Tax Day in April is the deadline Americans are most familiar with, but the end of the year on December 31 is an important tax deadline, too.
After all, what happened within the tax year determines most of your tax bill and how you do your taxes.
To better understand what steps members should consider taking before year's end, AAA spoke with Casey Schulte, Manager of Tax Development at TaxAct and an enrolled agent with more than 10 years of tax experience.
1. Calculate how much you're likely to owe
Before doing anything, Schulte recommends estimating whether you expect to owe money or receive a refund, and how much. "It gives you some insight into what your tax situation is going to look like when you go to file," he says, "and then also the ability to maybe mitigate some of those things that come up. 'Have I had enough withheld throughout the year? Am I going to have a huge tax bill?'" If you're not happy with your current tax situation, it's better to know ahead of time when you can still take steps to improve things.
There are many free tax calculators online, including TaxAct's free tax calculator. These usually just need your income, taxes withheld during the year, and a few other pieces of info to give you a rough idea of your current tax situation.
2. Sell underperforming investments to lower your capital gains
If you have stocks or other investments that are worth less than you bought them for, you can sell them and count that loss against any capital gains for the same year, Schulte says. This is called "tax-loss harvesting" and it can reduce or even eliminate capital gains taxes.
For example, say you sold stocks earlier in the year for a $5,000 capital gain, but hold other stocks that have lost $4,000 in value. Selling them will allow you to count those losses against the gains and only pay taxes on a net capital gain of $1,000.
"You can also harvest losses even if you don't have any gains in the current year," Schulte says. Up to $3,000 of other income (such as wages) can be offset in this way, and if your capital loss is larger than that, the rest can be carried over into the next year.
Consider tax-gain harvesting, too
Tax-gain harvesting is the mirror image of tax-loss harvesting. If you've already taken a capital loss for the year, you can sell investments that have gained value and some or all of the capital gains tax will be offset by the losses.
"This is another place where the tax calculator and knowing your expected taxable income is important," Schulte says. "Based on where your taxable income falls, you may be able to harvest some of your long-term capital gains at a more favorable capital gains rate."
3. Make contributions to your 401(k), IRA, and HSA
"Additional 401(k) contributions, if you haven't maxed that out for the year, or IRA or HSA contributions are an effective way to reduce the income tax that you have to pay," Schulte says.
- 401(k): A traditional 401(k) defers pre-tax money from each paycheck into a retirement savings account, reducing your taxable income. Temporarily increasing your per-paycheck contributions at the end of the year reduces your tax bill. Just be sure you haven't already hit the 2022 annual contribution limit, which is $20,500 for people under 50 and $27,000 for those 50 and older. Contributions to Roth 401(k)s are considered post-tax and will not reduce your tax bill.
- Traditional IRA: Like a 401(k), a traditional individual retirement account (IRA) lets you save untaxed money for retirement. Unlike a 401(k), you can contribute funds directly to an IRA—for 2022, up to $6,000 annually, or $7,000 if you're 50 or older. Schulte points out another difference: You can make IRA contributions that apply to the prior year's taxes up until the filing deadline (not including extensions). That means it's possible to reduce your tax bill for the previous year even after it has ended.
- HSA: Health savings accounts are available to many people with high deductible health plans. The money that goes in isn't taxed, and it remains tax-free if spent on qualifying medical expenses. If you have an HSA, you can put money into it with regular payroll deferrals like a 401(k) or direct contributions like a traditional IRA.
4. Give to charity, too (if you itemize deductions)
Charitable giving to 501(c)(3) organizations is a common way to get a tax deduction. Only taxpayers who itemize their deductions can take advantage, however—this isn't available if you're one of the roughly 3 in 4 Americans who take the standard deduction.
That's a change from 2020 and 2021, Schulte says, when individual and married joint filers who took the standard deduction were able to deduct up to $300 and $600 of giving. "But if you're on the cusp or you already have enough to itemize, additional charitable contributions can be a good way to increase those itemized deductions."
5. Time your business expenses strategically
If you run a small business, many of your expenses are tax deductible, so fitting them in by the end of the current tax year can lower what you owe. But Schulte points out 2 important things to consider before doing so.
The first is whether you expect to be making more or less money next year than this year: "Do you expect next year to be a breakout year?" If you expect to have more income (and thus more taxes you'll want to deduct against) in the coming year, "then you may want to hold off on some of those things."
The second is that if you plan to use bonus depreciation to deduct the purchase price of a new piece of equipment like a truck, that asset must be placed in service by the end of the year. "2022 is the last year for the 100% bonus depreciation that was put in place by the Tax Cuts and Jobs Act," Schulte says. "This essentially allows you to deduct the entire amount of the purchase. The important thing is you cannot just buy it and then not receive it until February. It has to be placed in service in the same year." (Note that bonus depreciation will still be available in gradually decreasing amounts until tax year 2027.)
6. Organize your tax documents as they arrive
"You may not start receiving a lot of end-of-year tax documents until after the year, your 1099s and W-2s, that kind of thing," Schulte says. "But it's good to go ahead and set up a designated place, a folder or a spot on your desk, to store these tax documents and keep a hold of the things that you're doing throughout the year." That's especially important if you plan to itemize and need to keep track of charitable contributions, property tax bills, medical expenses, childcare receipts, and so on.
Schulte says you should also make sure you have a copy of the prior year's return, and ideally at least the last 3 years. "Make sure you're not forgetting a segment of income that you had or an expense or a deduction that you had in the prior year. If you didn't save a copy of return, you can request a transcript from the IRS or from your state, or get it from your tax preparer."
If you're self-employed, you'll also want to hold on to all your business records such as expenses, checks, invoices, loan details, payroll records, and so on. Organizing them before tax season will help things go more smoothly.
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AAA and affiliated AAA clubs do not provide tax, legal or accounting advice. The above article is for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
