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Review withholding tax
First, you want to examine how much money is withheld from your payroll for federal taxes. Having too little tax withheld could result in a tax bill or penalty. If too much tax is withheld, you may get a refund.
You should check your source deductions 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 get it right.
“Chances are these employers will assume you’re working for them by the end of the year,” said John Schultz, CPA and partner at Genske, Mulder & Company in Ontario, California.
“You can actually be very under-restrained when you’re working three, four, or five different jobs,” added Schultz, chairman of CalCPA’s State Committee on Taxation.
And don’t forget to determine if you’ve paid enough federal tax to cover other sources of income, such as dividends and interest on investments.
“Now you have all this capital gain, it’s income that won’t be subject to withholding,” said Collado, who is a CPA and certified financial planner. “So that tax difference that you have to offset either through additional withholding tax or estimated quarterly tax payments.”
You can always adjust your withholding and make an estimated payment for the fourth quarter if you had too little tax withheld. If you’ve had too many tax deductions this year, reducing your withholding now could increase your take-home pay, giving you the extra cash flow you might need in this inflationary environment, financial advisers say.
Access the “IRS Tax Withholding Estimator” online at IRS.gov to see if you are on the right track. If you need to make changes, it will tell you exactly what you need to do to complete a new Form W-4. Then submit this form to your employer.
Increase 401(k) contributions
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If you have room in your budget, consider increasing your pre-tax retirement savings through a 401(k) or workplace retirement plan. Placing money in these accounts reduces your gross income, so you pay less tax on your overall income.
You have until December 31 to contribute to the 401(k) plan for 2022. You can accumulate up to $20,500 this year in your 401(k). Add an additional $6,500 if you are 50 or older for a total of $27,000.
Even if you don’t have the budget to save near that amount, increase your 401(k) contributions at least enough to get your employer’s matching contribution, financial advisers say. It’s free money, after all.
Weighing Roth IRA Conversions
The year-to-date stock market decline 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 transferring the money to a Roth account, you’ll get tax-free growth in the future, but you’ll have to pay taxes up front on the converted amount.
The S&P 500 is down more than 20% so far this year, so you won’t pay as much tax on converting those assets as you did a few months ago — that’s another part of the savings of tax. For example, let’s say you invested $50,000 in a pre-tax IRA and it’s now worth $40,000. You will save on taxes since you will be converting $40,000 instead of the original $50,000.
Just make 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.
Consider “tax-loss cropping”
A common strategy that many financial advisors talk about when trying to find a silver lining after a sharp drop in stocks is “tax loss harvesting.”
If you sell an investment at a loss, you can subtract that loss from the capital gains you have realized by selling other investments. By doing this you can reduce the taxes you owe. And these losses or gains can come from stocks, real estate and other types of property.
“If you sold real estate for a large capital gain, you can use the losses of a [stock] portfolio to offset the capital gains associated with the sale of the real estate,” Collado said.
Once the losses exceed the gains, you can deduct up to $3,000 per year from your regular income and carry forward any additional losses indefinitely.
This is another decision to consider before the end of the year to ensure you can lock in those potential tax savings. Contact a tax preparer and financial advisor to see if these steps are right for you.
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