It is that time of year again where you should consider meeting with a tax professional to discuss any year end tax planning strategies that might reduce your 2022 taxes. The following are some of the tax breaks from which you may benefit, as well as the strategies that you could use to minimize your taxable income and resulting federal tax liability for 2022.
Your tax return filing status can impact the amount of taxes you pay. For example, if you qualify for head-of-household (HOH) filing status, you are entitled to a higher standard deduction and more favorable tax rates. To qualify as HOH, you must be unmarried or considered unmarried (i.e., legally separated or living apart from a spouse) and provide a home for certain other persons.
If you are married, you will either be filing your return using the married filing jointly or married filing separately filing status. Generally, married filing separately is not beneficial for tax purposes, but in some unique cases, such as when one party earns substantially less or when one party may be subject to IRS penalties for issues relating to their tax reporting, it may be advantageous to file as married filing separately. Additionally, if one spouse was not a full-year U.S. resident, an election is available to file a joint tax return where such joint filing status would otherwise not apply, and this may help reduce a couple’s tax liability.
Standard Deduction versus Itemized Deductions
The Tax Cuts and Jobs Act of 2017 (TCJA) substantially increased the standard deduction amounts, thus making itemized deductions less attractive for many individuals. For 2022, the standard deduction amounts are: $12,950 (single); $19,400 (head of household); $25,900 (married filing jointly); and $12,950 (married filing separately). If the total of your itemized deductions in 2022 will be close to your standard deduction amount, you should evaluate whether alternating between bunching itemized deductions into 2022 and taking the standard deduction in 2023 (or vice versa) could provide a net-tax benefit over the two-year period.
Medical Expenses, Health Savings Accounts, and Flexible Savings Accounts
For 2022, your medical expenses are deductible as an itemized deduction to the extent they exceed 7.5 percent of your adjusted gross income. To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They do not include expenses that are merely beneficial to general health, such as vitamins or a vacation. Deductible expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract. Depending on what your taxable income is expected to be in 2022 and 2023, and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2022 or defer them until 2023. The right approach depends on your income for each year, expected medical expenses, as well as your other itemized deductions.
You may also want to consider health saving accounts (HSAs) if you do not already have one. These are tax-advantaged accounts which help individuals who have high-deductible health plans (HDHPs). If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. These contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2022, the annual contribution limits are $3,650 for an individual with self-only coverage and $7,300 for an individual with family coverage.
In addition, if you are not already doing so and your employer offers a Flexible Spending Account (FSA), consider setting aside some of your earnings tax free in such an account so you can pay medical and dental bills with pre-tax money. Since you do not pay taxes on this money, you will save an amount equal to the taxes you would have paid on the money you set aside. FSA funds can be used to pay deductibles and copayments, but not for insurance premiums. You can also spend FSA funds on prescription medications, as well as over-the-counter medicines, generally with a doctor’s prescription. Reimbursements for insulin are allowed without a prescription. And finally, FSAs may also be used to cover costs of medical equipment like crutches, supplies like bandages, and diagnostic devices like blood sugar test kits.
The tax benefits of making charitable contributions and taking an itemized deduction for such contributions were narrowed as a result of the increase in the standard deduction in the TCJA. More people are forgoing itemized deductions as their standard deduction is more favorable.
If you are itemizing deductions, you can maximize the tax benefit of making a charitable contribution by donating appreciated assets, such as stock, instead of cash. Doing so generally allows you to deduct the fair market value of the asset while also avoiding the capital gains tax that would otherwise be due if you sold the asset.
In addition, individuals who have a retirement account and are 70 1/2 years old and older are eligible to make a charitable contribution directly from their IRA. This is more advantageous than taking a distribution and donating to the charity that may or may not be deductible as an itemized deduction. If your itemized deductions, including the contribution, are less than your standard deduction, then you receive no tax benefit from making the donation in this manner. By making the donation directly from your IRA to a charity, you eliminate having the IRA distribution included in your income. This in turn reduces your adjusted gross income (AGI). And because various tax-related items, such as the medical expense deduction or the taxability of social security income or the 3.8 percent net investment income tax, are calculated based on your AGI, a reduced AGI can potentially increase your medical expense deduction, reduce the tax on social security income, and reduce any net investment income tax.
Hiring a tax resolution expert is the best action a taxpayer could take in a tax matter before the IRS or a state tax authority.
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