It’s the time of year when we are thinking about back to school, the start of cooler weather, leaves turning into fall colors, the upcoming holiday season — and, dare we say, year-end tax planning?

Now may be the best time to coordinate with your tax and legal advisor to review plans and implement strategies to optimize tax efficiencies.

Here we focus on some strategies that may help you reduce this year’s tax liability and enhance your overall wealth plan.

Selected Tax Law Changes

In 2020 and 2021, Congress created several programs and benefits to help individuals and businesses impacted by the COVID-19 emergency. Many of the programs and benefits that they provided have expired. However, Congress passed the Inflation Reduction Act of 2022[1] (Inflation Reduction Act). As we approach the end of the year, we recommend that you consult with your personal tax advisors to discuss how these changes could impact your 2022 federal income tax liability. Following are some things to consider (whether derived from the various COVID-19 relief measures or the Inflation Reduction Act) when thinking about your 2022 federal income tax:

  • Most of the increased tax credits provided by the American Rescue Plan Act of 2021[2] (ARPA) have expired, with the notable exception of the increased credits for health care benefits, which were extended through 2025 by the Inflation Reduction Act.
  • The Inflation Reduction Act modified the credit for non-business energy property, which is now known as the energy efficient home improvement credit.[3] Subject to many requirements, this credit applies to the installation of energy efficient windows, doors, certain heating and cooling systems and certain heat pumps. In general, the modified credit applies to items placed in service in 2023. For items placed in service in 2022, the old version of the credit continues to apply. Because the availability and the amount of the credit changes for property placed in service in 2023, if you are considering installing items covered by the credit in your home, you should check with your tax advisor to determine whether you will receive a larger tax benefit by installing such items in 2022 or waiting until 2023.
  • The Inflation Reduction Act modified the energy efficient property credit, which is now known as the residential clean energy credit.[4] Subject to many qualifications, the credit is available in 2022 for the installation of qualified solar electric property, qualified solar water heating property, qualified fuel cell property, qualified small wind energy property and geothermal heat pump property. Additionally, a qualified biomass fuel property expenditure for property placed in service in 2022 will qualify for the credit (but not if placed in service after December 31, 2022).[5]
  • The Inflation Reduction Act replaces the “new qualified plug-in electric drive motor vehicles” credit with the clean vehicle credit.[6] Subject to many limitations (including income limitations), the new credit applies to certain electric and fuel cell vehicles. For two- and three-wheeled vehicles placed in service after December 31, 2023, the credit will cease to be available. If you are considering the purchase of a new vehicle that would qualify for the credit, check with your tax advisor to determine if you would receive a larger tax benefit by purchasing the vehicle in 2022 or by waiting until 2023.
  • The Inflation Reduction Act added a new credit that applies to the purchase of used clean vehicles.[7] The credit applies to purchases made after December 31, 2022. If you are considering buying such a vehicle, you may wish to wait until 2023.

Student Loan Relief

On August 24, 2022, the Biden-Harris administration announced a student debt relief plan. The U.S. Department of Education will provide up to $20,000 in debt relief for Pell Grant recipients and up to $10,000 in debt relief for others. Income limitations apply. You must apply for this relief. Applications will be accepted until December 31, 2023.[8]

Also, the forbearance for student loan payments has been extended until December 31, 2022. This is the final extension and payments will be required again in January 2023.[9] Because student loan payments are set to resume in January of 2023, “[b]orrowers are advised to apply before November 15th [2022]” for student debt forgiveness described above.[10]

ARPA included a provision that excludes student debt canceled through 2025 from federal gross income.[11] Some states do not follow the federal rules when calculating income subject to tax. Check with your tax advisor to determine if your student loan forgiveness would be subject to income tax in your state.

Philanthropy 

People give to charitable organizations for many reasons. As this article pertains to 2022 year-end planning, in this section we focus on tax benefits for gifts to charity (and those no longer available) in 2022.

If You Itemize — Consider Giving Cash

If you itemize deductions and make charitable contributions, you may be able to deduct on your federal income tax return the amount of such contributions, limited by the application of certain percentages of your contribution base. Your contribution base is your adjusted gross income (AGI) computed without regard to any net operating loss carryback to the taxable year. The Taxpayer Certainty and Disaster Relief Act of 2020[12] suspended the percentage limitations for qualified contributions made in 2021 but the suspension has now expired and the usual limitations with respect to charitable deductions apply for 2022. Nevertheless, if you are thinking about giving appreciated securities to a charitable organization, due to the 60% limitation for certain cash contributions[13] it remains worthwhile to analyze whether giving appreciated securities or selling the securities and giving cash will produce a greater tax benefit. A PNC Private Bank Wealth Strategist can work with you and your tax advisors to provide this analysis.

