Mid-Year Tax Planning Ideas for Individuals

The 2022 tax year is well underway, and year end will be here before you know it. Summer is a good time to take proactive steps to help reduce the current year's tax bill. Here are some federal tax planning strategies to consider.

Managing Gains and Losses in Taxable Investment Accounts  

It's been a wild year in the stock market. You may have collected some capital gains and suffered some capital losses.

You also might have some gains and losses that you have yet to realize from investments you still hold in taxable brokerage firm accounts. If you have such unrealized gains and losses, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The federal income tax rate on long-term capital gains recognized in 2022 is only 15% for most people, but it can reach a maximum of 20% at high income levels. The 3.8% net investment income tax (NIIT) can also potentially apply to gains that will be taxed at the 15% and 20% rates.   

To the extent you have capital losses that were recognized earlier this year or capital loss carryovers from pre-2022 years, selling winners this year won't result in any tax hit. In particular, sheltering net short-term capital gains with capital losses is a major tax-saving opportunity because net short-term gains would otherwise be taxed at higher ordinary income rates, which can reach 37% plus another 3.8% for the NIIT.   

What if you have some losing investments that you'd like to unload? Taking the resulting capital losses this year would shelter capital gains, including high-taxed short-term gains, from other sales this year.

If selling a batch of losers would cause your capital losses to exceed your capital gains, the result would be a net capital loss for the year. That net capital loss can be used to shelter up to $3,000 of 2022 ordinary income from salaries, bonuses, self-employment income, interest income, royalties and other sources ($1,500 if you use married filing separate status). Any excess net capital loss from this year is carried forward indefinitely.   

Having a capital loss carryover go into next year could turn out to be a good deal: The carryover can be used to shelter both short-term gains and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years because you won't have to hold appreciated securities for over a year to get a preferential tax rate. In addition, having a capital loss carryover into next year to shelter short-term gains recognized next year and beyond can be advantageous because the top two federal rates on net short-term capital gains recognized in 2023 through 2025 are 35% and 37% (plus the 3.8% NIIT, if applicable). 

Sharing Investments with Loved Ones and Charities

If you're feeling generous, you may want to make gifts to some relatives and/or charities. These gifts can be made in conjunction with an overall revamping of your taxable account stock and equity mutual fund portfolios. Keep these tax-smart gifting principles in mind.

Gifts to loved ones. Don't give away shares that are currently worth less than what you paid for them. Instead, you should sell the shares and book the resulting tax-saving capital loss. Then, you can give the cash sales proceeds to your relative or loved one.

On the other hand, it's a good idea to give your loved ones shares that are currently worth more than what you paid for them. Most likely, they'll pay lower tax rates than you would pay if you sold the same shares. Relatives in the 0% federal income tax bracket for long-term capital gains and qualified dividends will pay a 0% federal tax rate on gains from shares that were held for over a year before being sold.

For purposes of meeting the more-than-one-year rule for gifted shares, you can count your ownership period plus the gift recipient's ownership period. Even if the shares have been held for a year or less before being sold, your relative will probably pay a much lower tax rate on the gain than you would.     

Gifts to charities. The principles for tax-smart gifts to relatives also apply to donations to IRS-approved charities. That is, you should sell shares that are currently worth less than what you paid for them and collect the resulting tax-saving capital losses. Then you can give the cash from the sale to charity and claim the resulting tax-saving charitable deductions (assuming you itemize). Following this strategy delivers a double tax benefit: You recognize tax-saving capital losses plus tax-saving charitable donation deductions.

On the other hand, you should donate shares that are currently worth more than what you paid for them instead of giving away cash. Why? Because if you itemize, donations of publicly traded shares that you have owned over a year result in charitable deductions equal to the full current market value of the shares at the time of the gift. Plus, when you donate these shares, you escape any capital gains taxes on them. So, this strategy also delivers a double tax benefit: You avoid capital gains taxes and receive a tax-saving charitable contribution deduction, assuming you itemize. Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing anything to the IRS.

Converting a Traditional IRA into a Roth

The best profile for a Roth conversion is if you expect to be in the same or higher tax bracket during your retirement years. The current tax hit from a conversion done this year may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account's earnings. If your traditional IRA balance has taken a beating in the stock market, the tax hit from converting now will be lower than when the market was at its peak. 

Important: Years ago, the Roth conversion privilege was a restricted deal. It was only available if your modified adjusted gross income was $100,000 or less. That restriction is gone. Your SSB tax advisor can help you evaluate the wisdom of the Roth conversion idea. 

