Be Proactive: A Guide to Proactive Tax Planning for the New Year
- By Russ Hodgson, CFP® and Joe Pond, CFP®
It’s Not a One and Done
It’s not always on our minds. Many people think about it only once a year- usually around April 15th. Taxes affect every part of your financial life: income, savings, investing, business decisions – everything. All of your financial decisions have tax implications.
So thinking about taxes once a year is the wrong approach. You should be proactive about your tax planning and build a long term plan.
Nobody enjoys paying taxes, but too many people repeatedly overpay and miss out on using that money more effectively. This fact is the catalyst driving proactive tax planning. The importance of tax planning within a strategic and strong financial plan cannot be overstated.
Although there is a lot of nuance when it comes to taxes, having a general guide that helps you plan for the year ahead can be enough to set you up for success (or at least get the ball rolling in that direction). Even if you’re a long time tax planner, there are some new rules for 2022 that you should be aware of.
In this guide we will cover:
Tax Preparation vs Tax Planning
Tax preparation looks like this: once per year, we gather all of our financial documents (W-2s, 1099s, etc) and file our taxes, either on our own or with the help of a CPA . If you do enlist the help of a CPA, they will know some basic filing and deduction-gathering strategies but most will not have the time or desire to take a more comprehensive approach.
They’re busy, and there’s a lot of other people who need their taxes done, too. Simply put, tax preparation is all about accuracy and efficiency, and it’s retrospective.
Unlike tax preparation, tax planning is proactive. Instead of looking to minimize the taxes you pay this year, tax planning takes a more comprehensive approach, looking at minimizing the amount of taxes you pay over your lifetime.
This process necessitates a holistic way of tackling your finances and goes hand-in-hand with the more general financial planning process.Not only does tax planning minimize your tax liability, it simultaneously maximizes every other dollar you keep, invest, or donate.
Based on your entire financial picture and the goals you have, proactive tax planning ensures you’re being as effective as possible and gives you more confidence come tax season
The “Let’s wait and see” approach doesn’t work. Proactive planning enables you to take the guesswork out of your taxes and leaves you with more of what’s yours – a lot more.
Taxable Events and Your Finances
Not convinced you need to get started with tax planning? Here’s a short list of some taxable events that may hit your tax bill:
- Income (and business income)
- Capital gains (and losses)
- Charitable giving
- Tax-loss harvesting
- RMD strategies
- Asset allocation
- Asset location
- IRA conversions
- Social Security planning
- Fixed income strategies
- Healthcare/Medicare premiums
- Other retirement accounts (HSAs, TSPs, 529s)
- Trusts
The list goes on…
The point is, there are countless strategies available to you to become more tax efficient. The process for finding the proactive approach that should be utilized looks different for every person, depending on individual situations and goals. If you want to do it right, your tax planning should be led by a tax professional.
Impending Tax Changes - What’s New in 2022?
At least in part due to inflation and generally higher prices, the IRS has announced new standard deductions and tax brackets for 2022, as well as some other sweeping changes.
Marginal Rates
For 2022, 37% remains the top tax rate for individual taxpayers with incomes greater than $539,900 ($647,850 for married couples filing jointly).
The other rates are:
- 35% for incomes over $215,950 ($431,900 for married couples filing jointly)
- 32% for incomes over $170,050 ($340,100 for married couples filing jointly)
- 24% for incomes over $89,075 ($178,150 for married couples filing jointly)
- 22% for incomes over $41,775 ($83,550 for married couples filing jointly)
- 12% for incomes over $10,275 ($20,550 for married couples filing jointly)
- The lowest rate is 10% for incomes of single individuals with incomes of $10,275 or less ($20,550 for married couples filing jointly).
Most tax brackets increased by about 3%, the largest increases in four years.
