TAX PLANNING GUIDE 2022 2023 - Lutz, Selig & Zeronda
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2022 - 2023
TAX
PLANNING
GUIDE
YEAR-ROUND STRATEGIES TO MAKE THE TAX LAWS WORK FOR YOU
33 Century Hill Drive | Latham, NY 12110 | (518) 783-7200
3748 State Hwy 30 | Amsterdam, NY 12010 | (518) 773-2267
420 Lexington Avenue, Suite 300 | New York, NY 10170 | (212) 297-6204
www.lutzseligzeronda.com
Tax planning is a critical challenge
for higher-income taxpayers
M
inimizing taxes is never easy. But in times of legislative and economic uncertainty, it can be a real challenge.
And it’s a critical challenge for higher-income taxpayers subject to higher tax rates and certain additional
taxes, as well as to tax-break phaseouts.
To take advantage of all available breaks, you first need to be aware of relevant tax law changes that are going into
effect — or that have expired. For example, the Inflation Reduction Act, signed into law in August, includes some
tax breaks related to clean energy, plug-in electric vehicles and home energy improvements. But tax provisions
intended to provide relief during the height of the pandemic generally have expired. You also can’t forget about the
massive Tax Cuts and Jobs Act (TCJA) that generally went into effect four years ago but still significantly impacts
tax planning. Finally, you need to keep an eye out for any new tax law changes that might still be signed into law
this year and affect 2022 planning.
This guide provides an overview of some of the key tax provisions higher-income taxpayers need to be aware of.
It offers a variety of strategies for minimizing your taxes in the current tax environment. Use it to identify the best
strategies for your particular situation with your tax advisor, who also can keep you apprised of any new tax law
developments that might affect you.
Contents
Income & Deductions 2 Click here
Executive Compensation 6 Click here
Investing 8 Click here
Real Estate 12 Click here
Business Ownership 14 Click here
Charitable Giving 16 Click here
Family & Education 18 Click here
Retirement 20 Click here
Estate Planning 22 Click here
Tax Rates 24 Click here
2 Income & Deductions
Income and
deduction planning
to minimize 2022 taxes
T
ax rates on “ordinary income” will allow more income to be taxed But with the TCJA’s limit on the state and
are often higher than those that at your current year’s lower rate. And local tax deduction, property tax timing
apply to investment income. deferring expenses will make the deduc- will likely provide little, if any, benefit
(See page 8 for information about tions more valuable, because deductions for higher-income taxpayers. Through
the tax treatment of investments.) save more tax when you’re subject to a 2025, the entire itemized deduction for
Ordinary income generally includes higher tax rate. SALT — including property tax and
salary, income from self-employment either income or sales tax — is limited
or business activities, interest, and dis- Whatever the reason behind your to $10,000 ($5,000 for married taxpayers
tributions from tax-deferred retirement desire to time income and expenses, filing separately).
accounts. Some of it may also be subject you may be able to control the timing
to payroll tax, or you may have to pay of these income items: If you reside in a state with no, or low,
the alternative minimum tax (AMT), income tax, this change might be less
under which different tax rates apply. Bonuses, relevant. But keep in mind that deduct-
ing sales tax instead of income tax may
Deductions are valuable because they Self-employment income, be beneficial, especially if you purchased
reduce the amount of your income U.S. Treasury bill income, and a major item, such as a car or boat.
that’s subject to federal tax — and in
many cases, state tax, too. Retirement plan distributions, to Finally, be aware that increasing or
the extent they won’t be subject eliminating the SALT deduction limit
This is why careful planning for ordi- to early-withdrawal penalties and has been discussed. Check with your
nary income and deductible expenses aren’t required. (See page 20.) tax advisor for the latest information.
is always important.
Some expenses with potentially con- Suspension of miscellaneous item-
trollable timing are investment interest
Timing income and expenses ized deductions subject to the 2%
expense (see page 11), mortgage floor. This deduction for expenses such
Smart timing of income and expenses interest (see page 12), and charitable
can reduce your tax liability, and poor as certain professional fees, investment
contributions (see page 16). expenses and unreimbursed employee
timing can unnecessarily increase it.
When you don’t expect to be subject to business expenses is suspended through
The TCJA is still 2025. While this eliminates the home
the AMT (see page 3) in the current year
or the next year, deferring income to the
affecting timing strategies office deduction for employees who
next year and accelerating deductible Timing income and deductions is more work from home (even if your employer
expenses into the current year may be challenging under the TCJA because has required it), if you’re self-employed,
a good idea. Why? Because it will defer some strategies that taxpayers used you may still be able to deduct home
tax, which usually is beneficial. to implement no longer make sense. office expenses. (See page 12.)
Here’s a look at some significant TCJA
But when you expect to be in a higher tax changes that have affected deductions: More-restricted personal casualty
bracket next year — or you believe tax and theft loss deduction. Through
rates may rise — the opposite approach Reduced deduction for SALT. Property 2025, this itemized deduction is sus-
may be beneficial: Accelerating income tax used to be a popular expense to time. pended except if the loss was due to
an event officially declared a disaster
by the President.
Chart 1 2022 standard deduction Increased standard deduction. The
TCJA nearly doubled the standard
Filing status Standard deduction1 deduction. While many higher-income
taxpayers will still benefit from itemiz-
Singles and separate filers $ 12,950 ing, some — such as those in low-tax
Heads of households $ 19,400 states, who don’t have mortgages or
who aren’t as charitably inclined —
Joint filers $ 25,900
may now save more tax by claiming the
Taxpayers who are age 65 or older or blind can claim an additional standard deduction: $1,400
1
standard deduction. (See Chart 1 for
each if married, $1,750 if unmarried. the 2022 standard deduction amounts.)
Income & Deductions 3
Tax-advantaged you’re age 55 or older). HSAs can Smaller AMT threat
saving for health care bear interest or be invested, growing The top AMT rate is 28%, compared
tax-deferred similar to an IRA. With- to the top regular ordinary-income tax
If medical expenses not paid via tax-
drawals for qualified medical expenses rate of 37%. But the AMT rate typically
advantaged accounts or reimbursable by
are tax-free, and you can carry over a applies to a higher taxable income base.
insurance exceed a certain percentage
balance from year to year. You must pay the AMT if your AMT
of your adjusted gross income (AGI),
you can claim an itemized deduction for liability exceeds your regular tax liability.
the amount exceeding that “floor.” This FSA. You can redirect pretax income to an
floor can be difficult for higher-income employer-sponsored Flexible Spending The TCJA substantially increases the
taxpayers to exceed. Account up to an employer-determined AMT exemptions through 2025. (See
limit — not to exceed $2,850 in 2022. The Chart 8 on page 24.) This means fewer
plan pays or reimburses you for qualified taxpayers now have to pay the AMT.
