Many people believe tax planning is only for high earners. But that’s not true! There are several tax strategies that can benefit low-income earners, especially those experiencing a lower-than-usual income year. Here are some ways to potentially reduce your tax burden in 2022:
Reduce Your Taxable Income with Stock Options
Do you work for a company that offers employee stock options? These options allow you to purchase company shares at a fixed price in the future. If the stock price increases, you can exercise the option and potentially make a profit.
The key here is the tax treatment of non-qualified stock options. When you exercise these options, the difference between the purchase price and the fair market value of the stock is considered taxable income. In a low-income year, exercising some or all of your options might not push you into a higher tax bracket, resulting in minimal or no tax liability.
Consider a Roth IRA Conversion
Roth IRAs offer tax-free withdrawals in retirement, unlike traditional IRAs which are taxed upon withdrawal. Converting a traditional IRA to a Roth IRA typically incurs taxes on the converted amount. However, a low-income year presents a unique opportunity.
With the increased standard deduction for 2022, you might be able to convert some or all of your traditional IRA to a Roth IRA without any tax consequences. This allows your retirement savings to grow tax-free and be withdrawn tax-free in the future.
Maximize IRA Distributions
If you’re retired and receive IRA distributions, a low-income year might be the perfect time to maximize your withdrawals. The high standard deduction could allow you to take more money out of your IRA without incurring any tax liability.
This could be a great way to access additional funds without tax penalty. Even if you don’t need the money right away, you could withdraw it and invest it for future use.
Take Advantage of Low Capital Gains Rates
Capital gains taxes apply to profits made from selling investments like stocks. The good news? Long-term capital gains (held for over a year) benefit from lower tax rates compared to regular income tax rates.
In 2022, there are three long-term capital gains tax rates: 0%, 15%, and 20%. The 0% rate applies to single filers with taxable income below $41,775 and married couples filing jointly with taxable income below $83,550.
This presents a chance to sell appreciated investments (those that have increased in value) and pay little to no capital gains tax.
Self-Employed? Delay Business Expenses
Running your own business allows for deductions on business-related purchases. If you’re in a low-income year, consider delaying non-essential business purchases until the next year. This allows you to keep your current taxable income lower and claim the deduction on the expense next year.
Release Dependency Strategically
Are you the custodial parent of a child but don’t benefit from the child tax credit? In this case, you might consider releasing the dependency of the child to the non-custodial parent for the tax year. This allows the non-custodial parent to claim the child tax credit.
Bunch and Deduct Throughout the Year
If you typically itemize your deductions, consider “bunching” them. This means strategically grouping deductions into one year to maximize their tax benefit. For example, you could pay two years’ worth of charitable contributions in one year and claim the standard deduction the next.
Remember, speak to a tax professional before delaying any tax-related payments to avoid penalties.
By implementing some of these strategies, you can potentially lower your tax bill and keep more of your hard-earned money, even in a low-income year. Remember, consulting with a tax advisor is always recommended to ensure these strategies work best for your specific situation.
