Tax Traps You NEED To Know Before 2025

Having just passed Halloween, everyone has a clear memory of those scary haunted houses and a few good-natured frights. And while Halloween is a time to enjoy those mostly harmless pranks, there's one place you don't want to be spooked: that's your tax bill. Today I'm unmasking some tax tricks that could send a bit of a shiver down your spine if you're not prepared. So buckle up, this financial ride through the scary world of ghostly taxes is about to begin.

I'm Phil Clark, your host here on We're Talking Money. Let's get into it.

First up, the alternative minimum tax. Everyone knows this as AMT. Just hearing "the alternative tax," it sort of sounds sinister. Originally this tax was designed to ensure that higher earners paid their fair share. It can sneak up on you if you're not careful. It doesn't work like your typical tax calculation. In fact, it has its own set of rules, its own brackets, and it can leave you paying up to 28%.

You're sitting comfortably with your itemized deductions, ready to file, you're feeling good, and suddenly the AMT snatches things away. Things that can trigger AMT, they include high household income, large realized capital gains, and exercising stock options. Even if you don't sell the stocks, you might still owe taxes on what's called phantom profit. Talk about scary, this is it.

So how do you ward off the AMT tax Bond? It really all comes down to timing. First, you can consider moving transactions around to reduce the impact. You could sell assets more strategically, you can plan your deductions, and you simply don't let the AMT catch you off guard. There is a way to plan for it, but it takes time and it takes some effort. And remember, once the Tax Cuts and Jobs Act sunsets in 2025, we may see a lot more taxpayers getting hit with the AMT.

Next on the list, it's the net investment income tax, or NIIT. Now, currently it sits at 3.8%, and it is always lurking in the shadows, and it's ready to jump on anyone with modified adjusted income it's over $200,000 for single filers or $250,000 for joint filers or couples. It doesn't matter if you're paying long-term capital gains rates, the NIIT adds an extra layer of tax to your investment income. Imagine stacking taxes on top of taxes. That's terrifying, but that's how it works, unfortunately. I hate to bring political sides to the table, but politicians on the left want to increase this tax to 5%, so more tax is on the horizon.

Now, how do we tame this monster? First, you can max out your retirement contributions, because that can bring down your income. You could consider Roth conversions, but consider them carefully. Everyone is out there talking about why Roth conversions are such a great plan, and I agree, they are really good strategies for certain people. But these conversions, remember, they create income, and they can drive up your adjusted gross income, which makes NIIT a real threat.

And finally, don't forget about tax loss harvesting. Selling investments that are down, that can offset gains, up to $3,000 of ordinary income each year. And if you don't use all of those losses, you can carry them forward. Every bit helps when dealing with NIIT, so be careful.

Now let's move on to another tax threat. It's IRMAA, I-R-M-A-A, and it's a Medicare-related surcharge, and it is just preying on higher-earning retirees. This isn't your regular premium for Medicare. It is a surcharge based on your income from two years ago. This is a real horror story, because IRMAA is literally a tax cliff. If you earn just $1 over the threshold, you get hit with the full force of the next bracket for IRMAA.

So planning ahead here is key. You have to be strategic, you retirees with large income-generating transactions. If you're subject, for example, to required minimum distributions, consider something called a qualified charitable distribution, or a QCD. That can lower your income, and that's because distributions in this way never hit your tax return. And so if life circumstances have changed, like retirement or the loss of a spouse, you can also request a new assessment that can reduce things and avoid you having to pay more in this surcharge, or this extra tax.

Finally, I want to talk about a real tax torpedo. Social Security benefits, they can be taxed if you have something called provisional income. This is one of the most confiscatory taxes that I can think of. Here's how it works: you calculate your adjusted gross income, plus your non-taxable interest, plus half of your Social Security. If the total exceeds certain thresholds, boom, there you go, you have provisional income. And this torpedo can mean that up to 85% of your Social Security benefits become taxed as ordinary income, and every additional dollar of income can make a bigger portion of your Social Security taxable.

You've paid taxes all your life to reach a point where you can draw Social Security, and now all of a sudden you have to be worried that a big portion of it is going to be taxed as though you've just earned it. And it's not earnings at all, it's a repayment of what you've paid for.

So to dodge this, you can consider delaying Social Security until age 70, if you can. If you need the income, I get it, but if you can delay it, it's going to give you more income down the road. Then taking early withdrawals from retirement accounts, that might help you lower future tax burdens. And if you're charitably inclined, use your retirement accounts to directly fund those nonprofits. Why? This is part of that QCD that I talked about. It avoids any IRA distributions from ever hitting your tax return. That's huge. If you're nearing retirement, a Roth conversion strategy, that can also be a lifesaver, because it eliminates those required minimum distributions that will eventually hit you.

Taxes don't have to be as scary if you simply plan ahead. Let's leave the frights to Halloween, and let's embrace better planning when it comes to your tax environment. You will love having that peace of mind.

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