Fortunately, the 7.5% floor that had in
medical expenses. (If you have an HSA,
recent years been a temporary reduction
your FSA is limited to funding certain
from 10% is now permanent. In addition, deductions used to calculate
permitted expenses.) What you don’t
regular tax that aren’t allowed under the
use by the plan year’s end, you generally
Deductible expenses may include AMT can trigger AMT liability, and there
lose — though your plan might give
health insurance premiums, medical aren’t as many differences between
you a 21/2-month grace period to incur
and dental services, prescription drugs, what’s deductible for AMT purposes
expenses to use up the previous year’s
and long-term-care insurance pre- and regular tax purposes. (See Chart 2
contribution. Or it might allow you to roll
miums (limits apply). Mileage driven on page 4.) This also reduces AMT risk.
over up to $570 to 2023. Warning: Some
for health care purposes also can be However, the AMT will remain a threat
provisions allowing added FSA flexibility
deducted — at 18 cents per mile for for some higher-income taxpayers.
because of the pandemic have expired.
Jan. 1 – June 30, 2022, and at 22 cents
per mile for July 1 – Dec. 31, 2022.
Case
Consider whether there are any medical Study 1
Bunching medical expenses to save taxes
services and purchases you could bunch
into alternating years. This could save 2022 has been a tough year for
tax if it would help you exceed the Eric and Heather. The married
applicable floor and you’d have enough couple’s business has been
total itemized deductions to benefit struggling, so they project their
from itemizing. (See Case Study 1.) Of income will be lower than usual.
course, your and your family’s health Eric had knee replacement sur-
is more important than tax savings, so gery in January, which caused
don’t adjust timing in a way that would the couple’s medical expenses
be harmful health-wise. to be higher than normal in
2022. So although Eric and
Heather don’t normally have
If one spouse has high medical sufficient medical (including
expenses and a relatively lower AGI, dental and vision) expenses
filing separately may allow that spouse to exceed the 7.5% adjusted
to exceed the AGI floor and deduct gross income (AGI) floor, it’s
some medical expenses that wouldn’t looking like they will this year.
be deductible if the couple filed jointly.
Fortunately, their prospects are
Warning: Because the AMT exemp-
much brighter for 2023: The
tion for separate returns is considerably couple’s business is starting
lower than the exemption for joint to show signs of a turnaround, Eric’s knee is healing well and the biggest medical
returns, filing separately to exceed the expense they anticipate next year is elective surgery for Heather that will be mostly
floor could trigger the AMT. covered by insurance. The downside of this potential prosperity is that there’s a
chance the couple won’t exceed the medical expense deduction AGI floor in 2023.
You may be able to save taxes without
So, Eric and Heather decide to accelerate and pay what medical expenses they
having to worry about the medical can in 2022 to take advantage of the deduction:
expense deduction floor by contributing
to one of these accounts: Heather schedules her surgery for late 2022 instead of early 2023. $ 10,000
Eric and Heather undergo eye exams and get new glasses and contact
HSA. If you’re covered by a qualified lenses in 2022, which they otherwise would have done in 2023. 3,000
high deductible health plan, you can
contribute pretax income to an employer- They move their normal January dentist appointments to late November.
Eric also has some follow-up dental work done in December. 5,000
sponsored Health Savings Account — or
make deductible contributions to an Total additional deduction $ 18,000
HSA you set up yourself — up to $3,650
Federal tax rate 32%
for self-only coverage and $7,300 for
family coverage for 2022 (plus $1,000 if Tax savings $ 5,760
4 Income & Deductions
So before timing your income and for Social Security tax and 1.45% for
expenses, determine whether you’re Medicare tax) is deductible above the
already likely to be subject to the line. Warning: The first half of any
AMT — or whether the actions you’re 2020 Social Security tax deferred under
considering might trigger it. In addition the CARES Act was due by Dec. 31,
to deduction differences, some income 2021, and the second half is due by
items might trigger or increase AMT Dec. 31, 2022.
liability, such as:
As a self-employed taxpayer, you may
Long-term capital gains and qualified benefit from other above-the-line
dividend income, deductions as well. You can deduct 100%
of health insurance costs for yourself,
Accelerated depreciation adjustments
your spouse and your dependents, up
and related gain or loss differences
to your net self-employment income.
when assets are sold, and
You also can deduct contributions to a
Tax-exempt interest on certain retirement plan and, if you’re eligible,
private-activity municipal bonds. an HSA for yourself. And you might be
(For an exception, see the warning able to deduct home office expenses.
on page 11.) (See page 12.)
Finally, in certain situations exercising Payroll taxes Above-the-line deductions are particu-
incentive stock options (ISOs) can In addition to income tax, you must larly valuable because they reduce your
trigger significant AMT liability. (See pay Social Security and Medicare taxes AGI and, depending on the specific
the warning at the top of page 7.) on earned income, such as salary and deduction, your modified AGI (MAGI).
bonuses. The 12.4% Social Security tax AGI and MAGI are important because
Avoiding or reducing AMT applies only up to the Social Security they’re the triggers for certain addi-
wage base of $147,000 for 2022. All tional taxes and the phaseouts of many
With proper planning, you may be able
earned income is subject to the 2.9% tax breaks.
to avoid the AMT, reduce its impact
Medicare tax. Both taxes are split
or even take advantage of its lower
equally between the employee and Additional 0.9% Medicare tax
maximum rate:
the employer.
Another payroll tax that higher-income
If you could be subject to the AMT taxpayers must be aware of is the addi-
this year … consider accelerating
Self-employment taxes tional 0.9% Medicare tax. It applies to
income into this year, which may If you’re self-employed, you pay both FICA wages and net self-employment
allow you to benefit from the lower the employee and employer portions of income exceeding $200,000 per year
maximum AMT rate. And deferring payroll taxes on your self-employment ($250,000 if married filing jointly and
expenses you can’t deduct for AMT income. The employer portion (6.2% $125,000 if married filing separately).
purposes may allow you to preserve
those deductions. (But watch out
for the annual limit on the state What itemized deductions may
and local tax deduction.) If you also Chart 2
also be deductible for AMT purposes?
defer expenses you can deduct for
AMT purposes, the deductions may Regular
become more valuable because of Expense tax AMT For more information
the higher maximum regular tax
See “The TCJA is still affecting
rate. Finally, carefully consider the State and local income tax
timing strategies” on page 2.
tax consequences of exercising ISOs.