Taking Proactive Measures to Reduce AMT

The Tax Cuts and Jobs Act (TJCA) significantly reduced the odds that you'll owe the alternative minimum tax (AMT) through 2025. The law significantly increased the AMT exemption amounts and the income levels at which those exemptions are phased out.

The following table summarizes the AMT exemptions and phaseout ranges for 2022:

So, who will be subject to the AMT? Various interacting factors come into play when evaluating whether the tax will apply. In addition to high income levels, other risk factors that could trigger an AMT liability under current law include exercising "in-the-money" incentive stock options and receiving interest from "private activity bonds." In addition, the AMT may be an issue for sole proprietors and owners of other pass-through businesses that write off significant depreciation from older assets that are subject to pre-TCJA depreciation schedules.

Even if you still do owe the AMT, you'll probably owe considerably less than before the TCJA changes went into effect. Nevertheless, it's still critical to evaluate year-end tax planning strategies in light of the AMT rules. Because the rules are complicated, you may want some assistance.

Eye on Estate Planning

Thanks to the Tax Cuts and Jobs Act (TCJA), the unified federal estate and gift tax exemption for 2022 is currently $12.06 million or effectively $24.12 million for a married couple. Even though these whopping exemptions may mean that you're not currently exposed to the federal estate tax, your estate plan may need updating to reflect the current tax rules.

Also, we don't know how long the current historically generous federal estate and gift tax exemption will last. As the tax law currently reads, lower pre-TCJA exemption amounts are scheduled to return in 2026 (unless Congress acts to extend them). If that happens, the unified exemption could fall back to around $8 million, depending on inflation. (The $8 million figure is just a guess at this point.)

The current federal estate tax rate is 40%, but it was higher years ago. That's why making big gifts now, under today's favorable tax rules, could be a tax-smart idea.

Proposed Clawback Rules

High net worth individuals should consider making big gifts now—while the estate tax rules are taxpayer friendly. Proposed regulations issued in late 2018 stipulate that people who make large gifts in 2018 through 2025 and benefit from the ultra-generous unified federal estate and gift tax exemptions for those years wouldn't be penalized if the exemptions revert back to the lower pre-TCJA amounts after 2025.

If that scenario materializes, a decedent's federal estate tax exemption would be the greater of:

• The TCJA exemption amount that was used to shelter earlier gifts, or
• The exemption amount that's allowed in the post-TCJA year of death.

For example, in 2022, when the unified federal estate and gift tax exemption is $12.06 million, Alpha makes $10 million of taxable gifts. (These gifts are in excess of the $16,000 per-recipient annual gift tax exclusion for 2022.) Alpha passes away in 2026, and the unified exemption has reverted back to only $8 million. He leaves behind an estate with a fair market value of $5 million. What's the 2026 federal estate tax liability for Alpha's estate?

According to the proposed regulations, the $10 million of taxable gifts made in 2022 are added back to Alpha's $5 million date-of-death estate resulting in a gross estate of $15 million. The estate tax liability of Alpha's estate would then be calculated using a $10 million unified exemption. His estate would owe federal estate tax on $5 million ($15 million gross estate minus $10 million exemption). So, the $10 million of taxable gifts made while the larger TCJA unified exemption was in place wouldn't increase the 2026 federal estate tax liability.

How would the tax situation differ if Alpha instead gives away $12.06 million in 2022 (the full amount of the unified federal estate and gift tax exemption under current law)? In this situation, his remaining estate in 2026 would be only $2.94 million ($15 million minus $12.06 million). To calculate the 2026 federal estate tax liability for the estate, the $12.06 million of taxable gifts made in 2022 are added back to Alpha's $2.94 million date-of-death estate resulting in a gross estate of $15 million.

According to the proposed regulations, the estate tax liability would then be calculated using a $12.06 million unified exemption. Alpha's estate would owe federal estate tax on $2.94 million ($15 million gross estate minus $12.06 million exemption). So, the $12.06 million of taxable gifts made while the larger TCJA unified exemption was in place wouldn't increase the 2026 federal estate tax liability.

Beyond Taxes

You may need to make some adjustments to your estate plan for reasons that have nothing to do with taxes, such as changes in your health, personal goals and family situation. Contact us if you need an estate planning tune-up.

We Can Help

This article covers just a handful of tax planning ideas to consider in today's environment. Contact your SSB tax advisor to discuss mid-year planning strategies to make sure you're not missing opportunities to lower taxes for 2022.