Standard Deduction
Here are the increases in standard deductions by filing status:
- For individuals, the standard deduction will be $12,950 (up $400)
- For married couples filing jointly, the standard deduction will be $25,900 (up $800)
- For heads of households, the standard deduction will be $19,400 (up $600)
Contribution Limits
The new maximum employee contribution to a 401(k) plan will be $20,500 (up from $19,500), with the maximum contribution from employee and employer combined rising to $61,000 (up from $58,000). For those age 50 and older, an additional $6,500 catch-up contribution is allowed, bringing the total to $67,500 for 2022.
Unfortunately, IRA contribution limits remain unchanged ($6,000 per year, plus the $1,000 catch-up contribution for those age 50 and older). It is important to remember that this limit combines both IRA and Roth IRA contributions.
**For more information on the tax changes for the 2022 tax year, check out Revenue Procedure 2021-45 or consult with your tax professional.
Tax Planning for the Wealthy in 2022
As Democrats attempt to push through a $3.5 trillion spending plan, they’re targeting the wealthiest of Americans to foot the bill. If you fall into this camp, you may see your taxes increase as early as next year.
The spending plan and potential changes to the tax code remain in flux. Regardless, affluent Americans need to prepare themselves for the changes Washington is proposing.
The two most notable changes would be a higher capital gains tax rate and a lower estate tax exclusion.
Capital Gains Tax
As a reminder, long-term capital gains are incurred when an investor sells an appreciated asset after holding it for one year or longer.
House Democrats have proposed that the top federal tax rate on long-term capital gains (and qualified dividends) be raised from 20% to 25%. Including the existing 3.8% surcharge on net investment income, the top federal rate would be 28.8%.
If the current legislation passes, the higher tax rate would apply to all long-term capital gains realized after September 13, 2021. Single taxpayers with income exceeding $400,000 ($425,000 for head of household and $450,000 for married couples filing jointly) would be affected. Currently, the income threshold to incur the highest rate is $1 million.
Estate Tax
The new legislation proposes a few adjustments to handling estate taxes.
The current exemption of $11.7 million would be lowered to $5 million for individual taxpayers, and some current estate planning techniques would be limited (grantor trusts, for example).
Additionally, the proposed tax plan would impose the capital gains tax on appreciated assets upon the owner’s death – with certain exemptions – while current treatment allows for owners to leave appreciated assets to beneficiaries without triggering the capital gains tax.
Marginal Income Tax
In 2022, the plan adds a 3% surtax on modified adjusted gross income exceeding $5 million. The proposal also increases the top marginal income tax rate from 37% to 39.6%.
Qualified Retirement Accounts
For individuals earning more than $400,000 and married couples earning more than $450,000, the proposal could also change how they use IRAs and 401(k) plans.
High earners with qualified retirement accounts exceeding $10 million would no longer be allowed to contribute to those accounts. Additionally, once their account balance reaches $10 million, these individuals would be required to take significantly higher distributions.
Preparing for Changes
These proposed changes would target the wealthiest of Americans, disproportionately affecting those earning a high amount from their investments. They would also take away large portions of would-be inheritances.
At this point, we don’t yet know what the final legislation will look like (if there’s any at all). But, it may be an appropriate time to review your estate plans with a professional and create a strategy that is ready for anything.
Estate Taxes and Charitable Giving
Do you want to leave behind a legacy and simultaneously reduce your estate taxes? Make contributions to charitable organizations.
Giving While You’re Still Living
Many people choose to leave large portions of their estates to charities when they pass, but giving what you can each year while you’re still living can be a great strategy to maximize your tax benefits. If done properly, giving each year can result in a much higher amount of lifetime donations than giving once when you pass.
Charitable Gifts
Any asset you decide to gift to charity is excluded from your taxable-estate, with no limits, assuming the recipient is a qualified 501(c) 3 organization. If you have decided to leave your entire estate, you will not be liable for any estate taxes.
