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Year End Tax Savings Strategies

Insights Tax Planning Retirement Planning Investing

It's hard to believe 2022 is almost over.  As we approach the final few weeks, it is time to look at some year-end tax savings strategies.  We will also talk about a strategy to help you reduce future taxes as well.

Watch Now: Year-End Tax Savings Strategies

  • 0:00 Intro
  • 0:21 - Welcome
  • 0:58 - Tax loss harvesting - the basics
  • 1:54 - Tax loss harvesting - wash sales
  • 3:20 - Tax loss harvesting - the strategy 
  • 4:07 - Qualified Charitable Distributions - the basics
  • 5:11 - Qualified Charitable Distributions - the rules
  • 6:47 - Roth conversions - the basics
  • 7:35 - Roth conversions - think long-term
  • 8:48 - Roth conversions - key factors
  • 10:55 - Final thoughts - refocus your plans and strategy
  • 11:50 - Final thoughts - making lemonade out of lemons
  • 13:08 - Outro

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Tax loss harvesting - the basics

Tax loss harvesting is the process of reviewing your taxable accounts and identifying the positions that can be sold for a capital loss.  A capital loss occurs when you sell a position with a market value below its cost basis.

The cost basis is what you paid for a position plus any income distributions that were reinvested.  If you inherited the asset, your cost basis is the value on the original owner's death.   If the market value is less than this value, you realize a capital loss. If the market value is more than your cost basis, you would have a capital gain when you sell it.

Tax loss harvesting - knowing the rules.

Here are the basics of the tax rules surrounding capital losses.

  1.  Capital losses are used to offset any capital gains.
  2.  You can use $3,000 of capital losses to reduce your other income.
  3.  Any excess losses are carried forward to be used in future years until you have used them.
  4.   You need to avoid a potential wash sale. (A wash sale happens when you repurchase the same investment within 30 days of the sale).

Here's an example.

You sell stock XYZ in 2022 and you realize a $6,800 loss and you have no other gains during the year.  You can use $3,000 of the loss to reduce this year's income.  You carry forward the amount and use $3,000 against next year's income (assuming you have no gains).  You would then have $800 to use in 2024.

The strategy behind tax loss harvesting.

1. Tax Benefits -  The main benefit of realizing tax losses is to reduce your tax bill.

2. Tax-efficient rebalancing and repositioning - It can be difficult to rebalance taxable accounts due to tax ramifications.   Realized losses can allow you to sell some of those investments you no longer want to hold and reduce the tax cost of doing so.  

3. Adjusting cost basis on appreciated assets - You may own an investment that has appreciated in value. If you have realized losses, you can sell that asset and immediately repurchase the asset with the realized gain. (There are no wash sale rules for capital gains).  This will increase your cost basis of the appreciated position.   When you go to sell it in the future, you will use the new higher basis to figure your taxes.

Qualified Charitable Distributions

Qualified Charitable Distributions allow you to send a distribution from your IRA to a charity of your choice.  When done correctly, you will not have to report the amount donated as income on your tax return.  

Qualified Charitable Distributions - the rules

Here are the rules for QCD's.

  1.   You must be at least 70 1/2 years old.
  2.   The distribution must go directly from your IRA to a qualifying charity.
  3.   You will likely have to sign a form for the distribution.
  4.   You will need to tell your tax professional how much was donated.

Please remember, if the money goes to you first, it will not qualify.

Qualified Charitable Distributions - Why consider this?

A few years ago the tax laws were changed.  Now more than 90% of filers will claim the standard deduction.  This means most people cannot receive any tax benefits for charitable contributions.  The QCD allows you to receive this benefit.  Because you do not report the income donated, you will not pay state or federal income taxes on the amount.

Here is a simple example.  Joe and Mary put $20 in the collection plate each week at church.  They used to be able to take a tax deduction for their donation, but now they claim the standard deduction.  Over the course of the year, they will donate a total of $1,000 to their church.  If they elect to do a qualified charitable distribution from one of their IRA's, they will not report the income on their tax return.  The church will receive the same amount.

Roth IRA Conversions

A Roth IRA conversion is electing to take some of your existing IRA and converting it to a Roth IRA.  You pay the taxes on the amount you convert.  Then if you follow the rules, the future growth on that account will not be taxed.  This will actually increase your tax liability in the current year.  But you are doing this for tax advantages in the future.  

Roth conversions - think long term

The goal when doing a Roth conversion is to pay the government as little as possible on your IRA and other tax-qualified assets.  This may impact your own tax situation, or it may have an impact on your children's tax situation.  

If you are a younger person, converting to a Roth IRA now will allow you flexibility when planning your retirement income.  For older people, a conversion creates a more tax-efficient wealth transfer tool.

Roth conversions - the key factors

There are a few important factors when considering a Roth conversion.

1.  Think Long Term - The biggest benefits of a Roth conversion come from the compounded growth on the accounts.  The longer the money has to compound the better.

2.  How will you pay the taxes? The math of Roth conversions works better if you can pay the taxes from sources outside of your IRA.  If you have to withdraw the funds from your IRA, and potentially face early withdrawal penalties, it is less advantageous.

3.  Know your tax bracket and your children's tax bracket - The goal is to send the government the least amount possible on these tax-advantaged accounts.  If your children's tax rate is higher than yours, a conversion may make sense. 

4.  What are your charitable intentions?  If the beneficiary of your IRA is a charity, the charity won't have to pay taxes on what they receive.  It wouldn't make sense to do a conversion in this case.

Final Thoughts

The end of this year provides an opportunity to make lemonade from lemons, but they need to fit within your overall plans.  It is a good time to refocus on your long-term goals.  If you would like to connect with a financial advisor to discuss your situation, please fill out the form below.

Appearing in this video...

Todd Kimpel, CLU, ChFC

Todd is a financial advisor in Wheeling, West Virginia.

Vince McManus

Vince is a Financial Consultant in Parkersburg, WV.

Neal Watson, CFP

Neal is a Certified Financial Planner Professional in Marietta, Ohio.