Year-end tax planning is essential for everyone, especially considering taxes are one of the biggest expenses people pay annually. Tech employees face some additional complexities come tax time, namely understanding the tax liabilities of their equity compensation options.
With plenty of time left to prepare, here are five year-end tax planning best practices for getting a headstart on your taxes and feeling confident come April.
#1: Consider Your Deduction Strategy
One of the first decisions you’ll have to make is whether to itemize or take the standard deduction.
Here are the standard deduction amounts for 2022:
- Single filers: $12,950
- Joint filers: $25,900
- Married filing separately: $12,950
- Heads of household: $19,400
To determine whether it’s better to take the standard deduction or itemize, add up all potential deductions to see if they exceed the above amounts. These could include:
- Medical expenses that surpass 7.5% of your gross income
- Mortgage interest
- Student Loan Interest
- Home Equity Line of Credit (HELOC) interest
- Charitable giving
If your deductions exceed the standard deduction, you’ll likely benefit from itemizing when filing your tax return. But this process can get complicated, especially if you have an extensive list of deductions to sort through.
I’m happy to help work with you and your CPA to determine the best course of action regarding your deductions.
#2: Estimate The Tax Liability Of Your Equity
In the world of tech companies, the word “taxes” usually gets employees thinking about their equity. As you prepare to file your taxes, set aside time to conduct an equity review of all the options that are vested, exercised, or scheduled.
The tax liability changes depending on the type of equity you own. To avoid an unnecessarily large bill or tax penalties, you must know the equity type, holding periods, vesting schedules, and other financial obligations. For example, if you have RSUs, did you withhold enough to cover the tax bill? Or are you setting aside some savings to cover the additional amount? How will this impact your decision to hold or sell the stock?
Don’t Forget to Monitor Your Holding Periods
Each stock option has its own set of tax rules and liabilities, including the holding period needed to achieve favorable tax treatment.
Long-term capital gains are generally taxed at a lower rate than short-term capital gains. For most stock options, that means holding on to the shares for at least one year.
Keep in mind this is a generalization, and certain equity compensation options like ISOs or ESPPs have additional rules for achieving favorable, long-term capital gains tax treatment.
Nobody wants a surprise come April, so planning ahead can help you look at what equity will vest in the coming months (and into the new year). Doing so is the first step in creating a forward-looking strategy to help manage taxes.
Figuring out the potential tax liabilities of your equity compensation can get complex, and we can work through it together. We’ll proactively create a plan to minimize your tax obligation and develop a strategy that works for you.
If you haven’t reached out to your CPA yet, get booked on their calendar as soon as possible. The closer to April, the less availability they’ll have to meet with you and discuss your options.
#3: Don’t Be Afraid To Sell Assets That Aren’t Working For You
A popular strategy for managing capital gains liabilities is tax loss harvesting. This method involves selling securities at a loss to help offset capital gains. Doing so helps minimize your tax obligations by “harvesting” unrealized losses.
It’s also possible to offset up to $3,000 in ordinary income if your losses exceed your capital gains. If there’s additional loss left over, you can push them forward into the next tax year.
As you consider your gains and losses, you can also reassess and rebalance your portfolio. Given how bumpy the market has been throughout 2022, there’s a good chance your investments might not be in the same place they were when you started the year.
In that case, it may be necessary to rework your portfolio to more closely align your investments with your target risk, time horizon, and long-term goals.
#4: Keep Saving For Financial Freedom
So, you want the ability to live a work-optional lifestyle, that’s great!
Setting aside extra savings in an employer-sponsored tax-advantaged plan like a 401(k) is fundamental to building post-work income. If possible, try maxing out 401(k) contributions yearly to take full advantage of the tax benefits.
For 2022, you can contribute up to $20,500 to a 401(k), 403(b), and most 457 plans. If you’re over 50, you can contribute an extra $6,500 in catch-up contributions for a total of $27,000.2 You make contributions to these accounts with pre-tax dollars, meaning they lower your taxable income for that year. If you’re on the edge of a tax bracket, contributing more could help you drop down to a lower tax rate.
If leaving work is your ultimate goal, look outside the workplace for other places to invest and save, like in a taxable brokerage account, real estate, and other investments.
Brokerage accounts can help you save for medium-term goals or even goals you haven’t quite identified yet (like extended travel, supporting a sabbatical, a child’s future wedding, etc.). As you consider your options, keep the tax efficiency of your investment selections in mind.
#5: Give Money Away Intentionally
Charitable giving is often on people’s minds around the holidays. If giving is integral to your life, you’ll want to go about it efficiently.
There are many strategies people use to give with intention. Some find it helpful to donate highly-appreciated assets rather than write a check. Others choose to open a donor-advised fund and create a legacy of ongoing giving to their favorite organizations.
Charitable donations to an eligible non-profit are tax-deductible. If you’re looking to use this deduction to your advantage, consider bunching your donations to years where you plan on itemizing your deductions.
Bonus Tip: Work With Us!
Tech employees tend to require more year-end tax planning due to their complex compensation and benefit options.
Before the new year hits, let’s work together with your CPA to develop a tax-focused plan that addresses all aspects of your wealth—equity compensation, investments, charitable giving, retirement savings, and more.
Feel free to reach out anytime. I understand the intricacies involved in your financial life and am happy to help you prepare for this upcoming tax season.