Everyone’s tax situation is unique but it is wise for every taxpayer to begin their final year-end planning now…
Evaluate the use of itemized deductions versus the standard deduction.
For 2023 tax returns, the standard deduction amounts will increase to $13,850 for individuals and married couples filing separately, $20,800 for heads of household, and $27,700 for married couples filing jointly and surviving spouses.
As a reminder, the Tax Cuts and Jobs Act roughly doubled the standard deduction. Its goal was to decrease tax payments for many of those who typically claim this standard deduction. Although personal exemption deductions are no longer available, the larger standard deduction, combined with lower tax rates and an increased child tax credit, could result in less tax. You should consider running the numbers to assess the impact on your situation before deciding to take itemized deductions.
The TCJA still eliminates or limits many of the previous laws concerning itemized deductions. An example is the state and local tax deduction (SALT), which is still currently capped at $10,000 per year, or $5,000 for a married taxpayer filing separately.
Consider bunching charitable contributions or using a donor-advised fund.
For those taxpayers who are charitably inclined it makes sense to think about a plan. One way to utilize the tax advantages of charitable contributions is through a strategy referred to as “bunching”. Bunching is the consolidation of donations and other deductions into targeted years so that in those years, the deduction amount will exceed the standard deduction amount.
Another strategy is to consider using a donor-advised fund. A donor-advised fund, or DAF, is a philanthropic vehicle established at a public charity. It allows donors to make a charitable contribution, receive an immediate tax benefit and then recommend grants from the fund over time. Taxpayers can take advantage of the charitable deduction when they’re at a higher marginal tax rate while actual payouts from the fund can be deferred until later. It can be a win-win situation.
Another vehicle is to use your IRA required minimum distribution (RMD) to make a donation. Taxpayers who are 70½ or older can transfer up to $100,000 from a traditional IRA tax-free to charity each year, as long as the custodian transfers the money to the charity directly. The qualified charitable distribution will count towards your RMD without being added to your adjusted gross income, which can be a boon if you were going to take the standard deduction instead of itemizing. The transfer could also help keep your income below the threshold at which you’re subject to the Medicare high-income surcharge as well as hold down the percentage of your Social Security benefits subject to tax.
Review your home equity debt interest.
For mortgages taken out after October 13, 1987, and before December 16, 2017 (i.e., enters into a binding contract by that date), mortgage interest is fully deductible up to the first $1,000,000 of mortgage debt incurred to acquire or improve a qualified residence. The TCJA lowered the threshold to $750,000 or $375,000 (married filing separately) for homes purchased after December 15, 2017, but before January 1, 2026. All interest paid on any mortgage taken out before October 13, 1987, is fully deductible regardless of your mortgage amount (“grandfathered debt”). Many mortgage holders refinanced for lower rates or to cash out in the last few years, so remember, to the extent debt increases the interest might not be deductible.
Interest on home equity lines of credit (HELOCs) and cash-out refinancing may be deductible as well if the funds were used to improve the home that secures the loan (or if the proceeds were invested). Please share with us how the proceeds of your home equity loan were used. If you used the cash to pay off credit cards or other personal debts, the interest isn’t deductible, but that may change when the TCJA sunsets at the end of 2025.
Revisit the use of qualified tuition plans.
Qualified tuition plans, also named 529 plans, are a great way to tax efficiently plan the financial burden of paying tuition for children or grandchildren to attend elementary or secondary schools. Earnings in a 529 plan originally could be withdrawn tax-free only when used for qualified higher education at colleges, universities, vocational schools or other post-secondary schools. However, they changed that so 529 plans can now be used to pay for tuition at an elementary or secondary public, private or religious school, up to $10,000 per year. Unlike IRAs, there are no annual contribution limits for 529 plans. Instead, there are maximum aggregate limits, which vary by plan. Under federal law, 529 plan balances cannot exceed the expected cost of the beneficiary’s qualified higher education expenses. Limits vary by state. Some states even offer a state tax credit or deduction up to a certain amount.
Contributions to a 529 plan are considered completed gifts for federal tax purposes, and in 2022 up to $16,000 per donor, per beneficiary, qualifies for the annual gift tax exclusion. Excess contributions above $16,000 must be reported on IRS Form 709 and will count against the taxpayer’s lifetime estate and gift tax exemption amount ($12.920 million in 2023).
There is also an option to make a larger tax-free 529 plan contribution, if the contribution is treated as if it were spread evenly over a 5-year period. For example, a $80,000 lump sum contribution to a 529 plan can be applied as though it were $17,000 per year, as long as no other gifts are made to the same beneficiary over the next 5 years. Grandparents sometimes use this 5-year gift-tax averaging as an estate planning strategy.
