It’s hard to believe another year is almost over! You may wonder if it is still possible to gain some tax benefits this late in the year. The answer is YES; November and December are definitely the time to take action to reduce your tax burden. Depending upon your situation, you may think about performing some of these activities.
Bunching Itemized Deductions
With passage of the Tax Cuts and Jobs act of 2017, most people now take the standard deduction and no longer itemize their deductions. However, if your itemized deductions are close to the standard deduction, “bunching” may reduce your tax bill if employed over adjacent years. Bunching is a method of combining itemized deductions into one year, while taking the standard deduction in the next year when the itemized deductions are low. By leveraging as many itemized deductions as possible in one year while maximizing the benefit of the itemized deduction in the following year, overall taxes can be reduced over the two-year time period. Let’s take a look at an example to see how this works.
Let’s say you are a single filer and your itemized deductions would typically consist of:
Property tax $6,000
Sales tax $2,000
Charitable contributions $4,000
TOTAL $12,000
The total of these itemized deductions falls below the 2021 standard deduction of $12,550, so you would be better off to take the standard deduction. If your adjusted gross income (AGI) were $100,000, your taxable income would be $87,450 and your federal tax bill would be $15,009 (excluding any credits).
Let’s assume you have the same itemized deductions in 2022 (I know inflations is pretty high right now, but let’s ignore it for purposes of this discussion), which means you would again utilize the standard deduction, which will be $12,950 for 2022. Let’s say your salary did appreciate and your 2022 AGI is $105,000, which means your 2022 tax income would be $92,050. This would result in $15,927 tax bill, excluding any credits. The combined tax bill for 2021 and 2022 is $30,936.
Now, what if you decided to “bunch” your deductions in 2022? Let’s say your property tax bill can be paid in January without penalty, so you decide to wait until mid-January 2022 to make the payment. You will also make your 2022 property tax payment in December so that both 2021 and 2022 property tax bills are paid in the same year. If you normally make your charitable contributions in December, how about putting those off until 2022 also? With this plan in place your 2021 itemized deductions would be:
Sales tax $2,000
TOTAL $2,000
(2021 Standard Deduction = $12,550)
Your 2022 itemized deductions will be:
Property tax $12,000
Sales tax $2,000
Charitable contributions $8,000
TOTAL $22,000
(2022 Standard Deduction = $12,950)
Wait a minute, some of you might be saying; the above is not correct. Good Catch! The 2017 Tax Cut and Jobs Act had provisions that limited the state and local tax (SALT) deduction to $10,000/year. Therefore, the SALT limitation will reduce the effectiveness of bunching and the above example demonstrates how charitable contributions and similarly-treated deductions can be more effectively applied to the bunching strategy. OK, so if we incorporate the SALT cap into the above, the allowable itemized deductions for 2022 will be:
SALT taxes $12,000
Charitable contributions $8,000
TOTAL $18,000
(2022 Standard Deduction = $12,950)
Using the bunching strategy, 2021 taxable income would be 87,450 and your federal tax bill would be $15,009 (excluding any credits). 2022 taxable income would be $105,000 – $18,000 = $87,000, resulting in a tax bill of $14,757. The combined 2021/2022 tax bill is now $29,766, which is now $1,170 less than the “nonbunching” strategy!
Congress is also looking at eliminating or raising the SALT tax cap. If those provisions were to become law, the above bunching strategy would result in greater tax savings as all of the SALT taxes would likely be deductible.
Donating Appreciated Stock (Or Other Assets)
Donations to 501c(3) charities are tax-deductible as itemized deductions. Donations can be made in cash or through giving away assets. When you give an asset, the charity can turn around and sell the asset utilizing the cash to support its cause. When you donate an asset, you get to claim the fair market value of the asset as an itemized deduction. A common method familiar to everyone, is to give away no-longer used household items. An underutilized strategy, if you have held taxable securities, including stocks, bonds, mutual funds and ETFs for more than a year, is to donate these appreciated assets to charity and you can deduct the value of the securities on the day of donation.
If you have significant unrealized capital gains in the assets, you have the opportunity to both donate to charity and to reduce your tax bill by donating the appreciated assets instead of a providing the cash donation. Let’s say you have a stock that you bought for $1,000 and it is now worth $2,000. By donating this stock to charity, you effectively give the charity $2,000 and can claim that deduction on your taxes. If you had sold that ETF and then given the cash directly to the charity, you would owe capital gains taxes on the $1,000 capital gain appreciation. If you are in the 15% capital gains tax bracket, you just saved yourself $150 in taxes by donating the stock directly instead of selling and then donating cash.
If you’d like to start donating to charity using appreciated securities, contact your financial planner or broker to find out the proper procedures.
Donating to Charity From an IRA
If you are over the age of 70½ and charitably inclined, you can contribute up to $100,000 per year to charity from your IRA account. These IRA distributions are called Qualified Charitable Distributions (QCDs) and provide tax savings in that the donated funds will not be treated as taxable distributions subject to ordinary income tax.
If you are between age 70½ and age 72, the amount of the QCD will not be included as income on your tax return. If you were to take the IRA distribution and then give the cash to a charity, the distribution would be taxed at your ordinary income tax rate. Therefore, the QCD allows you to pull the charitable contribution from your pre-tax IRA, where you will not be taxed on the donation and you will be able to reduce your IRA balance (which would result in lower required minimum distributions in future years).
If you are age 72 or older, you can reduce your tax bill by making all or a portion of your Required Minimum Distribution (RMD) a direct donation to charity. Because RMD distributions are subject to ordinary income tax, these charitable donations offer even more tax reduction benefit than do donations of stock through taxable investment accounts (reference the discussion above). Donating all or a portion of your RMD will offset your income on a 1-to-1 basis as the distribution will count as a part (or all) of your RMD distribution but you will not realize the income from the distribution.
Actions to Take with Regard to Trusts
If you are beneficiary of a non-grantor trust, end-of-year tax planning is an important aspect to minimize taxes for both yourself and the trust. Non-grantor trusts are treated as their own taxpayer and trust tax brackets are much lower than individual tax brackets, meaning that higher taxes kick in at lower levels of income. Therefore, it is generally advisable to keep the taxable trust income in the lower trust tax brackets. Dividends and capital gains distributions paid to the trust throughout the year (and particularly at the end of the year) should mostly be distributed from the trust to beneficiaries prior to the end of the year. In this manner, trust income is kept within lower brackets and other income that would otherwise be taxable to the trust is passed on to the beneficiary to be included in their individual taxes.
Distributions from the trust must be made in accordance with the rules established for each individual trust, so it is important to makes sure tax strategies discussed above comply with the trust rules. Trust rules are established by the grantor during trust formation, so trustees and beneficiaries must be thoroughly familiar with the trust rules in order to execute proper tax planning for the trust.
Closing
With any tax-related strategy, it is recommended that you consult with your tax professional before executing ideas presented on the internet. Your financial planner may also be able to provide input regarding strategies that might be most appropriate for your individual situation.