Year-end planning ideas to lighten the tax burden

Bill Cass, CFP®, CPWA®

Bill Cass, CFP®, CPWA®, 11/02/22

As year-end approaches, there may be steps taxpayers can take to better manage their current tax bill, or to hedge the risk of higher taxes in the future. Now is an opportune time to assess finances and determine if any adjustments are needed — especially this year, as rising inflation means key tax figures will change in 2023.

Tax figures such as deductions and brackets are set to jump, and savers will be able to add more to their retirement accounts next year. Still, there are other areas of the tax code where inflation adjustments mean higher tax rates or increased borrowing costs.

Here are six year-end planning considerations for tax-smart financial plans.

1. Determine marginal tax bracket to drive timing of income (or deductions) at year-end

Estimating projected income before the year-end can help taxpayers answer two questions. First, what is my marginal tax bracket? And second, how much income can be realized without “creeping” into the next bracket? Depending on the situation, taxpayers may want to realize more income in 2022 or defer income into 2023 if possible.

  • For example, distributing more funds from retirement accounts if subject to lower tax brackets
  • Alternatively, if a higher tax rate applies, maybe a contribution to a retirement account or health savings account (HSA) makes sense. See our post, "Estimating your tax bracket can guide tax planning."

2. Consider Roth strategies to hedge the risk of higher taxes in the future

Given rising federal budget deficits and the expiration of these tax rates in 2025 (or sooner if Congress takes action), taxpayers may want to consider Roth strategies now as a hedge against the risk of higher tax rates in the future. This is especially relevant for those who hold all or most of their retirement savings within traditional, pretax accounts like 401(k)s. For example, determine how much income can be realized within the current tax bracket before “creeping” to the next tax bracket. Use this as a basis for how to convert from a traditional IRA to a Roth IRA.

3. Identify opportunities to harvest tax losses

In the process of reviewing portfolios, are there opportunities to strategically generate losses to offset other gains? For example, using a tax-swap strategy for mutual fund holdings allows you to realize a tax loss while retaining essentially equivalent market exposure. However, since the IRS has not provided definitive guidance on how the wash-sale rule applies to portfolios such as mutual funds, it is important to consult with a qualified tax professional when considering this type of transaction. In general, to avoid a disallowed tax loss on a swap between two mutual funds, the investments should not be considered “substantially identical.” For more information on reporting investment losses, consult IRS Publication 550, "Investment Income and Expenses."

4. Review required minimum distributions (RMDs)

Many investors are required to take distributions from retirement accounts annually in December to satisfy minimum distribution requirements. It is a good idea to review the requirements, and if necessary, to make sure there is a plan in place to satisfy them. The Internal Revenue Service has specific rules for taking RMDs. In fact, the penalty for not taking a required distribution is steep: 50% of the required amount. Additionally, those with inherited retirement accounts need to be aware of the new rules. Most non-spouse heirs are required to fully distribute inherited accounts by the end of the 10th year following the account owner’s death. Taxpayers with inherited retirement accounts should consider their current and projected tax brackets when planning distributions over the 10-year time frame.

Business owners may want to consider certain tax-efficient strategies.

5. Tax loss associated with a business? A Roth conversion may make sense.

Business owners reporting a net operating loss (NOL) this year may be able to use it to their advantage. Unlike net capital losses, where taxpayers are limited to applying only $3,000 annually against ordinary income once capital gains are offset, taxpayers can generally apply NOLs against 80% of taxable income for a single tax year. Roth conversions can be a flexible way to add ordinary income before year-end.

  • Business owners carrying forward large NOLs can use those losses to offset the additional income from a Roth IRA conversion.
  • The rules on calculating and utilizing NOLs are complicated, so it is critical for clients to consult with a qualified tax professional.
  • More information on NOLs can be found with IRS publication 536, “Net operating losses for individuals, estates and trusts.”

6. Consider a retirement plan review

With the daily demands of managing their companies, business owners may neglect retirement planning for themselves. A retirement plan can not only provide a foundation for a secure future, but it can also assist in attracting and retaining good employees.

  • Business owners without retirement plans may wish to get started by establishing a SEP-IRA or SIMPLE-IRA
  • Or, it may make sense to upgrade to a 401(k) plan that can be customized to meet the business owners’ needs. See our article, "Retirement plan options for business owners."

Consult with a financial professional

It is important to consult with a financial professional who understands your financial situation before acting on a tax planning strategy. Review our "Year-end planning review checklist."

Financial professionals: Join our November 17 webinar (1 p.m. ET) for a discussion of the post-election landscape and year-end planning. Register here.

register for webinar on year-end planning