2022 Year End Tax Planning for Investors, Estate, and Gift Planning

Maxwell Locke & Ritter has outlined a few 2022 year end tax planning for investors and individuals with estate and gift planning needs.

Estate and Gift Taxes

During the last decade, the unified estate and gift tax exclusion has gradually increased, while the top estate rate has not budged. For example, the exclusion for 2022 is $12.06 million, and the IRS recently announced the 2023 exemption amount will be $12.92 million, an increase of $860,000. (It is scheduled to revert to $5 million, plus inflation indexing, in 2026.)

YEAR-END MOVE: Incorporate this into your estate plan. For instance, your year end tax planning may involve various techniques, including trusts, that maximize the benefits of the estate and gift tax exemption. The following table shows the exemption and top estate tax rate for the last ten years.

In addition, you can give gifts to family members that qualify for the annual gift tax exclusion. For 2022, there is no gift tax liability on gifts of up to $16,000 per recipient (up from $15,000 in 2021). The limit is $32,000 for a joint gift by a married couple.

Tip: You may “double up” by giving gifts in both December and January that qualify for the annual gift tax exclusion for 2022 and 2023, respectively. The IRS recently announced that the limit for 2023 is $17,000 per recipient.

Capital Gains and Losses

Frequently, investors “time” sales of assets like securities at year-end to produce optimal tax results. It is important to understand the basic tax rules.

For starters, capital gains and losses offset each other. If you show an excess loss for the year, it offsets up to $3,000 of ordinary income before being carried over to the next year. Long-term capital gains from sales of securities owned longer than one year are taxed at a maximum rate of 15% or 20% for certain high-income investors. Conversely, short-term capital gains are taxed at ordinary income rates reaching as high as 37% in 2022.

YEAR-END MOVE: Review your investment portfolio. If it makes sense, you may harvest capital losses to offset gains realized earlier in the year or cherry-pick capital gains that will be partially or wholly absorbed by prior losses.

Be aware of even more favorable tax treatment for certain long-term capital gains. Notably, a 0% rate applies to taxpayers below certain income levels ($41,675 for singles and $83,350 for joint filers in 2022). Furthermore, some taxpayers who ultimately pay ordinary income tax at higher rates due to their investments may qualify for the 0% tax rate on a portion of their long-term capital gains.

Tip: The 0%/15%/20% tax rate structure for long-term capital gains also applies to qualified dividends you receive in 2022.

Net Investment Income Tax

Investors should account for the 3.8% tax that applies to the lesser of “net investment income” (NII) or the amount by which MAGI for the year exceeds $200,000 for single filers or $250,000 for joint filers. (These thresholds are not indexed for inflation.) The definition of NII includes interest, dividends, capital gains and income from passive activities, but not Social Security benefits, tax-exempt interest and distributions from qualified retirement plans and IRAs.

YEAR-END MOVE: Make an estimate of your potential liability for 2022. Depending on the results, you may be able to reduce the tax on NII or avoid it altogether.

For example, you may invest in municipal bonds (“munis”). The interest income generated by munis does not count as NII, nor is it included in the MAGI calculation. Similarly, if you turn a passive activity into an active business, the resulting income may be exempt from the NII tax.

Tip: When you add the NII tax to your regular tax, you could be paying an effective 40.8% tax rate at the federal level alone. Factor this into your investment decisions.

Required Minimum Distributions

As a general rule, you must receive “required minimum distributions” (RMDs) from qualified retirement plans and IRAs after reaching age 72 (recently raised from age 70½). The amount of the distribution is based on IRS life expectancy tables and your account balance at the end of last year.

YEAR-END MOVE: Arrange to receive RMDs before December 31. Otherwise, you will have to pay a stiff tax penalty equal to 50% of the required amount (less any amount you have received) in addition to your regular tax liability.

Do not procrastinate if you have not arranged RMDs for 2022 yet. It may take some time for your financial institution to accommodate these transactions.

Conversely, if you are still working and do not own 5% or more of the business employing you, you can postpone RMDs from an employer’s qualified plan until your retirement. This “still working exception” does not apply to RMDs from IRAs or qualified plans of employers for whom you no longer work.

Tip: RMDs are not treated as NII for purposes of the 3.8% tax. Nevertheless, an RMD may still increase your MAGI used in the NII tax calculation.

See bullet point below for specific guidance regarding RMDs for inherited IRAs, including RMD and penalty relief for 2021 and 2022.

Installment Sales

Normally, when you sell real estate at a gain, you must pay tax on the full amount of the capital gain in the year of the sale.

YEAR-END MOVE: Arrange to sell real estate on the installment basis. If you receive installment payments over two or more tax years, the tax on a gain is paid over the years in which payments are actually received. This tax deferral treatment is automatic for most installment sales other than sales by “dealers” like real estate developers.

The taxable portion of each payment is based on the “gross profit ratio.” Gross profit ratio is determined by dividing the gross profit from the real estate sale by the price.

Not only does the installment sale technique defer some of the tax due on a real estate deal, it will often reduce your overall tax liability if you are a high-income taxpayer. Reason: By spreading out the taxable gain over several years, you may pay tax on a greater portion of the gain at the 15% capital gain rate as opposed to the 20% rate.

Tip: If it suits your purposes (e.g., you have a low tax year), you may “elect out” of installment sale treatment when you file your return.

Miscellaneous

• Watch out for the “wash sale” rule that disallows losses from a securities sale if you reacquire substantially identical securities within 30 days. Wait at least 31 days to buy them back.
• Contribute up to $20,500 to a 401(k) in 2022 ($27,000 if you are age 50 or older). If you clear the 2022 Social Security wage base of $147,000 and promptly allocate the payroll tax savings to a 401(k), you can increase your deferral without any further reduction in your take-home pay.
• Weigh the benefits of a Roth IRA conversion, especially if this will be a low-tax year and considering the impact of this year’s decline in the stock market. Although the conversion is subject to current tax, you generally can receive tax-free distributions in retirement, unlike taxable distributions from a traditional IRA.
• Skip this year’s RMD if you recently inherited an IRA and are required to empty out the account within ten years. Under new IRS guidance, there is no penalty if you fail to take RMDs for these inherited IRAs in 2021 or 2022. On the flip side, proposed regulations were issued in 2022 that would begin to require annual RMDs for these inherited IRAs in addition to the requirement that the inherited IRA account be totally distributed by December 31^st of the tenth calendar year following the IRA owner’s death. The IRS may issue final regulations soon, so be aware of this for 2023.
• If you rent out your vacation home, keep your personal use within the tax law boundaries. No loss is allowed if personal use exceeds the greater of 14 days or 10% of the rental period.
• From a tax perspective, it is often beneficial to sell mutual fund shares before the fund declares dividends (the ex-dividend date) and buy shares after the date the fund declares dividends.
• Consider a qualified charitable distribution (QCD). If you are age 70½ or older, you can transfer up to $100,000 of IRA funds directly to a charity. Although the contribution is not deductible, the QCD is exempt from tax. This may improve your overall tax picture.

We Are Here to Help

Maxwell Locke & Ritter can help you with any questions you might have regarding year end tax planning for investors and estate and gift planning. Please contact us if you have questions about these updates.