It’s tough to fight inflation when you have no control over the rising costs of many goods and services.
There’s also not much you can do to stop interest rates from climbing or stocks from falling, either. Still, you may have more control than you realize when it comes to another financial pain point that can significantly impact your budget — your taxes.
“The time to do tax planning is before the year has come to a close,” said Marianela Collado, CEO and co-owner of Tobias Financial Advisors in Plantation, Florida. “The fourth quarter is an ideal time, because it’s going to be your last opportunity.”
Whether you usually get a refund or owe a tax bill, here are several moves to consider now to improve your chances of tax savings.
Review tax withholding
First, you want to review how much money is being withheld from your pay for federal taxes. Having too little tax withheld could result in a tax bill or penalty. If too much tax is withheld, you could get a refund.
You should check your withholdings when you have major life changes, such as getting married, having children or starting a side business. Also, if you recently started a new job or have held jobs with multiple employers this year, you want to make sure you’re getting it right.
“Odds are that those employers may be only assuming you’re working for them by the year-end,” said John Schultz, a CPA and partner at Genske, Mulder & Company in Ontario, California.
“You actually can be very under withheld when you’re working three to four or five different jobs,” added Schultz, chair of CalCPA’s State Committee on Tax.
And don’t forget to consider whether you’ve paid enough federal tax to cover other sources of income, such as dividends and interest from investments.
“Now you have all this capital gain, this is income that is not going to be subject to withholding,” said Collado, who is a CPA and certified financial planner. “So that difference in the tax you need to make up through either additional withholding or quarterly estimated tax payments.”
You can still adjust your withholding and make an estimated payment for the fourth quarter if you’ve had too little tax withheld. If you’ve had too much tax withheld this year, decreasing your withholding now could increase your take-home pay, giving you the extra cash flow you may need in this inflationary environment, financial advisors say.
Go online to the “IRS Tax Withholding Estimator” at IRS.gov to see if you’re on track. If you need to make some changes, it will tell you exactly what you need to do to fill out a new Form W-4. Then, submit that form to your employer.
Boost 401(k) contributions
If you have room in your budget, consider boosting pre-tax retirement savings in a 401(k) or workplace retirement plan. Putting money in these accounts reduces your gross income so you’re paying less tax on your overall income.
You have until Dec. 31 to make 401(k) plan contributions for 2022. You can stash up to $20,500 this year into your 401(k). Add an extra $6,500 if you’re 50 or older for a total of $27,000.
Even if you don’t have the budget to save nearly that amount, bump up your 401(k) contributions at least enough to get the matching contribution from your employer, financial advisors say. That’s free money, after all.
Weigh Roth IRA conversions
The stock market’s slide since the start of the year gives you a chance to save on taxes in the future using a strategy called “Roth IRA conversions.” Here’s how it works:
If you have a pretax IRA or individual retirement account, you can convert some or all of those funds to a Roth IRA. By moving the money into a Roth account, you’ll get tax-free growth in the future — but you have to pay taxes upfront on the amount that’s converted.
The S&P 500 Index is down more than 20% so far this year so you won’t pay as much tax on converting those assets as you would have a few months ago — that’s another part of the tax savings. For example, let’s say you have $50,000 invested in a pretax IRA and it’s now worth $40,000. You’ll save on taxes since you’ll convert $40,000 rather than the original $50,000.
Just be sure you have enough money outside of your IRA to pay those taxes. You don’t want to dip into your retirement accounts to pay for it.
Consider “tax-loss harvesting”
A common strategy many financial advisors talk about when trying to find a silver lining after a steep slide in stocks is “tax-loss harvesting.”
If you sell an investment at a loss, you can subtract that loss from any capital gains you had from selling other investments. By doing that, you can reduce the taxes you owe. And, those losses or gains can be from stocks, real estate and other types of property.
“If you sold real estate for a significant capital gain, you’re able to use losses from a [stock] portfolio to offset the capital gains related to the sale of the real estate,” Collado said.
Once losses exceed gains, you can deduct up to $3,000 a year from your regular income — and carry forward any extra losses indefinitely.
It’s another move to consider making before the end of the year to make sure you can lock in that potential tax savings. Reach out to a tax preparer and financial advisor to see if these moves make sense for you.