Increases in deductions and exemptions are one of the few areas that inflation can help out investors – but you’ll need to plan ahead to take advantage of some of the increases.
The spike in inflation we’ve seen this year has impacts beyond having to pay more for goods and services. The IRS uses consumer price inflation (CPI) to determine certain increases to exemptions and deductions for federal tax purposes. These are automatic and calculated from the rise in CPI. That means that the increased inflation this year may actually end up saving you money. While the changes are for 2022 and you won’t be paying the associated taxes until 2023, it’s a good idea to be aware of the new limits.
You may be able to make changes as you go that can help you maximize the benefit. For example, the amounts for Flexible Spending Accounts (FSAs) and the commuter benefit increased, so you may want to have more taken out of your paycheck. This saves you money by paying with pre-tax dollars.
The income levels at which AMT applies also went up. If you have stock options, AMT very often comes into play. The increase amounts to $2,300 over the 2021 level for a single filer. While it doesn’t seem like much, it may be enough to allow you some flexibility in structuring them that will save you on taxes.
Taking the Standard Deduction
The standard deduction increased in 2018, and many taxpayers now opt not to itemize. For 2022, this choice becomes even more attractive as the deduction for a married couple filing jointly increased by $800. Taking the standard deduction simplifies tax preparation, but if you have deductible expenses such as medical expenses, property taxes, mortgage interest, charitable giving, or others (and there are hundreds), you may be passing up tax savings.
If your total itemized deductions are close to the amount of the standard deduction, there are strategies for charitable giving that can increase your tax deductions in any one year. This can be done without increasing your overall plans for giving. Giving some thought to your deductions as you move through the year can help you keep track of where you want to be.
Alternative Minimum Tax
The alternative minimum tax was created to limit the amount that high-income taxpayers can lower tax amounts through deductions or credits. It sets a floor on the amount of tax that must be paid. The AMT is particularly relevant if you have been granted incentive stock options (ISOs) as part of your compensation.
The AMT is adjusted based on the price you pay for the shares (the strike price) and the fair market value when you exercise. Because you can choose when to exercise, you have some flexibility in avoiding or minimizing AMT, but it requires careful planning of your income.
Flexible Spending Accounts and Commuter Benefits
The dollar limit for 2022 contributions to a flexible savings account is $2,850, an increase of $100 over 2021. If your plan allows carryovers, the new carryover limit is $570. The monthly commuter benefit contribution limit for 2022 to your qualified parking and transit accounts increased to $280.
Gift and Estate Tax Exclusions
The annual federal exclusion for gifts was bumped up $1,000 to $16,000 for 2022. For a married couple, this means they can gift $32,000 to any individual without using their lifetime exemption. The lifetime exemption also went up, to $12.06 million per person.
The Takeaway
Increases in deductions and exemptions are one of the few areas that inflation can help out investors – but you’ll need to plan ahead to take advantage of some of the increases. There are lot of moving parts to a comprehensive plan that can save you money on taxes, and it’s never too early to get started in making the right moves.
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