See “Home-related
Property tax
deductions” on page 12.
If you could be subject to the
AMT next year … consider taking See “Home-related
Mortgage interest
the opposite approach. For instance, deductions” on page 12.
defer income to next year, because Interest on home equity debt
See “Home-related
you’ll likely pay a relatively lower AMT used to improve your principal
deductions” on page 12.
rate. Also, before year end consider residence or second residence
selling any private-activity municipal See “Investment interest
bonds whose interest could be subject Investment interest
expenses” on page 11.
to the AMT.
See “Tax-advantaged saving
Medical expenses
for health care” on page 3.
Also be aware that, in certain circum-
stances, you may be entitled to an Charitable contributions See page 16.
AMT credit.
Income & Deductions 5
If your wages or self-employment
income varies significantly from year
Case
to year or you’re nearing the threshold
Study 2
Avoiding underpayment penalties
for triggering the additional Medicare
tax, income timing strategies may help
you avoid or minimize it. For example:
If you’re an employee, perhaps you
can time when you receive a bonus
or exercise stock options.
If you’re self-employed, you may
have flexibility on when you pur-
chase new equipment or invoice
customers.
If you’re an S corporation
shareholder-employee, you might
save tax by adjusting how much you
Jessica works full-time, but she also does some consulting on the side, and her busy
receive as salary vs. distributions.
season tends to be the last quarter of the year. She is always careful to make quarterly
(See “Owner-employees” below.)
estimated tax payments on time, but when she met with a tax advisor about her 2021
tax return, she learned she would be subject to underpayment penalties.
Also consider the withholding rules.
Employers must withhold the addi- Why? Because her consulting income spiked at the end of the year, and she hadn’t
tional tax beginning in the pay period paid enough tax during the year through estimated tax payments and withholding.
She couldn’t satisfy any of the exceptions, so she was subject to the underpayment
when wages exceed $200,000 for the
penalty for 2021.
calendar year — without regard to an
employee’s filing status or income from Here are some strategies that Jessica’s advisor suggested she could use to avoid
other sources. So your employer might facing underpayment penalties for 2022:
withhold the tax even if you aren’t Know the minimum payment rules. For you to avoid penalties, your estimated
liable for it — or it might not withhold payments and withholding must equal at least 90% of your tax liability for 2022 or
the tax even though you are liable for it. 110% of your 2021 tax (100% if your 2021 adjusted gross income was $150,000
or less or, if married filing separately, $75,000 or less).
If you don’t owe the tax but your
Use the annualized income installment method. This method often benefits
employer is withholding it, you can
taxpayers who have large variability in income from month to month due to bonuses,
claim a credit on your 2022 income tax investment gains and losses, or seasonal income (at least if it’s skewed toward the
return. If you do owe the tax but your end of the year). Annualizing computes the tax due based on income, gains, losses
employer isn’t withholding it, consider and deductions through each estimated tax period.
increasing your income tax withholding,
which can be used to cover the shortfall Estimate your tax liability and increase withholding. If you determine you’ve
and avoid interest and penalties. Or underpaid, consider having the tax shortfall withheld from your salary or year-end
bonus by Dec. 31. Because withholding is considered to have been paid ratably
make estimated tax payments.
throughout the year, this is often a better strategy than making up the difference
with an increased quarterly tax payment, which may still leave you exposed to
Owner-employees penalties for earlier quarters.
There are special considerations if
you’re a business owner who also
works in the business, depending on S corporations. Only income you taxes and, if applicable, the 0.9%
its structure: receive as salary is subject to payroll Medicare tax. Nonetheless, you may
taxes and, if applicable, the 0.9% prefer to take more income as salary
Partnerships and limited liability Medicare tax. To reduce these taxes, (which is deductible at the corporate
companies. Generally, all trade or you may want to keep your salary level) as opposed to dividends (which
business income that flows through relatively — but not unreasonably — aren’t deductible at the corporate level
to you for income tax purposes is low and increase the income that is yet are still taxed at the shareholder
subject to self-employment taxes — taxed to you through your Schedule K-1 level and could be subject to the 3.8%
even if it isn’t distributed to you. But by virtue of your share of the earnings NIIT) if the overall tax paid by both the
such income may not be subject to from the business. That income isn’t corporation and you would be less.
self-employment taxes if you’re a subject to the corporate level tax or the
limited partner or the limited liability 0.9% Medicare tax and, typically, isn’t Warning: The IRS scrutinizes corporate
company member equivalent. Check subject to the 3.8% NIIT. payments to shareholder-employees
with your tax advisor on whether the for possible misclassification, so tread
0.9% Medicare tax or the 3.8% NIIT C corporations. Only income you carefully.
(see page 11) will apply. receive as salary is subject to payroll
6 Executive Compensation
Smart tax planning for your
exec comp package is crucial
C
ompensation may take several the stock’s fair market value (FMV) at There are some potential disadvan-
forms, including salary, fringe your ordinary-income rate. (The FMV tages of a Section 83(b) election,
benefits and bonuses. If you’re will be considered FICA income, so it however. First, prepaying tax in the
an executive or other key employee, could trigger or increase your exposure current year could push you into a
you might receive stock-based com- to the additional 0.9% Medicare tax. higher income tax bracket and trigger
pensation, such as restricted stock, See page 4.) or increase your exposure to the
restricted stock units (RSUs) or additional 0.9% Medicare tax. But if
stock options (either incentive or But with a Section 83(b) election, you your company is in the earlier stages of
nonqualified). Nonqualified deferred can instead opt to recognize ordinary development, the income recognized
compensation (NQDC) may also be income when you receive the stock. may be relatively small.
included in your exec comp package. This election, which you must make
The tax consequences of these types within 30 days after receiving the stock, Second, any taxes you pay because of
of compensation can be complex — allows you to convert potential future the election can’t be refunded if you
subject to ordinary income, capital appreciation from ordinary income to eventually forfeit the stock or sell it
gains, payroll and other taxes. So long-term capital gains income and at a decreased value. However, you’d
smart tax planning is crucial. defer it until the stock is sold. have a capital loss in those situations.
