Year End Tax Planning Strategies

For those who had not already filed their 2021 tax returns, yesterday marks another tax year in the books.  Taxpayers (or should we say their CPAs) received a bonus weekend to complete their returns with October 15^th falling on a Saturday.  With one quarter left in 2022, it is now time to consider some year-end tax planning strategies.  While thoughtful tax planning throughout the year is ideal, here are some ideas to ponder before ringing in a new tax year.

• Roth Conversions
• Back Door Roth IRA
• Tax Loss Harvesting
• IRA Required Minimum Distributions (RMDs)
• Annual Gifting
• Special Mention to Medicare
• Inherited IRA IRS Clarification
• Possible CA Long-Term Care Legislation Brewing

Roth Conversions

With investment portfolio values experiencing significant drawdowns year to date, it could be an attractive time to consider a Roth conversion by moving assets from a Traditional IRA to a Roth IRA.  While there are advantages of a Roth, it must be weighed against the additional taxable income recognized on the converted amount.  Positives include tax diversification given future tax-free distributions, no Required Minimum Distributions (RMDs) at age 72 and providing heirs with tax-free assets.  If you are a business owner who experienced a net operating loss, these losses can offset the ordinary income from a Roth conversion and lighten that tax bill.

Back Door Roth IRA

Concerns of this strategy’s demise due to the proposed Build Back Better legislation never materialized in the watered-down Inflation Reduction Act which passed back in early August.  A Backdoor Roth IRA allows individuals with high income to work around the Roth income limits. For those who waited, wait no further and make that non-deductible Traditional IRA contribution and transfer those assets into a Roth IRA before year end.

For the two strategies mentioned above, be mindful of the IRA Aggregation Rule IRC 408(d)(s) which is also known as the Pro-Rata rule, if you have existing pre-tax IRA dollars.  You should contact your tax advisor for tax advice and to keep them informed of these types of activities.

Tax Loss Harvesting

You may have heard the phrase every cloud has a silver lining. This year’s extreme market volatility has provided the opportunity to proactively realize capital losses through a strategy known as tax-loss harvesting. Tax-loss harvesting by another name is tax-asset creation and can reduce taxes now or in the future.  Tax-loss harvesting allows you to sell investments that are down, replace them with reasonably similar investments, and then offset realized current or future capital gains with those losses.  For some, this can be helpful in mitigating other capital gains from real estate or business/partnership interests sold this year or expected to be realized in the future.

IRA Required Minimum Distributions (RMDs)

For those aged 72+ years and who inherited IRAs prior to 2020, you have until year end to withdraw your entire RMD and avoid a 50% tax penalty on the amount not withdrawn.  For those charitably inclined and over 70.5 years old, you can make a Qualified Charitable Distribution (QCD) and donate up to $100,000 directly to charities from your IRA instead of taking your RMD.  By utilizing the QCD, you (the donor) can lower your taxable income, which may provide greater income tax savings in comparison to making a cash gift and claiming an income tax deduction.

Annual Gifting

Speaking of gifting, you still have time to take advantage of the annual gift exclusion to transfer wealth to future generations or to make tax-free transfers on behalf of another individual by paying education or medical expenses directly to the provider. The 2022 annual gift exclusion allows for tax-free gifts up to $16K per person ($32K for married couple using gift splitting) without it counting toward the lifetime gift and estate tax exemption (currently $12.06 million).  For those who want to fund 529 Education Plans for family members, there is the ability to frontload up to 5 years’ worth of annual gifting.  It might be advantageous to delay this specific strategy until next year, given the expected record IRS increases to exemption and exclusion amounts due to higher inflation adjustments.

There are many qualified plan limits listed above, which also serves as a good reminder to review account beneficiary designations, given the drastic changes in the mandatory distribution period made by the SECURE Act, not to mention any life changes (e.g., marriage, divorce, birth of child/grandchild, death, etc.).

Special Mention to Medicare

Open enrollment begins October 15^th through December 7^th for those turning 65 and enrolling for the first time or those who would like to change their current insurance plan.  According to a 2019 Kaiser Family Foundation survey, seven in ten Medicare beneficiaries did not even compare plans, and while switching plans is not necessary, reviewing current coverage and offerings is a healthy thing to do.

Inherited IRA IRS Clarification

On October 7^th, the IRS released Notice 2022-53 announcing that final regulations will be forthcoming and will apply (at the earliest) to the 2023 distribution year. The central change the IRS is proposing would impact beneficiaries who inherited an IRA from a non-spouse who was subject to RMDs on the date of death and passed away after 12/31/2019.  The new IRS proposal would require individuals who inherited a retirement account from decedents meeting these criteria to take RMDs during this 10-year period based on their life expectancy and fully disburse funds by the end of 10 years. Individuals affected by the new rules who ‘failed’ to take RMDs in 2021 and 2022 will not be subject to the ordinary penalties. Although the proposed changes haven’t been officially announced, judging by the notice, it seems highly likely to pass.

Possible CA Long-Term Care Legislation Brewing

The passage of AB 567 established a Long-Term Care Insurance Task Force in the California Department of Insurance to explore the feasibility of developing and implementing a statewide insurance program for long-term care services and supports.  California is looking to mirror the state funded long term care benefits program that Washington State (WA Cares Fund) set up to help their citizens have access to long term care.  The WA Cares Fund is funded by an uncapped payroll tax and provides a guaranteed lifetime benefit amount.  The program is expected to allow for “Opt-Out” provisions if individuals have existing long term care private insurance prior to the program’s legislative enactment.  A feasibility report of proposed options (who pays, how much, benefit amount, eligibility criteria, etc.) is expected to be announced on or before January 1, 2023, to the commissioner, the Governor, and the Legislature with an actuarial recommendations report to follow within 12 months.

We covered a range of topics in this article, and everyone’s situation is as unique as their own specific goals and objectives.   We would be more than happy to have a discussion with you and your family to provide guidance, evaluation, and the analysis necessary to assist with these financial decisions.  This year has been exceedingly challenging on many fronts.  We are here to listen, support and advise through these tough times and the better days ahead.  Thank you for your continued trust and we look forward to speaking with you soon.

Karin T. Le, CFP^®
Senior Wealth Advisor