Tax increases are most likely coming.
Even if Congress doesn’t agree on substantial increases this year, they’re still coming.
The 2017 tax law is scheduled to expire after 2025.
The pre-2018 tax law will be reinstated automatically unless Congress agrees to something else.
Plus, the trillions of dollars added to the national debt the last few years must be paid at some point, possibly through tax increases.
The best way to avoid the coming tax increases is tax-free investing.
You can make some of your assets income tax-free.
Here are 7 tax-free investing strategies to consider adding to your portfolio – or increasing if you already have them.
Tax-Free Investing for 2022 Tip #1: Long-term capital gains
The maximum tax rate on long-term capital gains is 20%. But many people forget the 20% rate applies only at the highest income levels.
There are lower rates at lower income levels.
For many people, the tax rate on long-term capital gains is 0%. And for many others the rate is only 10%.
The same rates apply to qualified dividends.
If taxable income other than long- term gains or dividends does not exceed $40,400 for single taxpayers, $54,100 for heads of household or $80,800 for joint filers, then qualified dividends and profits on sales of assets owned more than a year are taxed at a 0% federal rate until they push you over the threshold amounts.
A word of caution on the 0% rate is the gains and dividends might not be taxed at the federal level, but they do hike adjusted gross income, which could increase the tax on Social Security benefits.
Also, your state may tax the gains at a different rate.
You can pay a 0% tax rate on long- term capital gains by managing your taxable income.
Avoid actions that will increase your gross income, such as taking additional distributions from traditional IRAs and 401(k)s. Instead, take additional distributions from a tax-free account if you can. Or you can wait until next year to sell some investments when there isn’t an urgent need to sell.
You also can consider ways to increase deductions and decrease your taxable income.
For example, several years of charitable contributions can be bunched into one year when you deduct itemized expenses.
Tax-Free Investing for 2022 Tip #2: Sell investments in which you have paper losses
The losses are deducted against capital gains for the year.
Up to $3,000 of losses that exceed the gains can be deducted against other income, and any additional losses can be carried forward to future years to be used in the same way.
Remember that to qualify for long-term capital gains, an asset must be held for more than one year.
Sell an asset only one day early, and the gain will be short term and taxed as ordinary income.
Tax-Free Investing for 2022 Tip #3: 529 savings plans
These college savings plans make great estate planning tools and make investment returns tax free. You contribute money to a 529 plan and name a beneficiary of the account.
Usually, a child or grandchild is named the beneficiary with the expectation the account eventually will pay for college education.
You can use up to five years’ worth of your $15,000 annual gift tax exclusion in one year when contributing to the account, ensuring a contribution of up to $75,000 avoids gift taxes and doesn’t use any of your lifetime estate and gift tax exclusion.
You don’t receive a federal income tax deduction for making contributions, but many states allow at least limited deductions against state income taxes. Investment returns compound tax-free in the account.
Distributions are tax free when used to pay for qualified education expenses.
The definition of qualified education expenses has expanded over the years and now includes pre-college education expenses up to $10,000 paid to either public or private institutions.
Computer and internet expenses also are allowed. You can change the beneficiary of the account if plans change, and even take the money back if you need it.
Tax-Free Investing for 2022 Tip #4: Health savings accounts
These are the only strategies with triple tax benefits and are a great way to save for retirement. Many medical insurance plans and policies with high deductibles make the insured eligible for contributions to health savings accounts (HSAs).
Contributions up to an annual limit are tax deductible when you make them and excluded from gross income when your employer makes them.
The account can be invested, and the earnings compound tax free in the account.
Distributions from an HSA are tax free when used to pay for or reimburse you for qualified medical expenses that aren’t reimbursed by other sources.
Plus, if you incurred medical expenses in earlier years, the HSA can reimburse you for them this year tax-free. Everyone who is eligible for an HSA should open an account and ensure the maximum is contributed each year.
If your employer doesn’t contribute to the annual limit, make the contributions yourself. It makes sense to move money from a taxable financial account to an HSA.
Tax-Free Investing for 2022 Tip #5: Qualified opportunity funds
Qualified opportunity zones were created in the 2017 tax law.
Investors receive tax breaks for investing in designated economically disadvantaged areas.
Most investors make these investments through funds and partnerships formed to qualify for the opportunity zone tax breaks.
You can defer long-term capital gains by investing the gains in a qualified opportunity zone within 180 days of the event that triggered the gain.
The gain can be deferred until the earlier of December 2026 and when the fund is sold or exchanged.
In addition, when the fund is held for at least five years, the taxable gain is reduced by 10%.
When the fund is held for at least seven years, the taxable gain is reduced by 15%, though that possibility for new investment has passed.
Hold the fund long enough, and any gains from selling the fund will be tax free.
A qualified opportunity zone fund might be a good idea for someone who is recognizing substantial capital gains from the sale of a business, real estate or securities.
A qualified small business stock is a profitable investment in a small business that can be tax free up to a certain amount. A qualified small business is one that is organized as a U.S. “C” corporation.
Sole proprietorships, LLCs and sub- chapter S corporations don’t qualify.
The stock must be issued after August 10, 1993 and be acquired by the taxpayer directly from the corporation in exchange for money, property (other than stock) or services.
Also, the tax basis of the total gross assets of the business must be less than $50 million when the stock was received.
When the requirements are met, gain from the sale of the stock are tax free up to $10 million or 10 times the adjusted tax basis of the stock, whichever is higher.
Many small business owners and investors qualify for tax-free gains from qualified small business stock but don’t realize it.
Others could qualify by considering the rules when forming or investing in a business.
Tax-Free Investing for 2022 Tip #6: Roth IRAs and 401(k)s
Transferring assets to a Roth account sets up a lifetime of tax-free gains and income.
There are no tax breaks when money is contributed to a Roth account.
The benefits are tax-free compounding of investment returns and tax-free distributions of the accumulated money. We’ve discussed Roth accounts a lot in past issues of my monthly advisory, Retirement Watch.
You can contribute to a Roth IRA or Roth 401(k). You also can convert a traditional IRA or 401(k) into a Roth IRA.
Those who still are participating in a 401(k) plan can use the back door Roth IRA strategy. But keep in mind that there are proposals in Congress to eliminate this strategy.
Tax-Free Investing for 2022 Tip #7: Life insurance
Life insurance benefits are perhaps the most enduring tax-free asset, and the status is unlikely to be changed anytime soon.
In addition to the life insurance benefits for beneficiaries, you can borrow tax-free from the cash value account of most permanent life insurance policies during your life, though any unpaid loans decrease the benefits paid to beneficiaries.
A good strategy can be to reposition assets as permanent life insurance.
For example, you can take distributions from a traditional IRA and use the after-tax amount to buy permanent life insurance payable to your children or grandchildren, or a trust for their benefit.
The life insurance benefit is guaranteed and will be tax free to the beneficiaries.
For many people, the life insurance benefit will be higher than the after-tax value of the IRA.
Plus, it won’t be subject to market fluctuations the way an IRA will be.
Other assets can be repositioned as permanent life insurance, providing guaranteed tax-free inheritances for beneficiaries.