Restricted stock The election can be beneficial if the Third, when you sell the shares, any
Restricted stock is stock your employer income at the grant date is negligible gain will be included in net investment
grants to you subject to a substantial or the stock is likely to appreciate income and could trigger or increase
risk of forfeiture. Income recognition significantly before income would your liability for the 3.8% NIIT. (See
is normally deferred until the stock otherwise be recognized. And with page 11.)
is no longer subject to that risk (that ordinary-income rates now especially
is, it’s vested) or you sell it. When the low under the TCJA, it might be a Work with your tax advisor to map
restriction lapses, you pay taxes on good time to recognize income. out whether the Sec. 83(b) election is
appropriate for your situation. You also
might be eligible for a tax break under
the TCJA that allows for the deferral
Case of tax on stock-based compensation
Study 3
Watch out for falling stock prices after exercising ISOs
in certain circumstances. Generally,
it gives taxpayers the opportunity to
Zane was granted incentive stock match the taxation of restricted stock
options to buy 50,000 shares of his
and stock options with the timing of
company’s stock at $15 a share.
the sale of the stock. It’s intended for
When he first became eligible one situations in which there is no ready
year later, Zane exercised 10,000 market for the sale of the stock.
shares at the trading price of $25.
He might be subject to an alternative The availability of the deferral oppor-
minimum tax (AMT) liability as high as
tunity is limited, however. It gener-
$28,000. That’s because the exercise
ally will apply only if at least 80% of
results in a $100,000 tax preference
item on the bargain element (the
full-time employees are covered by
difference between the $250,000 the stock-based compensation plan.
trading price and the $150,000 exercise price), which could be taxed at the top
AMT rate of 28%. This might be a problem, because exercising the option doesn’t RSUs
generate any cash with which to pay the tax. RSUs are contractual rights to receive
The problem is magnified if the stock price drops after the exercise. For example, stock, or its cash value, after the award
if Zane pays the AMT but the trading price per share later falls back to $15, he’ll has vested. Unlike restricted stock, RSUs
have paid the tax even though the selling price of his shares is equal to the price aren’t eligible for the Sec. 83(b) election.
he paid for them. Fortunately, he’ll be able to claim a credit in future years for the So there’s no opportunity to convert
AMT paid. ordinary income into capital gains.
Executive Compensation 7
But they do offer a limited ability to Warning: If you don’t sell the stock in under “Restricted stock.” With your tax
defer income taxes: Unlike restricted the year of exercise, a tax “preference” advisor, evaluate the risks and crunch
stock, which becomes taxable imme- item is created for the difference between the numbers to determine the best
diately upon vesting, RSUs aren’t the stock’s FMV and the exercise price strategy for you.
taxable until the employee actually (the “bargain element”) that can trigger
receives the stock. So rather than the alternative minimum tax (AMT). NQSOs
having the stock delivered immedi- (See Case Study 3.) A future AMT credit,
The tax treatment of nonqualified
ately upon vesting, you may be able however, should mitigate this AMT hit.
stock options is different from the
to arrange with your employer to Plus, you may now be at lower AMT risk
tax treatment of ISOs: NQSOs create
delay delivery. because of the higher AMT exemption
compensation income (taxed at
and exemption phaseout range under
ordinary-income rates) on the bargain
Such a delay will defer income tax the TCJA. (See Chart 8 on page 24.)
element when exercised (regardless
and may allow you to reduce or Consult your tax advisor because the
of whether the stock is held or sold
avoid exposure to the additional 0.9% rules are complex.
immediately), but they don’t create an
Medicare tax (because the RSUs are AMT preference item.
treated as FICA income). However, If you’ve received ISOs, plan carefully
any income deferral must satisfy the when to exercise them and whether
You may need to make estimated tax
strict requirements of Internal Revenue to immediately sell shares received
payments or increase withholding to
Code Section 409A. Also keep in mind from an exercise or hold them. Waiting
fully cover the tax on the exercise. Keep
that it might be better to recognize to exercise ISOs until just before the
in mind that an exercise could trigger
income now because of the currently expiration date (when the stock value
or increase exposure to top tax rates,
low tax rates. may be the highest, assuming the stock
the additional 0.9% Medicare tax and
is appreciating) and holding on to the
the NIIT.
ISOs stock long enough to garner long-term
capital gains treatment often is ben-
Incentive stock options allow you to NQDC plans
eficial. But there’s also market risk to
buy company stock in the future (but
consider. Plus, acting earlier can be These plans pay executives in the future
before a set expiration date) at a fixed
advantageous in several situations: for services to be currently performed.
price equal to or greater than the
They differ from qualified plans, such as
stock’s FMV at the date of the grant.
Exercise early to start the holding 401(k)s, in several ways. For example,
Thus, ISOs don’t provide a benefit
period so you can sell and receive unlike 401(k) plans, NQDC plans can
until the stock appreciates in value.
long-term capital gains treatment favor highly compensated employees,
If it does, you can buy shares at a
sooner. but plan funding isn’t protected from
price below what they’re then trading
the employer’s creditors. (For more on
for, provided you’re eligible to exercise Exercise when the bargain element 401(k)s, see page 20.)
the options. is small or when the market price is
close to bottoming out to reduce or One important NQDC tax issue is
ISOs receive tax-favored treatment but eliminate AMT liability. that payroll taxes (see page 4) are
must comply with many rules. Here are
Exercise annually so you can buy generally due once services have been
the key tax consequences:
only the number of shares that will performed and there’s no longer a
achieve a breakeven point between substantial risk of forfeiture — even
You owe no tax when ISOs are though compensation may not be
the AMT and regular tax and thereby
granted. paid or recognized for income tax
incur no additional tax.
You owe no regular income tax purposes until much later. So your
Sell in a disqualifying disposition employer may withhold your portion
when you exercise the ISOs.
and pay the higher ordinary-income of the payroll taxes from your salary
If you sell the stock after holding rate to avoid the AMT on potentially or ask you to write a check for the
the options for at least one year disappearing appreciation. liability. Or it may pay your portion,
and then holding the shares for in which case you’ll have additional
at least one year from the exercise On the negative side, exercising early taxable income. Warning: The
date, you pay tax on the sale at accelerates the need for funds to buy additional 0.9% Medicare tax could
your long-term capital gains rate. the stock, exposes you to a loss if the also apply.
