Although it’s important to take steps to reduce your taxable income before the end of the year due to looming deadlines, you don’t have to wait until the last minute. Employing tax-smart strategies throughout the course of the year can help save you money. And the money you save on taxes can help drive other financial goals, like saving for retirement or donating to charity.
You have the opportunity to take proactive steps now that could save you money on next year’s tax bill. Here are several tax-saving strategies you can implement before year’s end – and throughout the year. As always, consult your tax advisor before attempting to execute these strategies. And remember, the earlier you start on these strategies the better.
How can I lower my taxable income?
Retirement contributions for individuals
Contribute the maximum to workplace retirement plans and IRAs. For 2022, employees who save for retirement through 401k, 403b, most 457 plans and the federal government’s Thrift Savings Plan can contribute up to $20,500 to those plans during the year – up $1,000 from 2021. The “catch-up” contribution for those age 50 or older holds steady this year – at $6,500 (for a total contribution limit of $27,000 for those who are 50 and older).
Those saving for retirement through an IRA can contribute $6,000 again this year – the same as in 2020 and 2021. The IRA catch-up contribution for those who are 50 and older stays at $1,000 (for a total of $7,000 for that age group). The contribution limit for a Savings Incentive Match Plan for Employees, or SIMPLE IRA, a retirement plan for small businesses with 100 or fewer employees, is $14,000 for 2022, a $500 increase from 2021.
No matter which of these plans you have, you should try to contribute the maximum – or at least as much as you can – because the money may be tax deductible (except for nondeductible Roth 401k and Roth IRA contributions), thereby reducing your taxable income.
If your 401k plan at work allows you to contribute after-tax dollars and it will not affect your current lifestyle, consider adding more after-tax dollars to your 401k plan and converting those dollars to a Roth (when permitted).
Retirement contributions for small-business owners as a tax saving strategy
If you’re a business owner with no employees, you could set up and contribute to a solo 401k, or what the IRS calls a one-participant 401k, as a tax-saving strategy. You must set up the account by Dec. 31. When you do, because you are both employer and employee, you can contribute up to $61,000 in 2022, with an additional $6,500 catch-up contribution if you’re 50 or older. You can have a traditional or Roth 401k. If you choose the traditional, your contributions may be tax-deferred, reducing your taxable income for the year.
If you own a business, there are several tax-saving strategies you can employ by establishing a retirement plan for your business. Most commonly, this will be a solo 401k or a Simplified Employee Pension IRA. A solo 401k is only available for a business with no employees other than the spouse of the owner. Your tax advisor can help you decide which is the better plan for your needs and how much you can contribute to it. You’ll need to act before the end of the year to establish the plan, but it can be funded up until your tax-filing deadline. However, a SEP IRA can be created and funded up until the tax-filing deadline, and if you elect to take a tax extension, you have up until Oct. 15, 2023, to fund it.
How do charitable donations affect taxes?
Donate to charity
It’s important to note that two charitable tax breaks first available in 2020 and – extended for 2021 – no longer apply in 2022.
Taxpayers who itemize their deductions used to be able to deduct cash donations to qualified charities totaling up to 100% of their Adjusted Gross Income, but now that is back to 60% of AGI.
Those who don’t itemize were able to take a deduction of up to $300 for cash donations to qualifying nonprofit organizations, or $600 for married couples filing jointly, in 2021, but those tax breaks have expired.
Any donations you make must be dated no later than Dec. 31, including stock donations to charities. Tangible gifts must also be received by the charity by Dec. 31. Just make sure you don’t try to overstate a donation; the penalty for doing so is 50% of the underpayment. Also, be aware that the IRS requires you to keep a record of any charitable gifts of $250 or more that you write off.
Take advantage of a qualified charitable distribution
A QCD is a direct transfer of funds from your IRA, payable directly to a qualified charity. You must be at least 70 ½ years old at the time you request a QCD, which can draw down a high-balance IRA to lessen future required minimum distributions that people are now required to take starting at age 72. Amounts distributed as a QCD can be counted toward satisfying your RMD for the year, if you haven’t already taken it, up to $100,000 if you meet these rules:
The funds must come out of your IRA by your RMD deadline, usually Dec. 31.
Funds must be transferred directly from your IRA custodian to the charity. If you receive a distribution and then give it to charity, it won’t be counted as a QCD but as taxable income instead. Both traditional and inherited IRAs are eligible for QCDs.
Consider donor-advised funds
A DAF is an account in which you can deposit assets for a donation to charity over time. The advantage over direct giving? Say you have appreciated stock but aren’t yet sure to whom you want to donate it. When you open a DAF, you can get a tax deduction for 2022 but delay making the actual donation to charity for years. You can also donate more complex assets – such as real estate, restricted stock or even cryptocurrencies – to your fund. You won’t have to pay capital gains tax on assets donated directly to a DAF.
ADDITIONAL TAX SAVING STRATEGIES
There are also some tax-saving strategies related to your health and wellness. For example, schedule medical procedures now. Taxpayers can deduct qualified, unreimbursed medical expenses that exceed 7.5% of their 2022 AGI. That means if your AGI is $100,000, anything beyond the first $7,500 of medical bills – or 7.5% of your AGI – could be deductible.
Perhaps you’re already near that threshold and know that you will soon need a certain costly medical procedure. If you schedule it before the end of this year – you still have time to do so – you can benefit from a tax deduction when you file an itemized tax return next year.
Max out your health savings account. If you have an HSA, you can contribute a maximum of $3,650 individually if you have a high-deductible plan or $7,300 if you have a family high-deductible plan in 2022. You’re allowed another $1,000 in catch-up contributions once you reach age 55.
For further details about these items, consult with your Edelman Financial Engines advisor about engaging in any of the tax-saving strategies described here. You can also find more year-end financial tips in our checklist. Remember, it’s best to start no later than early December because some of them might take a week or two to complete.
Neither Edelman Financial Engines nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to seek advice from qualified tax and/or legal experts regarding the best options for your particular circumstances.