Mitigating taxes was the topic of our recent webinar for advisors, “Ideas to engage clients during tax season.” In addition to sharing tax-efficient planning ideas, we shared our outlook on the future of tax rates.
Strategies discussed include steps to hedge the risk of higher taxes in the future, wealth transfer considerations, and key planning ideas for business owners.
Financial professionals, if you missed our webinar on tax ideas, watch the replay here.
Here are highlights of some questions we received from advisors on the webcast.
Is there still time to do a backdoor Roth contribution for 2022?
Yes. The first step is to make a non-deductible contribution into a traditional IRA followed by a conversion of those funds to a Roth IRA. For 2022, individuals can contribute $6,000 ($7,000 for those age 50 and older). The contribution for the prior year must be made by the tax filing deadline (April 18, 2023). For tax year 2023 contributions, the limit is $6,500 ($7,500 for those age 50 and older). Taxpayers need to be aware of the pro-rata rule associated with calculating taxable income associated with a Roth IRA conversion. The backdoor Roth contribution strategy isn’t viable if the individual holds pretax IRA funds in other accounts that are not being converted. Every dollar that is converted to a Roth IRA will consist of a pro-rata portion of pretax, and after-tax dollars owned by the individual when figuring the taxes due. That is, an individual cannot choose to convert only the after-tax IRA funds solely to a Roth IRA.
Is there a way to avoid the pro-rata rule when converting traditional IRA funds to a Roth?
The backdoor strategy works best if the individual does not own any other pretax IRAs (including SEP or SIMPLE). If participating in a qualified retirement plan like a 401(k), the individual could transfer the pretax IRA funds to the 401(k) if the plan allows, eliminating their holdings in pretax IRA funds. That would provide an opportunity to do a backdoor Roth contribution. However, because of tax rules and reporting, the individual would need to wait until the following calendar year (after transferring the IRA to the 401(k)) before executing the backdoor Roth strategy. There may be other considerations on moving savings from the IRA to a 401(k), such as fewer investment options being available.
If you make contributions to your employer’s 401(k) through salary deferrals for 2022, can you also fund a SEP-IRA with earnings from self-employment for 2022?
Yes, as long as they are separate companies. Contributions to the SEP plan are not reduced by 401(k) plan contributions into the retirement plan. For 2022, the maximum contribution into a SEP-IRA is the lesser of 25% of earnings or $61,000.
Can someone who inherited an IRA take advantage of the qualified charitable distribution (QCD) option?
Yes, as long as the beneficiary (not the deceased owner) is age 70½ or older, the QCD option can be utilized. For more information on QCDs, see “Donating IRA assets to charity."
Can you explain how some business owners may be able to avoid the cap on deducting state and local taxes (SALT)?
Since the Tax Cuts and Jobs Act (TCJA) took effect beginning in 2018, taxpayers were limited to deducting $10,000 in SALT (state and local taxes) on their tax return. In response to the cap, roughly 30 states have passed laws that generally allow business owners/partners to elect to pay state income taxes at the entity level as a means of avoiding the SALT cap. The structure of these new “pass-through entity” (PTE) taxes may vary, so it’s important for the business owner to consult with a qualified tax professional to see if it makes sense for their particular situation. For a more in-depth look at this topic and the laws, see “Some business owners may bypass the SALT deduction cap.”
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.