You also may owe the NIIT. shares’ value drops below your exercise
cost, and may create a tax cost if the Keep in mind that the rules for NQDC
If you sell the stock before long-term
preference item from the exercise gen- plans are tighter than they once were,
capital gains treatment applies, a
erates an AMT liability. and the penalties for noncompliance
“disqualifying disposition” occurs
and any gain is taxed as compen- can be severe: You could be taxed on
sation at ordinary-income rates. The timing of ISO exercises also could plan benefits at the time of vesting, and
(Disqualified dispositions aren’t, positively or negatively affect your a 20% penalty and potential interest
however, subject to FICA and Medi- liability for higher tax rates and the charges also could apply. So check
care tax, including the additional NIIT. You also might be eligible for tax with your employer to make sure it’s
0.9% Medicare tax.) deferral under the TCJA, as described addressing any compliance issues. 
8 Investing
The ins and outs of tax
planning for investments
T
ax treatment of investments varies Being tax-smart with losses as wages, self-employment and busi-
dramatically based on factors Losses aren’t truly losses until they’re ness income, interest, dividends, and
such as type of investment, type realized — that is, generally until you taxable retirement plan distributions).
of income it produces, how long you’ve sell the investment for less than what But you can carry forward excess losses
held it and whether any special limita- you paid for it. So while it’s distressing until death.
tions or breaks apply. And higher-income to see an account statement that shows
taxpayers generally face higher tax rates a large loss, the loss won’t affect your If you don’t have enough gains to
on their investment income. current tax situation as long as you still absorb losses, you could be left with
own the investment. losses in excess of the annual ordinary-
But there are many additional factors income deduction limit. So think twice
to evaluate before deciding whether Realized capital losses are netted before selling an investment at a loss.
to sell or hold an investment, such as against realized capital gains to After all, if you hold on to the invest-
investment goals, time horizon, risk determine capital gains tax liability. ment, it may recover the lost value. In
tolerance, factors related to the invest- If net losses exceed net gains, you can fact, a buy-and-hold strategy works
ment itself, fees and charges that apply deduct only $3,000 ($1,500 for married well for many long-term investors
to buying and selling securities, and taxpayers filing separately) of losses because it can minimize the effects of
your need for cash. Nevertheless, taxes per year against ordinary income (such market volatility.
are still important to consider.
Capital gains tax and timing
Although time, not timing, is generally Chart 3 What’s the maximum 2022 capital gains tax rate?
the key to long-term investment success,
timing can have a dramatic impact on the Type of gain Rate1
tax consequences of investment activities.
Taxpayer’s ordinary-
Your marginal long-term capital gains Short-term (assets held 12 months or less)
income tax rate
rate can be as much as 20 percentage
points lower than your ordinary-income Long-term (assets held more than 12 months) 15%
tax rate. Some key exceptions
The long-term capital gains rate applies Long-term gain of certain higher-income taxpayers 20%2
to investments held for more than 12 Most long-term gain that would be taxed at 10% or 12%
0%
months. The applicable rate depends based on the taxpayer’s ordinary-income rate
on your income level and the type of Long-term gain on collectibles, such as artwork
asset you’ve sold. (See Chart 3.) 28%
and antiques
Long-term gain attributable to unrecaptured depreciation
Under the TCJA, through 2025, the 25%
on real property
top long-term gains rate of 20% kicks
in before the top ordinary-income Gain on qualified small business (QSB) stock held more
rate does. (See Chart 8 on page 24.) than 5 years
Lawmakers could, however, make Acquired before Feb. 18, 2009 14%3
changes to the rates sooner. Higher
Acquired on or after Feb. 18, 2009, and before
rates already apply to certain types of 7%4
Sept. 28, 2010
assets. (See Chart 3.)
Acquired on or after Sept. 28, 2010 0%
Holding on to an investment until 1
In addition, the 3.8% net investment income tax (NIIT) applies to net investment income to the
you’ve owned it more than one year extent that modified adjusted gross income (MAGI) exceeds $200,000 (singles and heads of
may help substantially cut tax on any households), $250,000 (married filing jointly) or $125,000 (married filing separately).
gain. Keeping it even longer can also
2
The 20% rate applies only to those with taxable income exceeding $459,750 (singles), $488,500
(heads of households), $517,200 (joint filers) or $258,600 (separate filers).
make tax sense. But be sure to look at 3
Effective rate based on a 50% exclusion from a 28% rate.
your specific situation, and keep an 4
Effective rate based on a 75% exclusion from a 28% rate.
eye out for possible tax law changes.
Investing 9
Of course, an investment might continue
to lose value. That’s one reason why tax
Case
considerations shouldn’t be the primary
Study 4
Use capital losses to absorb unrecognized gains
driver of investment decisions. If you’re
ready to divest yourself of a poorly per- Mirabel’s year-to-date net realized
forming stock because, for example, losses are $53,000. Her portfolio
you don’t think its performance will includes $100,000 of stock that
improve or your investment objective she paid only $50,000 for. Mirabel
or risk tolerance has changed, don’t has been thinking about selling it to
hesitate solely for tax reasons. diversify her portfolio and because
year-to-date the stock had dropped
Plus, building up losses for future from $130,000 to $100,000 in value
use could be beneficial. This may be and she’s not confident it will recover.
especially true if you have a large But she’s been concerned about the
investment portfolio, real estate capital gains tax.
holdings or a closely held business
Her tax advisor suggests that now might be a good time to sell the stock because
that might generate substantial
her $50,000 gain would essentially be tax-free: The gain would absorb $50,000 of
future gains, or if tax rates increase. losses, leaving Mirabel with a $3,000 net loss, the maximum that she could use to
offset ordinary income.
