While our firm’s year-end tax planning checklist is similar each year, the emphasis changes depending on what happened in investment markets and with new tax laws. With this in mind, here’s a quick list of tax-saving and tax-planning opportunities for you to consider before this year comes to a close.
Tax-loss harvesting
With stocks, bonds, and cryptocurrencies down for the year, tax-loss harvesting tops the list of possible tax moves for 2022.
As of November 18, 2022, the largest 500 publicly traded companies as measured by the S&P 500 Index are down 15.6%, while small US companies measured by the Russell 2000 Index are down 16.6%. The Russell 1000 Growth Index, which measures the performance of large-growth companies, including many tech companies, is down 25.6%. International stocks are down a little more than those in the US.
Many individual stocks, especially from the tech sector, are doing even worse this year: Meta -67%, PayPal -55%, Netflix -52%, AMD -49%, Tesla -49%, NVIDIA -48%, Amazon -44%, Intel -42%, Salesforce -42%, Google -33%, Microsoft -28%, and Apple -15%.
Bonds are also down, since bond prices go down as interest rates rise, and interest rates have risen with the US Federal Reserve taking aggressive action to bring inflation down from its June 2022 peak of 9.1%. A mixture of corporate bonds and US government bonds with maturities from 5 to 10 years is down almost 14% this year.
Digital assets are down too. Our cryptocurrency winter continues with market leaders Bitcoin and Ethereum down about 65% and 69% respectively for the year.
While this year’s investment performance is disappointing, ups and downs are a normal part of investing and financial planning, and can play a beneficial role in tax planning. To save money on taxes, this year and in future years, you can consider selling your investments that are down in value and using those realized losses to offset taxable gains you have in other areas of your investments. You can also deduct up to $3,000 of losses against your ordinary income on your federal tax return. If you have losses of more than $3,000, you can carry those losses forward and use them to reduce income and capital gains in future years.
If, on the other hand, you want to keep your investments that are down this year for the long term, you can still take advantage of tax-saving opportunities using a technique called tax-loss harvesting. With tax-loss harvesting, you sell your investments that are at a loss this year to recognize the loss for tax purposes, and then buy them back so you can continue to hold them for the long term. If you want to use this technique, there are special tax rules you need to follow. To avoid committing a “wash sale” under IRS rules, in which your losses on sales are not allowed, you need to wait 30 days before you buy back the investments you sell.
A variation on this approach that is popular with professional investors is buying back a similar, substitute security immediately, so you remain invested and your portfolio continues to perform as before. Then once 30 days have passed, you can sell the substitute security and buy the original security that you want to hold for the long term.
With either approach, tax-loss harvesting is a way of realizing tax savings in the current year without changing the way your investment portfolio is designed to perform.
A special note on cryptocurrency: If you had funds on the FTX cryptocurrency exchange, you’ve likely lost a substantial portion of that money, and you should start rounding up documentation of your investment so you can claim the loss in the FTX bankruptcy case and for tax purposes, either this year or next year as the FTX bankruptcy case plays out. Your documentation might include deposit receipts from FTX and bank statements showing your transfers of cash to FTX.
Restructuring your investments
As we wrote about earlier this year, market downturns can be a great time to restructure your investments, and it’s still true now. If you have been wanting to make changes to your investments held in taxable accounts but have been reluctant to do so because of large, embedded capital gains, this might be a good year to make those changes. The unrealized capital gains in your investments are smaller now because the stock, bond, and cryptocurrency markets are down. You can sell those investments now at a lower tax cost and move into investments you like better. You can couple your restructuring with targeted tax-loss harvesting, pairing gains on restructuring sales with losses from tax-loss harvesting, thereby reducing your tax bill. This allows you to improve your investment portfolio and position yourself for the next market upswing—at less cost.
Incentive stock option (ISO) disqualifying dispositions
If you exercised incentive stock options (ISOs) early in 2022, you may have triggered alternative minimum tax (AMT). If the stock price of the shares you exercised has dropped since the beginning of the year, you may want to consider selling those shares before year-end in a disqualifying disposition. Selling the shares before year-end would allow them to be taxed as ordinary income, potentially reducing the amount of tax you will pay. If you don’t sell the shares in a disqualifying disposition, the gain on the shares at the time of exercise will be taxable as income under the AMT system, even if the share price has dropped since you exercised. You could wind up paying tax on a large amount of gain from earlier in the year when the stock price was higher. Selling the shares before year-end would eliminate the gain under the AMT tax system and potentially lower your tax bill this year, perhaps substantially.
Donor-advised fund for charitable contributions
We’re still big fans of using donor-advised funds (DAFs) to make charitable contributions. If this was a big income year for you and you are charitably inclined (i.e., you already regularly give to charity), then you may want to make a larger-than-usual charitable contribution this year to reduce your taxable income. When you contribute to a DAF, you get a charitable tax deduction in the year of your contribution. Then you can make grants from your DAF over many years into the future. Funds in the DAF can be invested and grow, but you cannot take them back. Once you give, the money is no longer yours. It’s best to contribute appreciated assets like stock, mutual funds, or exchange traded funds (ETFs) to your DAF. By doing so, the unrealized gain in the investments you contribute disappears inside the DAF, because the DAF is a 501(c)(3) charitable organization. This amounts to double tax savings—you get the current year charitable tax deduction, and you will never have to pay tax on capital gains in the investments you contribute. Get started early to get your DAF account set up to beat the year-end rush.
Top off your 401(k)
This is a low-hanging fruit and it’s easy to miss. If you are planning to make the maximum 401(k) contribution at work this year, be sure to check if you’re on track to max out before year-end. If you’re running a little short, and your paycheck deductions won’t quite get you to the 2022 maximum of $20,500 (or $27,000 if you’re 50 years old or older), you may need to change your contribution amount for the next two or three paychecks to be able to get enough socked away. Don’t forget to change it back early next year to smooth out your 401(k) contributions over the whole year.
Benefits open enrollment
Looking ahead to next year, this time of year is open enrollment for many company employee benefit plans. If you’re eligible for your company’s deferred compensation program, this is the time to figure out how much you can contribute next year and get those paycheck deductions set up.
Also, if your company offers a High Deductible Health Plan paired with a Health Savings Account (HSA), this is a good time to think about whether making pre-tax contributions to the HSA will lower your overall cost of health insurance for next year. For example, if you expect to have a large amount of medical costs next year that won’t be covered under the group insurance plan you’re currently enrolled in, it might make sense to fund the HSA account and pay those expenses from that tax-advantaged account.
Year-end and the holiday season will be upon us soon. It may be helpful to look at your tax-planning options over the next couple of weeks and make any adjustments needed before time runs out. With the markets down this year, you may find you have more tax-planning opportunities than you realize.
Parkworth Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you would like to talk about our ongoing and year-end tax planning for your situation, schedule a complimentary consultation.