If You Are Close to Being Able to Itemize — Consider Bunching

Making larger contributions less often could allow you to accumulate deductions and itemize. For example, if a married couple filing jointly contributes $15,000 per year to charity, assuming no other itemized deductions, they would not exceed the $25,900 standard deduction for 2022 and would not receive a tax benefit for their contributions. However, if they contribute $30,000 every other year, they would be able to itemize in the year they make the charitable contribution and benefit from an additional $4,100 deduction that year. A donor-advised fund (DAF) can be an effective tool for bunching charitable contributions. You could be eligible to take an income tax deduction in the year the contribution is made, but no minimum required distribution must be made from the DAF in any given year. If this is an option for you, be sure to factor the cost of a DAF into your decision.

If You Don’t Itemize

The Tax Cuts and Jobs Act (TCJA)[14] substantially increased the amount of the standard deduction. After enactment of the TCJA, many taxpayers who had previously itemized deductions found that the standard deduction was larger than their previously itemized amounts and that taking the standard deduction provided a greater tax benefit.[15] For 2021, married taxpayers filing jointly were allowed up to a $600 above-the-line deduction for qualified contributions. This tax benefit was not extended for 2022 and is no longer available.

Individuals age 70½ and older may make qualified charitable distributions (QCDs) from their individual retirement accounts (IRAs) directly to qualified charities up to $100,000 annually. If you make a QCD, you will not receive a charitable deduction for federal income tax purposes. On the other hand, some or all of the amount distributed will be excluded from your gross income.

The excludable amount of qualified charitable distributions for a taxable year is reduced [but not below zero] by the aggregate amount of IRA contributions deducted for the taxable year and any earlier taxable years in which the individual was age 70 ½ or older by the last day of the year (post-age 70 ½ contributions) … other than the amount of post-age 70½ contributions that caused a reduction in the excludable amount of qualified charitable distributions for earlier taxable years.[16]

Your AGI is the starting point for calculating a number of tax-related items. For example, AGI is used in determining how much of your Social Security benefits are taxed, Roth contribution eligibility, applicability of the net investment income tax, your Medicare premium, your state income taxes and whether your itemized deductions are phased out. Accordingly, taking steps to reduce AGI can produce many benefits.

Further, if you have attained age 72, a QCD will count towards some or all of your required minimum distribution. If you no longer itemize deductions, a QCD may be a tax-efficient way to fulfill your charitable giving goals.

Deferred Compensation and Retirement Planning 

Revisit Deferred Compensation Arrangements

Before making 2023 elections regarding non-qualified deferred compensation arrangements, we believe it’s important to determine if deferring income is right for you and to decide on the deferral timing.

Deferred compensation plans allow highly compensated employees to defer a portion of their income to a future year. The idea is to lower income levels during high-earning years. The income is paid out at a future date of your choice that is typically when overall income is less, as is your corresponding tax bracket. Additionally, during the deferral period, the income may be invested in a selection of investments set by the plan provider and may grow on a tax-deferred basis. If you leave your job, the plan typically would return your vested balance at that time.[17]

Under the TCJA, most taxpayers are now in lower tax brackets, but the lower tax rates are scheduled to expire at the end of 2025. This means any income deferred to 2026 and beyond may be subject to higher tax rates.

The decision whether to defer income, the length of the deferral, and if election dates should be changed, if allowed, is complex. It is impossible to know what future tax rates may be, but it is possible to project what your income may be at the time the compensation is taken and how deferred compensation fits in with other available planning strategies. Deferred compensation elections for 2023 must be made by December 31, 2022. However, many employers may require elections to be finalized earlier in the year.

Converting Some or All of a Traditional IRA to a Roth IRA

For many Americans, 2022 continued to be financially difficult. Perhaps you had limited employment, business losses, large medical expense deductions or other reasons for a decline in income. Further, the later months of 2022 have seen the values of publicly traded stocks decline. In a year with reduced income and asset values, perhaps it makes sense to consider converting some or all of your traditional IRA to a Roth IRA.[18]

Converting your traditional IRA to a Roth IRA could save income tax over the long term. Although converting your IRA will cause an income tax today on the amount converted that would not have been subject to income tax had you not converted to a Roth IRA,[19] future growth in the converted assets (now in a Roth IRA) will be tax-free. This could be important if tax rates rise in the future. Qualified distributions from a Roth IRA are tax free to the owner and/or beneficiary and the lifetime required minimum distribution rules do not apply to Roth IRAs.

Converting to a Roth works best when the tax incurred on the conversion can be paid from assets not held in an IRA or qualified retirement plan, as withdrawing assets therefrom to pay the income tax attributable to the Roth conversion will incur additional income tax. Roth conversions require careful analysis to determine whether incurring an income tax today will save income tax in the future. As each person’s financial circumstance is unique, before undertaking a Roth conversion you should seek the advice of your tax and financial advisors.

Repayment of COVID-19-Related Distributions

The Coronavirus Aid, Relief and Economic Security Act[20] (CARES Act) allowed qualified taxpayers impacted by COVID-19 to withdraw up to $100,000 from certain qualified plans and IRAs as a “coronavirus related distribution.” The CARES Act allows coronavirus related distributions to be repaid within three years. The U.S. Treasury Department has provided detailed guidance regarding this repayment.[21] If you repaid some or all of a coronavirus distribution this year, you should take this into consideration when determining your withholding or estimated tax payments for 2022.