Finally, remember that capital gains
distributions from mutual funds can
also absorb capital losses. Warning: You can’t avoid the wash Why? The distribution itself is a taxable
sale rule by selling stock at a loss in event. If capital gains distributions
Wash sale rule a taxable account and purchasing from the mutual fund are reinvested in
If you want to achieve a tax loss with the same stock within 30 days in a the fund, the distribution itself doesn’t
minimal change in your portfolio’s tax-advantaged retirement account. change your value in the fund. It simply
asset allocation, consider the wash sale increases the number of shares you
rule. It prevents you from taking a loss Mutual funds own, yet now at a lower per-share value.
on a security if you buy a substantially Investing in mutual funds is an easy
identical security (or an option to buy way to diversify your portfolio. But Small business stock
such a security) within 30 days before beware of the tax pitfalls. By purchasing stock in certain small
or after you sell the security that created businesses, you can diversify your port-
the loss. You can recognize the loss only First, mutual funds with high turnover folio. You also may enjoy preferential
when you sell the replacement security. rates can create income that’s taxed at tax treatment:
ordinary-income rates. Choosing funds
Fortunately, there are ways to avoid that provide primarily long-term gains Conversion of capital loss to ordinary
triggering the wash sale rule and still can save you more tax dollars because loss. If you sell qualifying Section 1244
achieve your goals. For example, you can: of the lower long-term rates. small business stock at a loss, you can
treat up to $50,000 ($100,000, if married
Sell the security and immediately Second, earnings on mutual funds are filing jointly) as an ordinary, rather than a
buy securities of a different company typically reinvested. Unless you or your capital, loss — regardless of your holding
in the same industry or shares in a investment advisor records increases period. This means you can use it to
mutual fund that holds securities in your tax basis accordingly, you may offset ordinary income, reducing your tax
much like the ones you sold, report more gain than required when by as much as 37% of this portion of the
you sell the fund. Brokerage firms are loss. Sec. 1244 applies only if total capital
Sell the security and wait 31 days to
required to track (and report to the invested isn’t more than $1 million.
repurchase the same security, or
IRS) your cost basis in mutual funds
Before selling the security, purchase acquired in recent years. Tax-free gain rollovers. If within 60
additional shares of that security days of selling qualified small business
equal to the number you want to Third, buying equity mutual fund (QSB) stock you buy other QSB stock
sell at a loss, and then wait 31 days shares late in the year can be costly with the proceeds, you can defer the
to sell the original portion. taxwise. These funds often make capital tax on your gain until you dispose of
gains distributions toward year end. the new stock. The rolled-over gain
Alternatively, you can do a bond swap, If you purchase shares before such reduces your basis in the new stock.
where you sell a bond, take a loss and a distribution, you’ll end up with a For determining long-term capital
then immediately buy another bond capital gain, reportable on your tax gains treatment, the new stock’s hold-
of similar quality and duration from a return for the year of the distribution. ing period includes the holding period
different issuer. Generally, the wash sale It doesn’t matter whether the actual of the stock you sold. To be a QSB, a
rule doesn’t apply because the bonds value of the shares has increased or business must be engaged in an active
aren’t considered substantially identical. even decreased since you purchased trade or business and must not have
Thus, you can achieve a tax loss with vir- them, or whether you reinvest the assets that exceed $50 million, among
tually no change in economic position. proceeds back into the same fund. other requirements.10 Investing
Exclusion of gain. Generally, tax-
payers selling QSB stock are allowed
Case
to exclude up to 100% of their gain if
Study 5
How to qualify for the 0% capital gains rate
they’ve held the stock for more than
five years. But, depending on the Faced with a long-term capital gains
acquisition date, the exclusion may tax rate of 23.8% (20% for the top
be less: The exclusion is 75% for stock tax bracket, plus the 3.8% NIIT),
acquired on or after Feb. 18, 2009, and Marc and Angela decide to give some
before Sept. 28, 2010; it’s 50% for stock appreciated stock to their adult son,
acquired before Feb. 18, 2009. Jacob. Just out of college and making
only enough from his entry-level job
When the exclusion is less than 100%, to leave him with $25,000 in taxable
the taxable portion of any QSB gain income, Jacob falls into the 12%
ordinary-income tax bracket and the
will be subject to the lesser of your
0% long-term capital gains bracket.
ordinary-income rate or 28%, rather
than the normal long-term gains rate. However, the 0% rate applies only to
(See Chart 3 on page 8.) Thus, if the the extent that capital gains “fill up”
28% rate and the 50% exclusion apply, the gap between Jacob’s taxable
the effective rate on the QSB gain will income and the top end of the 0%
be 14% (28% × 50%). bracket. For 2022, the 0% bracket
for singles tops out at $41,675 (just
$100 less than the top of the 12%
Keep in mind that all three of these ordinary-income bracket). So if Jacob sells the stock his parents transferred to him
tax benefits are subject to additional and his gains are $16,000, the entire amount will qualify for the 0% rate. The sale
requirements and limits. Consult your will be tax-free vs. the $3,808 Marc and Angela would have owed had they sold
tax and financial advisors to be sure the stock themselves.
an investment in small business stock
is right for you. Warning: If Jacob had been subject to the “kiddie tax” (see page 18), the results
would have been quite different. It’s also important to consider any gift tax conse-
quences before transferring stock. (See page 22.)
Passive activities
If you’ve invested in a trade or business
in which you don’t materially partici- If you don’t pass the material participa- Even if you do pass the material
pate and where income or loss flows tion test, consider: participation test, be aware that
through to your tax return, remember your loss deduction might be affected
the passive activity rules. Why? Passive Increasing your involvement. If you by the TCJA’s rules for deducting
activity income may be subject to the can exceed 500 hours, the activity no lon- business losses. (See “Loss deductions”
3.8% NIIT (see page 11), and passive ger will be subject to passive activity rules. on page 14.)
activity losses generally are deductible
only against income from other passive Grouping activities. You may be able Income investments
activities. You can carry forward disal- to group certain activities together to be Qualified dividends are taxed at the
lowed losses, subject to the same limits treated as one activity for tax purposes favorable long-term capital gains
each tax year. and exceed the 500-hour threshold. But tax rate rather than at your higher
the rules are complex, and there are ordinary-income tax rate. Interest
To avoid passive activity treatment, potential downsides to consider. income, however, generally is taxed
you must “materially participate” in
at ordinary-income rates. So stocks
the activity, which typically means Looking at other activities. If you have that pay qualified dividends may be
you must participate in the trade or passive losses, one option is to limit your more attractive taxwise than other
business more than 500 hours during participation in another activity that’s income investments, such as CDs
the year or demonstrate that your generating net income, so that you don’t and taxable bonds.