Giving to Family Members (Gift Tax)
In 2021, you can give up to $15,000 ($16,000 in 2022) in cash or other assets to someone in a year and not have to deal with the IRS. If you give above that limit, you will have to fill out paperwork (link to IRS form 709 – https://www.irs.gov/forms-pubs/about-form-709) and potentially owe a gift tax.
Note that this amount is per recipient and per person, meaning a married couple can each give $15,000 to each of their children every year, if they so choose.
On top of the $15,000 annual exclusion, a lifetime exclusion of $11.7 million is currently in place. Notably, any excess given in a single year typically “spills over” into the lifetime exclusion bucket – while you will have to file extra paperwork, you probably won’t have to pay a gift tax.
For example, if you give your daughter $50,000 this year, the extra $35,000 ($50,000 – $15,000) will count against your lifetime exclusion of $11.7 million. You will need to file the paperwork and you’ll whittle away at the lifetime exclusion, but you shouldn’t need to pay any gift tax. Next year, you’ll be able to give a gift to your daughter again.
Irrevocable Trusts
An irrevocable trust is one which cannot be amended or terminated without the approval of the grantor’s beneficiary.
An irrevocable trust has a grantor, a trustee, and a beneficiary or beneficiaries. Once the grantor places an asset in an irrevocable trust, the grantor cannot revoke it – it is the trust’s. The grantor can, however, dictate the terms of the trust assets with the consent of the trustee and the beneficiary (typically done upon creation of the trust).
For the purposes of this paper, setting up an irrevocable trust allows you to take advantage of the estate tax exemption – any property transferred into an irrevocable trust does not count toward the gross value of the estate.
Beyond that, additional benefits include preventing beneficiaries from misusing assets, gifting assets to the estate while still retaining the income from those assets, depleting one’s property to ensure eligibility for government benefits, among others.
Setting up and correctly using an irrevocable trust is complex and should not be done without the careful oversight of an experienced tax professional and/or estate attorney.
Want to learn more about proactive tax planning? Reach out to one of our financial advisors at ARS
IRS Secrets - What They Don’t Want You to Know
Nobody wants to hear from the IRS. They never have good news. But, this fear may be irrational based on what you (don’t) know about the IRS and its collection activities.
The truth is, the IRS doesn’t want to contact you anymore than you want them to contact you.
The IRS wants your money, not you – people in jail don’t pay taxes. Furthermore, collection activities require time and money that the IRS would rather devote elsewhere.
No, you can’t ignore collection notices – the IRS has too broad a set of powers for that. But pausing to consider what the IRS really wants can help you align their interests with your own and lead you to find a win-win solution.
Here are 6 secrets the IRS doesn’t want you to know about:
- They don’t want to seize your assets or go to court
- They can’t handle all of the paperwork
- They may owe you interest
- There will likely be delays on refunds next year
- You can avoid paying income taxes on tax-deferred retirement accounts by donating to charity
- They negotiate penalties
Are you in debt with the IRS? If so, you’re not alone – millions of Americans owe federal taxes they cannot afford to pay. Although it may feel overwhelming, the worst thing you can do is ignore the problem. Tax issues have far-reaching implications and can easily destroy almost every aspect of your life.
Fortunately, you do not need to go at it alone. Hiring a professional that knows the law and can create a plan based on your current situation is all you may need. Furthermore, good professional tax assistance can easily pay for itself – don’t fret about the cost, it will likely save you more than you spend.
Certified Financial Planners™ at Advanced Retirement Strategies
Working with a Certified Financial Planner™ is an excellent investment of your time and money. With the high standards for CFP® certification, you’ll know you’re getting the expertise and knowledge of a highly-trained and educated professional who will always act in your best interests and with the loftiest ethical standards.
The team of retirement planners and investment advisors at Advanced Retirement Strategies in Bountiful, Utah includes two Certified Financial Planners™ who specialize in helping diligent savers with $250,000 or more of investment and retirement assets (not counting your primary residence) prepare for and then transition into retirement.
If you’re looking for a CFP® to help you live the retirement you have dreamed of, contact us today.
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