5 year-end tax moves financial advisors should make now

5 year-end tax moves to make for clients now

December 1, 2022 10:33 PM

With the number of days left to minimize tax bills for this year rapidly dwindling, six core moves now can lessen the pain from Uncle Sam. As inflation slices into paychecks and the end-2025 deadline for tax rates to increase draws closer, "you'll want to snag every tax break you can now," says Fidelity Investments. Here's what advisors can nudge clients to do now, and why it benefits both sides:

Why pushing clients to max retirement contributions benefits advisors

Investors can wait until April 18, 2023, the next federal return filing date, to make contributions to an individual retirement account for 2022. Whether to a traditional IRA or a Roth, the annual limit this year is $6,000, plus an extra $1,000 for people age 50 or older. The figures cover total contributions to all IRAs combined. Traditional IRAs are funded with pre-tax dollars, so their withdrawals are taxed at ordinary rates. By contrast, Roth are stuffed with dollars on which taxes have already been paid, making withdrawals tax-free. Contributions to traditional IRAs are deductible if you or your spouse don't have an employer-sponsored 401(k) plan.

Investors with a 401(k) or 403(b) — the latter for employees of public schools and nonprofits — face a tighter deadline and must kick in extra dollars for the year by Dec. 31, 2022. Savers can contribute up to $25,500, plus an additional $6,500 if they're 50 or older. Contributions reduce taxable income.

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Wait to get paid

People with freelance work or side hustles or who work for a company with a deferred compensation plan might consider delaying billing for their services until early next year. The move limits your taxable income, and thus your tax bill, this year. With the income levels at which specific tax rates kick in set to rise for 2023, the move also potentially gives you room to earn more income taxed at a lower rate.

Deferring taxable compensation, such as a bonus, can also reduce your exposure to income and capital gains taxes and the 3.8% Medicare surtax on investment income, according to Rosenberg Rich Baker Berman & Co., an accounting and advisory firm. That's because when modified adjusted gross income — taxable income before deductions for things like student loan interest and the 15.3% self employment tax — exceeds $200,000 ($250,000 for married couples filing jointly), a 3.8% tax kicks in.

Regardless of how much they make, those who expect to land in a higher tax bracket next year shouldn't use this approach, Gosling & Co., an accounting firm, says. With current tax rates set to expire come 2026, deferring income too far into the future could result in a bigger tax bill.

Read more: Millions of Americans just got a tax 'cut.' Will it save them money?

Open the wallet

Bunching up charitable contributions in one calendar year, rather than spreading them out over several years, can allow an investor to itemize his deductions and use them to reduce his taxable income. Currently, a taxpayer can itemize only when his deductions exceed the standard deduction, now $12,950( $25,900 for joint filers.)

An investor who donates appreciated shares after holding them for at least one year doesn't owe federal capital gains tax, now as high as 23.8%, or state levies on the profits. The donor can write off the full fair market value of the securities at the time of donation. The corresponding deduction reduces taxable income, which lower the amount of money owed to the IRS that year.

"If you have significantly increased income, such as in the year of a business sale, it may make sense to make outsized charitable donations," JPMorgan Chase says. Gifts must be made on or before Dec. 31 to receive an income tax deduction for this year.

Investors can gift up to $16,000 per recipient to as many people as they like. And each person in a married couple can gift this amount. There's no tax deduction, but the recipients won't owe taxes, and the largesse reduces the value of your estate without cutting into your lifetime gift and estate tax exemption of just over $12 million (double that for married couples). Ed Slott, an accountant and retirement expert in Rockville Centre, New York, says that a "regular"' beneficiary, like a son or daughter, to a Roth plan in 2020 or later doesn't have to take RMDs for years one through nine.

Read more: 'Personal finance secret': Donating stock is more lucrative than giving cash

Get your RMD ducks in order

People over age 72 must take minimum distributions from their tax-deferred retirement accounts by the end of the year. Miss the deadline, and you could be hit with a 50% penalty on the chunk of the RMD you failed to withdraw. Those who turned 72 in 2022 have until April 1, 2023, to take their first RMD, according to Schwab.

The situation for heirs of retirement plans is different.

Before 2020, people who inherited individual retirement accounts and 401(k)s used to be able to "stretch" out distributions over their lifetimes, a timeline that allowed more money to accumulate. But since that year, recent heirs who aren't a spouse, minor child, disabled or sick person or more than 10 years younger than the original owner, such as a sibling, must drain an inherited plan within 10 years of the original owner's death.

Spouses who inherit a traditional IRA after 2019 aren't hit by the 10-year rule as long as they make a spousal rollover that stuffs the inherited plan into an existing IRA.

But non-spousal heirs must take annual distributions regardless of their age and drain the account by year 10, according to a proposed rule from the Internal Revenue Service last February. When the original owner hadn't yet begun taking RMDs, the heir can wait until the end of the 10-year term to empty the account.

Wealth advisors have offered conflicting advice on whether RMDs are required for inherited Roth IRAs.

Read more: Inherited a Roth retirement plan? Advice on withdrawals is all over the map

Read more: Inheriting a retirement plan has gotten complicated. How advisors can keep up

Plight your troth to a Roth

There's still time this year to convert a traditional individual retirement account or employer-sponsored 401(k) plan to a tax-free Roth. You have to bite a bullet up front by paying the taxes owed on the converted amount, but the pot then appreciates with no tax due on withdrawals once you've held the account for at least five years and are at least 59 ½ years old. Unlike with direct contributions to Roth plans, there's no limit on the amount that can be converted. So far, more than the 2022 limit of $6,000 (plus an extra $1,000 for those age 50 and over) that governs total contributions to both traditional and Roths can make its way to tax-free withdrawals.

The big benefit of converting now comes from an unexpected place: the lousy stock market. As Morgan Stanley's global investment committee wrote in a December 2022 note, "The grueling, double-barreled bear market for stocks and bonds— catalyzed by the highest inflation in more than 40 years and a Federal Reserve response featuring one of the most rapid hiking cycles in history—has produced among the most challenging years for investment returns in the last half century."

So where's the fun in that?
"With many investments down this year, you can convert more shares for the same total amount and same potential tax bill," Fidelity Investments says. "Also, tax rates are set to increase in 2026, so you could end up paying higher rates later on conversions."

Read more: Roth conversion? Why to gamble on one this tax filing season

Read more: This Roth IRA conversion trick can save investors big money