involvement constitutes substantially meet the 500-hour test. Another is to
all of the participation in the activity. invest in an additional income-producing Some dividends are already subject to
But there are other ways to meet the trade or business that will be passive to ordinary-income rates. These include
material participation test. Plus, there you. Under both strategies, you’ll have certain dividends from:
are special rules that apply to real passive income that can absorb some or
estate. (See page 13.) all of your passive losses. Real estate investment trusts (REITs),
To help ensure your hours claim will be Disposing of the activity. This generally Regulated investment companies
able to withstand IRS scrutiny, carefully allows you to deduct all passive losses — (RICs),
track and document your time. Contem- including any loss on disposition (subject
poraneous recordkeeping is better than Money market mutual funds, and
to basis and capital loss limitations). But,
records that are created after the fact. again, the rules are complex. Certain foreign investments.Investing 11
Also note that the tax treatment of Keep in mind that state and municipal Net investment income can include
bond income varies. For example: bonds usually pay a lower interest rate. capital gains, dividends, interest, passive
(See Case Study 6.) business income, rental income and
Corporate bond interest is fully other investment-related income. But it
taxable for federal and state Warning: Tax-exempt interest from doesn’t include business or self-rental
purposes. private-activity municipal bonds can income from an active trade or business.
trigger or increase alternative minimum
Bonds (except U.S. savings bonds)
tax (AMT). liability. However, any income Many of the strategies that can help
with original issue discount (OID)
from tax-exempt bonds issued in 2009 you save or defer income tax on your
build up “interest” as they rise
and 2010 (along with 2009 and 2010 investments can also help you avoid
toward maturity. You’re generally
re-fundings of bonds issued after Dec. 31, or defer NIIT liability. And because
considered to earn a portion of
2003, and before Jan. 1, 2009) is excluded the threshold for the NIIT is based
that interest annually — even
from the AMT. And AMT is less of a risk on MAGI, strategies that reduce your
though the bonds don’t pay this
for most taxpayers now. (See page 3.) MAGI — such as making retirement
interest annually — and you must
plan contributions (see page 20) —
pay tax on it.
3.8% NIIT could also help you avoid or reduce
Interest on U.S. government bonds NIIT liability.
Taxpayers with modified adjusted gross
is taxable on federal returns but income (MAGI) over $200,000 ($250,000
exempt by federal law on state and if married filing jointly and $125,000 if Investment interest expense
local returns. married filing separately) may owe the Interest on debt used to buy assets
Interest on state and local govern- net investment income tax (NIIT) on top held for investment, such as margin
ment bonds is excludable on federal of whatever other tax they owe on their debt used to buy securities, generally
returns. If the bonds were issued in investment income. The NIIT equals is deductible for both regular tax and
your home state, interest also may 3.8% of the lesser of net investment AMT purposes. But special rules apply.
be excludable on your state return, income or the amount by which MAGI
depending on the state. exceeds the applicable threshold. Your investment interest expense
deduction is limited to your net
investment income, which, for the
purposes of this deduction, generally
Case includes taxable interest, nonqualified
Study 6
Tax-exempt or taxable bonds? It’s a question of yield
dividends and net short-term capital
gains (but not long-term capital
Working with his financial advisor, gains), reduced by other investment
Bob decides he needs more bonds expenses. Any disallowed interest
in his investment portfolio. He’s in the expense is carried forward, and you
37% bracket, so he’s leaning toward
can deduct it in a later year against
municipal bonds. After all, munici-
net investment income.
pal bond interest will be tax-free on
Bob’s federal return.
You may elect to treat all or a portion of
But the fact that an investment is net long-term capital gains or qualified
tax-exempt doesn’t necessarily make dividends as investment income in
it a better choice than a comparable
order to deduct more of your investment
taxable investment. Municipal bonds
interest expense. But if you do, that
typically offer lower yields than com-
parable corporate bonds. To make portion of the long-term capital gain
a fair comparison, Bob needs to or dividend will be taxed at ordinary-
calculate the tax-equivalent yield — income rates.
which incorporates tax savings into
the municipal bond’s yield — using Payments a short seller makes to the
this formula: stock lender in lieu of dividends may
Tax-equivalent yield = actual yield / (1 – Bob’s marginal tax rate)
be deductible as investment interest
expense. But interest on debt used
For example, Bob considers a municipal bond with a 4.00% yield and a compara- to buy securities that pay tax-exempt
ble corporate bond that offers a 6.25% yield. Because he’s in the 37% tax bracket, income, such as municipal bonds, isn’t
the municipal bond’s tax-equivalent yield is .04 / (1 – .37) = .0635, or 6.35%. deductible.
In terms of the amount of income he’ll get to keep, the municipal bond is a slightly
better choice. If the municipal bond is also exempt from state and local taxes, it’s Also keep in mind that passive interest
an even better choice. expense — interest on debt incurred to
fund a passive activity — becomes part
But Bob also needs to consider factors such as risk and how well each bond will
help achieve his overall investment goals. of your overall passive activity income
or loss, subject to limitations. 12 Real Estate
Making the most of tax
breaks for your home
and investment real estate
T
here are many ways you can max- income (AGI) floor. (See page 2.) But personal use of the home. However,
imize the tax benefits associated the self-employed can still claim the you can take the personal portion of
with owning a principal residence, deduction if their home office is their property tax as an itemized deduction
vacation home or rental property. Tax principal place of business (or used (subject to the SALT limit).
planning is also important if you’d like substantially and regularly to conduct
to sell your home or other real estate business) and that’s the space’s only use. Nonrental property. You can deduct
this year. But don’t forget about the rental expenses only to the extent of
TCJA. It impacts some home-related They can deduct from their self- your rental or other passive income.
deductions and some tax breaks for employment income a portion of their Any excess can be carried forward to
real estate investors and other real mortgage interest, property taxes, offset rental income in future years. You
property businesses. insurance, utilities and certain other also can take an itemized deduction for
expenses, and the depreciation alloca- the personal portion of both mortgage
Home-related deductions ble to the space. Or they can use the interest and property taxes, subject to
Consider these itemized deductions in simplified method for calculating the the applicable limits. In some instances,
your tax planning: deduction — $5 per square foot for up it may be beneficial to reduce personal
to 300 square feet. Although taxpayers use of a residence so it will be classified
using this method won’t be able to as a rental property.