Explore Tax Loss Harvesting

Losses in Your Portfolio

Recent market activity may have created assets with unrealized losses in your portfolio. You may be able to use those losses to decrease your 2022 tax bill through tax-loss harvesting.

Tax-loss harvesting generates capital losses by selling assets that are currently worth less than what you paid for them. These losses are then used to offset capital gains recognized during the year. Your plan may be to repurchase the asset at some point, but if you recognize a loss you must wait at least 31 days to repurchase the same asset or the tax loss will be disallowed.[22]

If your capital losses exceed your capital gains, you can use up to $3,000 of the excess loss to offset other income. Any remaining capital losses can be carried forward. For example, if you sell an asset and recognize a $15,000 capital loss and have $10,000 of capital gains, you can claim zero gains for the year. You can then use $3,000 of your remaining $5,000 in capital losses to offset other income in 2022. The remaining $2,000 may be used to reduce taxable income in 2023.

Gains in Your Portfolio

If you have realized capital gains and mutual fund capital gain distributions in excess of your realized capital losses in 2022, you may wish to adjust your income tax withholding or quarterly estimated income tax payment to take capital gains into consideration.

Gift and Trust Planning

In 2018, the TCJA increased the basic exclusion amount for the federal estate and gift tax. For 2022 that amount is $12.06 million and is indexed for inflation in future years. Unless Congress takes further action, the increased exclusion amount will “sunset” on January 1, 2026, causing the exclusion amount to be approximately halved (to 2017 levels, indexed for inflation). The beginning of 2022 marked the halfway point to sunset.

Now may be a good time to talk to your attorney about planning to use the increased exclusion amount. If you intend to use the increased exclusion amount we suggest not waiting until 2025 to meet with your attorney. Waiting until 2025 could see your plans go unfulfilled.

Perennial Items

Review Withholding and Estimated Tax Payments

Be sure that you are withholding enough to satisfy your federal tax liability. Failure to withhold sufficient tax (or pay sufficient quarterly estimated tax) may cause you to owe tax with your return and to be subject to interest and penalties. Similarly, by withholding too much, you are making an interest-free loan to the government.

The IRS has published a simplified withholding estimator that can provide a rough estimate of overall withholding and income. This calculator can be found at: https://apps.irs.gov/app/tax-withholding-estimator (last accessed September 23, 2022). By updating your W-4, your employer can adjust the amount withheld from your salary to cover any shortfall, avoiding potential underpayment penalties.

Fund Employer Sponsored Retirement Plans

Studies show that many Americans do not have resources adequate to provide for their retirement.[23] If you are able to do so, you should fund your retirement plans to the extent of the amount that can be set aside before taxes. If you cannot fully fund your employer-provided plan and if your employer matches your contributions to a defined contribution plan, at least save enough to get the employer’s match. Failing to do that is “leaving money on the table.”

Review Contributions to 529 Plans

529 plans can be an effective way to save for educational expenses. A unique feature of 529 plans allows donors to front-load accounts with up to five years of annual exclusion gifts.[24] This means that in 2022 (if you haven’t previously front-loaded a 529 plan) you can contribute up to $80,000 ($160,000 for a married couple) to a 529 plan, all of which would qualify for annual exclusion gift treatment (being reported ratably over five years). 529 plans grow tax-free, and distributions for qualified higher education expenses are tax-free. The term “qualified higher education expenses” means: (i) tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution, (ii) expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with such enrollment or attendance, and (iii) expenses for the purchase of computer or peripheral equipment (as defined in IRC § 168(i)(2)(B)), computer software (as defined in IRC § 197(e)(3)(B)), or internet access and related services, if such equipment, software or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution” provided that it shall not include expenses for computer software designed for sports, games or hobbies unless the software is predominantly educational in nature. The term also includes up to $10,000 per beneficiary per year for elementary and secondary school (grades K through 12) tuition, certain expenses for registered apprenticeship programs, and the payment of up to $10,000 (in total from all plans) in student loan debt for the beneficiary and the beneficiary’s siblings (including step-siblings). The state in which you live may offer a state income tax deduction for contributions to a 529 plan. Confer with a tax advisor who understands the laws of your state to determine how contributing to a 529 plan will affect you.

Plan Now

As the daylight wanes in the Northern Hemisphere, we turn our attention to the fall and winter holidays that make the dark days brighter. It seems somehow appropriate that at the “darkest” time of the year, our annual tax liabilities become fixed.

Each family’s tax and financial circumstances are different. Although the ideas presented herein are of a general nature, we hope you can use them to prepare for year’s end.

We encourage you to consult with your tax, legal and financial advisors with respect to your particular circumstances.

For more information, please contact your PNC Private Bank advisor.