By Austin Winsett, CPA, Financial Advisor

As we enter 2022, it’s essential to reevaluate financial plans to ensure maximum savings. As policies change and new plans are put in place, tax-efficiency should be top of mind, regardless of what happens in Washington.

After a year of proposed policy changes at the forefront of the Build Back Better Act, few tax proposals were brought to fruition, with the exception of a 5% surtax on adjusted gross income over $10 million and an additional 3% surtax over $25 million.¹ Although proposals in the bill passed by the House in mid-November may change before the Senate’s vote, we do not expect major changes in tax law for 2022, unless the direction of negotiation shifts.

Below are three strategies to consider as we enter the new year:

1. Maximize tax-advantaged accounts: Employer-sponsored retirement accounts, IRAs, Roth IRAs and health savings accounts (HSAs) all provide great tax-saving opportunities. The IRS has announced that 2022 contribution limits will be increased to $20,500 (up from $19,500) for employees who participate in 401(k)s, 403(b)s, most 457 plans and the federal government’s Thrift Savings Plan. Limits on contributions to traditional IRAs and Roth IRAs remain at $6,000 and additional “catch-up” limits for individuals age 50 or older also remain the same.²

2. Plan for current tax laws to sunset by 2026: Many of the tax changes implemented through the Tax Cuts and Jobs Act of 2018 (TCJA) are temporary and will sunset in 2025.³ Pending any new laws, ordinary income tax brackets will increase to the pre-TCJA rates. These lower tax brackets may continue to provide opportunities for investors to limit tax exposure in the long run. Roth IRA conversions are great tools to control tax brackets and freeze the growth of deferred tax liability associated with tax-deferred accounts such as IRAs and 401(k)s.

This year’s tax rates in comparison to the pre-TCJA rates provide 3% marginal tax savings for many of the brackets and, in some cases, as high as 9%.¹ By converting portions of IRAs to Roth IRAs, investors can maximize their current marginal tax rates on that capital, freeze the growth of that tax liability, and allow the capital to grow and compound tax-free over their lifetime while providing more tax-efficient inheritance to their beneficiaries.

2022 ordinary income tax rates — married filing jointly and surviving spouses⁴

3. Charitable lumping: Congress allows taxpayers to claim various deductions that will reduce their taxable income. In some cases, the deductions are tax incentives intended to encourage certain behaviors (e.g., deductions for charitable giving).

Under the TCJA, the standard deduction was doubled and will sunset in 2025. The standard deduction for married couples filing jointly for the 2022 tax year will rise to $25,900, an $800 increase from the prior year. For single taxpayers and married individuals filing separately, the standard deduction rises to $12,950, up $400; and for heads of households, the standard deduction will be $19,400, up $600.

If a household has more individually itemized deductions than “just” the standard deduction, it’s permitted to claim the total of those itemized deductions on Schedule A. From the individual tax planning perspective, those who claim the standard deduction will find their previously itemized deductions provide no tax benefit.

Deduction lumping attempts to shift the timing of deductions within the same year to clear the standard deduction hurdle. Investors can use donor-advised funds to lump charitable contributions together every five years, for instance. The donor-advised fund can also remain invested — which, under the standard rules for donor-advised funds, is tax-free growth — and if returns are favorable, what was originally five years’ worth of charitable contributions could last for six or seven years.

The key tax planning benefit is simple: By lumping the charitable contributions together, donations that otherwise would have been itemized deductions falling below the threshold for the standard deduction are at least partially above the threshold. This produces an immediate tax benefit that would not have been received at all if the contributions were made annually while using existing appreciated securities and avoiding future capital gains taxes.⁵

While every investor has unique and individual circumstances, these strategies can be used in combination to provide tax benefits and savings for the year ahead. As always, if you have any questions, please contact your Exencial advisor.

Sources:

1. Tax Foundation (12/2/21) — House Build Back Better Act: Details & analysis of tax provisions in the budget reconciliation bill
2. IRS (11/17/21) — IRS announces changes to retirement plans for 2022
3. House of Representatives (12/15/17)  — Tax Cuts and Jobs Act
4. IRS (11/10/21) — IRS provides tax inflation adjustments for tax year 2022
5. Kitces (1/31/18) — Timing tax savings with deduction lumping and charitable clumping

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