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It’s time to counsel clients on critical year-end tax considerations

It’s time to schedule year-end tax conversations with clients — before the coming holidays consume their schedules and yours.

The object is to reduce tax burdens for this year while setting clients up for the best outcomes in the year ahead. Despite a year marked by market volatility, inflation, rising interest rates, Russia’s invasion of Ukraine and the threat of recession, there are still many ways advisors can help clients navigate to calmer waters. No one can control market volatility, but tax-focused advisors can help clients avoid unexpected tax consequences as they work to control implications inside a financial plan.

Here are four key considerations to address with clients.

Year-end giving strategies
Tax benefits landed among the bottom three motivations for charitable giving in a BNY Mellon Wealth Management study, which polled 200 individuals whose wealth ranged from $5 million to more than $25 million. While avoiding the tax man is not a major impetus for giving, such gifts should still be strategically scrutinized for the tax benefits they can confer.

Often overlooked options such as donating tax-free funds from an individual retirement account should be considered. One way is via a qualified charitable distribution, which is a direct transfer of funds from the IRA custodian to a qualified charity. QCDs eliminate the amount donated from taxable income and can even be counted toward satisfying required minimum distributions for the year if certain rules are met.

Keeping taxable income lower can help to minimize the effect on some credits and deductions, impacting programs like Social Security. Another way to reduce taxable income is via family gifting, which allows up to $16,000 per recipient. Keep in mind that there is also a lifetime exclusion of $12.06 million in 2022. Staying within those thresholds means your client can avoid having to file a form to disclose the gift to the IRS.

Income and deduction bunching
Investors may be aware of bunching when it comes to medical expenses, 529 plans and charitable deductions. However, investors can also use the bunching tactic to smooth their tax impact over multiple years. Income and deduction bunching is the practice of accelerating or deferring income or deductions to mitigate a tax impact. Individuals in control of their income, for instance entrepreneurs or business owners, can use these tactics to pull some income forward into this tax year if they anticipate a larger tax bill in the following year. Similarly, one could defer deductions to a subsequent year to ensure that they are able to optimize their tax situation.

Retirement account conversions
Contributing the maximum allowable amount to retirement accounts to reduce taxable income is a common strategy within the industry, but many clients outside of it may not realize the benefits of Roth IRA conversions, particularly when markets are down. With equity markets down significantly, a Roth IRA conversion transfers pre-tax IRA funds to a Roth IRA for future tax-free growth, with the catch of paying taxes up front. The tax savings via a conversion can be compounded over many years, and with portfolios being worth considerably less than they were at the start of 2022, tax impacts will be lower as well.

Management of taxable accounts
Non-qualified accounts, which encompass largely taxable non-retirement accounts, investments in securities like mutual funds, REITs, fixed income, high-dividend stocks and actively managed funds, can trigger capital gains taxes, even when markets are down. It’s critical to determine the capital gains your client will face this year so decisions can be made to realize the gains or sell positions to minimize tax exposure. Independent advisors can work with their broker-dealer to leverage potentially tax-reducing tools such as a 1031 exchange, or “like-kind” exchange, which would potentially postpone the capital gains tax.

Another popular strategy is tax-loss harvesting, which should be done throughout the year and not just at year-end. Identifying and selling investments that have decreased in value can offset other profits or gains in the client’s portfolio. Clients can offset up to $3,000 per year in ordinary income and the remaining losses can be carried forward to future years.

When it comes to tax-loss harvesting it’s important to remember that advisors can’t place the client in a “substantially identical” position within a 30-day window, pre- or post-sale. So-called “wash sales” can be avoided, though, by replacing the asset for one with a similar goal.

No one knows where the market is headed, so we can only react to what transpires over the course of a given year. While 2022 has seen large declines due to an onslaught of negative news, inflation and geopolitical events, savvy advisors are already having conversations with clients to determine the best tax-advantaged outcomes, while positioning them for whatever surprises 2023 might hold. The most important course of action is clear and consistent communication with clients throughout the year — not just during tax season.

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