Careful tax planning can mean fewer surprises when it comes time to file. Here are a few tips to consider before the year winds down.
With the holidays right around the corner, taxes might be the last thing on your mind. But a little bit of preparation now could make a big difference come April.
Here are five things to keep an eye on as the year ends.
1. Increase your 401(k) contributions if you can
Contributing to an employer-sponsored retirement plan, like a 401(k), allows you to save for retirement — and get a tax break for doing so. Contributions are typically made pre-tax, which means that they can reduce your taxable income for the year.
How much you contribute is likely influenced by what you can afford and how far away from retirement you are. In 2022, taxpayers can contribute up to $20,500 into a 401(k), and those age 50 or older get a catch-up that allows them to contribute up to $27,000.
Employers also often match a portion of your contributions. According to a 2022 Vanguard study, the average promised employee match hovered around 4.4% of salary in 2021.
But if you’re contributing only enough to get that match, you could be leaving some money on the table, says Clay Ernst, a Colorado Springs-based certified financial planner and the executive director of financial planning for Edelman Financial Engines. Why? Because the more you contribute by Dec. 31, the more you can shave off your taxable income for the year.
2. If you’re newly self-employed, think about a solo 401(k)
If you’re a freelancer or otherwise self-employed, opening a solo 401(k) — a retirement savings plan for an individual who is a business owner with no employees — may not have been at the top of your list this year. But there are several benefits to establishing a plan, including that contributions you make can lower your taxable income.
A nice bonus? While you only have until Dec. 31 to open the account, you get until the tax-filing deadline — April 18, 2023 — to make contributions to the account that will qualify for a 2022 deduction, says Ernst.
3. Take stock of your investment losses
If you’re an investor who’s been watching the stock market take downward swings through gritted teeth in 2022, this may be an especially good year to take advantage of tax-loss harvesting, a strategy that can help you to squeeze a little lemonade out of the lemons in your portfolio, says Ernst.
How it works: Investors who sell investments at a loss can generally subtract that loss against any investment gains they’ve cashed in. And if their total losses exceed gains, they can even offset up to $3,000 of ordinary income and carry over any leftover losses to deduct in future years.
A few notes: Tax-loss harvesting can only be performed on assets sold in taxable accounts, like brokerages. The strategy can’t be applied to investments in tax-advantaged accounts, like 401(k)s or IRAs. It’s also worth working with a tax or financial advisor, as an expert can ensure this strategy is the right one for you and keep you on the right side of IRS rules, which can be complicated.
4. Consider deferring income
The hope is that you’ve had enough tax withheld throughout the year to avoid a surprise bill. However, a few things — like freelance work or a bonus — could inflate your total earnings.
If you’re a self-employed worker who bills their clients per project, you might consider holding off on invoicing if you think extra income might bump up your 2022 earnings.
“If you bill for your services, say, later in the year, in the third or fourth week of December, it’s highly likely at that point that you won’t receive the income until the next tax year,” says Ernst. This move can allow you to rein in your taxable income for 2022 and plan for 2023.
If you’re expecting a bonus and think your income might be lower next year, you could ask your employer to hold off on paying it out until January. Weigh it carefully, though; this maneuver doesn’t make sense for everyone. After all, you’re merely pushing off the taxes until 2023 — not avoiding them forever.
5. Look into a Roth IRA conversion
Roth IRA conversions allow you to transfer the assets in your traditional IRA into a Roth IRA so that your investments’ growth, and qualified withdrawals, get tax-free treatment in the future. The downside is you’ll likely pay taxes on the amount converted.
A down market can actually help here: If the value of your account has gone down, you’re converting less money, which can translate to lower taxes owed.
Be mindful of a few drawbacks, however. In addition to the conversion taxes, the move can push you into a higher tax bracket. And an inflated income can have a ripple effect on a few other things, like your general tax liability. If you’re retired or about to retire, it can also affect how much of your Social Security is taxable and how much you pay for certain Medicare premiums.