donating IRA assets to charity"
  • Is there an opportunity to convert pretax retirement assets to a Roth IRA? A Roth can provide tax-free income in retirement, is not subject to RMDs, and the income generated will not negatively impact the taxation of Social Security benefits
4. Managing capital gains (line 7) capital gains
  • Throughout the calendar year, taxpayers may want to consider harvesting capital losses that may be used to offset capital gains. For more information read, "Using investment losses to your advantage"
  • An additional 3.8% surtax applies on investment income – including capital gains – at MAGI of $200,000 for an individual and $250,000 for a married couple filing a joint return
  • Don’t forget that some taxpayers will not pay taxes on long-term capital gains (single filers with taxable income less than $41,675, married couples filing a joint return with less than $83,350)
5. Tax-smart options for deductions (line 12) deductions
  • With the scale-back for many popular deductions after 2017 and a near-doubling of the standard deduction, the majority of taxpayers currently claim the standard deduction when filing their tax return
  • Does it make sense to lump deductions, if possible, into one tax year in order to itemize deductions for that year?
  • For example, instead of making consistent charitable gifts each year, consider making a large gift in one year, or funding a donor-advised fund, if it allows taxpayers to itemize deductions on their tax returns. Claim the standard deduction in other years
6. Deduction for business owners (line 13) deduction for business owners
  • Since 2018, certain business owners of pass-through entities have benefited from a 20% deduction on qualified business income (QBI)
  • There are limits to the deduction based on income and the nature of the business. Owners may want to consult with their tax professional on options to manage income throughout the year. This strategy may help maximize the deduction.
7. Determine your marginal tax bracket (line 15) tax bracket
  • A review of their 2021 return may give taxpayers a sense of their projected marginal income tax bracket for 2022
  • Knowing their marginal income tax bracket can provide a basis for determining whether it may make sense to defer income throughout the year (increasing retirement plan contributions for example) or maybe generating income through a Roth IRA conversion in exchange for the benefit of tax-free income in retirement
8. Should tax withholding be adjusted? (line 25)

withholding

  • Withholding too much during the tax year is akin to providing the federal government with an interest-free loan. Taxpayers should review their 2021 returns to see if changes should be made for 2022
  • Also, there may be IRS penalties for under-withholding as well. Generally, this applies if taxpayers pay less than 90% of their tax liability during the tax year

Tax planning

With many potential changes being debated by lawmakers, it’s important to discuss tax planning with a financial professional with knowledge of the latest updates on tax code changes and the impact on your financial situation.

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