Property tax deduction. Under the
depreciate the portion of their home
TCJA, through 2025, the property
that’s used as an office, they can claim Home sales
tax deduction is subject to a $10,000
mortgage interest, property taxes and
limit ($5,000 if you’re married filing When you sell your principal residence,
casualty losses as itemized deductions
separately) on combined deductions you can exclude up to $250,000 of gain
to the extent otherwise allowable, with-
for state and local taxes (SALT). (See ($500,000 for married couples filing
out needing to apportion them between
page 2 for more details.) jointly) if you meet certain tests. Gain
personal and business use of the home.
that qualifies for exclusion will also
Mortgage interest deduction. You be excluded from the 3.8% NIIT. (See
generally can deduct interest on mort- Home rental rules page 11.) To support an accurate tax
gage debt incurred to purchase, build If you rent out all or a portion of your basis, maintain thorough records,
or improve your principal residence principal residence or second home for including information on your original
and a second residence. Points paid less than 15 days during the year, you cost and subsequent improvements,
related to your principal residence don’t have to report the income. But reduced by any casualty losses and
also may be deductible. Through 2025, expenses directly associated with the depreciation claimed based on business
the TCJA reduces the mortgage debt rental, such as advertising and cleaning, use. Warning: Gain that’s allocable to
limit from $1 million to $750,000 for won’t be deductible. a period of “nonqualified” use generally
debt incurred after Dec. 15, 2017 (from isn’t excludable.
$500,000 to $375,000, for separate If you rent out your principal residence
filers), with some limited exceptions. or second home for 15 days or more, Losses on the sale of any personal
you’ll have to report the income. But you residence aren’t deductible. But if part
Home equity debt interest deduction. may be entitled to deduct some or all of of your home is rented out or used
Through 2025, the TCJA effectively limits your rental expenses — such as utilities, exclusively for your business, the loss
the home equity interest deduction to repairs, insurance and depreciation. attributable to that portion may be
debt that would qualify for the home Exactly what you can deduct depends on deductible.
mortgage interest deduction. (Under whether the home is classified as a rental
pre-TCJA law, interest was deductible property for tax purposes (based on the Because a second home is ineligible for
on up to $100,000 of home equity debt amount of personal vs. rental use): the gain exclusion, consider converting
used for any purpose, such as to pay off it to rental use before selling. It can
credit card debt or to buy a car.) Rental property. You can deduct rental be considered a business asset, and
expenses, including losses, subject to you may be able to defer tax on any
Home office deduction. Under the the real estate activity rules discussed gains through an installment sale or a
TCJA, employees can no longer deduct at right. Property tax attributable to Section 1031 exchange. Or you may be
home office expenses, because of the the rental use of the home isn’t subject able to deduct a loss, but only to the
suspension of miscellaneous deductions to the SALT limit. You can’t deduct extent attributable to a decline in value
subject to the 2% of adjusted gross any interest that’s attributable to your after the conversion.Real Estate 13
Real estate activity rules
Income and losses from investment real Case
estate or rental property are passive by Study 7
2 tax-deferral strategies for appreciated real estate
definition — unless you’re a real estate
professional. Why is this important? Leslie is ready to sell a property that had appreciated significantly since she
Passive activity income and losses have invested in it 10 years ago. But she’s concerned about the tax consequences.
some negative tax consequences. (See So she consults her tax advisor. He tells her about a couple of options that could
“Passive activities” on page 10.) allow her to defer the tax liability:
1. Installment sale. An installment sale would allow Leslie to defer gains by
To qualify as a real estate professional, spreading them over several years as she receives the proceeds. But her advisor
you must annually perform: warns that ordinary gain from certain depreciation recapture is recognized in the
year of sale, even if no cash is received.
More than 50% of your personal 2. Section 1031 exchange. Also known as a “like-kind” exchange, this technique
services in real property trades or would allow Leslie to exchange one real estate investment property for another
businesses in which you materially and defer paying tax on any gain until she sells the replacement property.
participate, and
Leslie’s advisor points out that such strategies may even help her keep her income
More than 750 hours of service in low enough to avoid triggering the 3.8% NIIT and the 20% long-term capital gains
these businesses during the year. rate. But they’re not without risks. For example, if tax rates go up, Leslie could
ultimately end up paying more in taxes.
Keep in mind that special rules for
spouses may help you meet the material
participation test. Warning: To help
withstand IRS scrutiny, be sure to keep
adequate records of time spent.
Depreciation-related breaks
Valuable depreciation-related breaks
may be available to real estate investors:
Section 179 expensing election. It
allows you to deduct (rather than depre-
ciate over a number of years) qualified
improvement property. The TCJA also
allows Sec. 179 expensing for certain
depreciable tangible personal property
used predominantly to furnish lodging
and for the following improvements
to nonresidential real property: roofs,
HVAC equipment, fire protection and
alarm systems, and security systems.
For qualifying property placed in Bonus depreciation is additional Interest expense deduction
service in 2022, the expensing limit first-year depreciation of 100% for for real estate businesses
is $1.08 million. The break begins to qualified property placed in service
Generally, under the TCJA, interest paid
phase out dollar-for-dollar when through Dec. 31, 2022. (For 2023
or accrued by a business is deductible
asset acquisitions for the year exceed through 2026, bonus depreciation is
only up to 30% of adjusted taxable
$2.7 million. (These amounts are scheduled to be gradually reduced.)
income (ATI). Taxpayers with average
adjusted annually for inflation.) annual gross receipts of $25 million
Fortunately, the 2020 CARES Act or less for the three previous tax years
QIP deduction. The TCJA classified included a technical correction to fix generally are exempt from the limitation.
qualified retail-improvement, restaurant the QIP drafting error. Commercial Larger real property businesses can elect
and leasehold-improvement property real estate owners (as well as other to continue to fully deduct their interest,
as qualified improvement property businesses) that made qualified but then they’re required to use the
(QIP). Congress intended QIP placed improvements from 2018 through alternative depreciation system for real
in service after 2017 to have an acceler- 2021 can claim an immediate tax property used in the business.
ated, 15-year MACRS recovery period refund for the bonus depreciation
and, in turn, qualify for 100% bonus they missed. Businesses investing
The CARES Act generally increased
depreciation. But the statutory language in QIP in 2022 and beyond also
the interest expense deduction limit to
didn’t define QIP as 15-year property, can claim bonus depreciation going
50% of ATI for the 2019 and 2020 tax
so QIP defaulted to a 39-year recovery forward, according to the phaseout
years, but the TCJA’s 30% deduction
period, making it ineligible for bonus schedule.
limit returned beginning in 2021, with
depreciation. tighter rules for 2022. You can also read