Maximize your qualified business income deduction (if applicable).
One of the most talked about changes from the Tax Cuts and Jobs Act enacted in 2017 is the qualified business income deduction under Section 199A. Current proposals want to change this deduction, but for 2022, taxpayers who own interests in a sole proprietorship, partnership, LLC, or S corporation may be able to deduct up to 20% of their qualified business income. Please be careful because this deduction is subject to various rules and limitations.
There are planning strategies to consider for business owners. For example, business owners can adjust their business’s W-2 wages to maximize the deduction. Also, it may be beneficial for business owners to convert their independent contractors to employees where possible, but before doing so, please make sure the benefit of the deduction outweighs the increased payroll tax burden and cost of providing employee benefits. Other planning strategies can include investing in short-lived depreciable assets, restructuring the business, and leasing or selling property between businesses.
Consider All of Your Retirement Savings Options for 2023
If you have earned income or are working, you should consider contributing to retirement plans. This is an ideal time to make sure you maximize your intended use of retirement plans for 2023 and start thinking about your strategy for 2024. For many investors, retirement contributions represent one of the smarter tax moves that they can make. Here are some retirement plan strategies we’d like to highlight.
401(k) contribution limits increased. The elective deferral (contribution) limit for employees under the age of 50 who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is $22,500. The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains the same at $7,500 ($27,000 total). As a reminder, these contributions must be made in 2023.
IRA contribution limits unchanged. The limit on annual contributions to an Individual Retirement Account (IRA) remains at $6,500 for 2023. The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000 (for a total of $7,000). IRA contributions for 2023 can be made all the way up to the April 15, 2024, filing deadline.
Higher IRA income limits. The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (MAGI) of $73,000 and $83,000 for 2023. For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $116,000 to $136,000. For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out in 2023 as the couple’s income reaches $218,000 and completely at $228,000. For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range remains at $0 to $10,000 for 2023. Please keep in mind, if your earned income is less than your eligible contribution amount, your maximum contribution amount equals your earned income.
Increased Roth IRA income cutoffs. The MAGI phase-out range for taxpayers making contributions to a Roth IRA is $218,000 – $228,000 for married couples filing jointly in 2023. For singles and heads of household, the income phase-out range is $138,000 – $153,000. For a married individual filing a separate return, the phase-out range remains at $0 to $10,000. Please keep in mind, if your earned income is less than your eligible contribution amount, your maximum contribution amount equals your earned income.
Larger saver’s credit threshold. The MAGI limit for the saver’s credit (also known as the Retirement Savings Contribution Credit) for low- and moderate-income workers is $73,000 for married couples filing jointly in 2023, $54,750 for heads of household and $36,500 for all other filers.
Be careful of the IRA one rollover rule. Investors are limited to only one rollover from all of their IRAs to another in any 12-month period. A second IRA-to-IRA rollover in a single year could result in income tax becoming due on the rollover, a 10% early withdrawal penalty, and a 6% per year excess contributions tax as long as that rollover remains in the IRA. Individuals can only make one IRA rollover during any 1-year period, but there is no limit on trustee-to-trustee transfers. Multiple trustee-to-trustee transfers between IRAs and conversions from traditional IRAs to Roth IRAs are allowed in the same year.
Roth IRA Conversions. In 2023, some IRA owners may want to consider converting part or all of their traditional IRAs to a Roth IRA. This is never a simple or easy decision. Roth IRA conversions can be helpful, but they can also create immediate tax consequences and can bring additional rules and potential penalties. Under the current laws, you can no longer unwind a Roth conversion by re-characterizing it. It is best to run the numbers with a qualified professional and calculate the most appropriate strategy for your situation.
Capital Gains and Losses
Looking at your investment portfolio can reveal a number of different tax saving opportunities. Start by reviewing the various sales you have realized so far this year on stocks, bonds and other investments. Then review what’s left and determine whether these investments have an unrealized gain or loss. (Unrealized means you still own the investment, versus realized, which means you’ve actually sold the investment.)
Know your basis. In order to determine if you have unrealized gains or losses, you must know the tax basis of your investments, which is usually the cost of the investment when you bought it. However, it gets trickier with investments that allow you to reinvest your dividends and/or capital gain distributions. We will be glad to help you calculate your cost basis.
Consider loss harvesting. If your capital gains are larger than your losses, you might want to do some “loss harvesting.” This means selling certain investments that will generate a loss. You can use an unlimited amount of capital losses to offset capital gains. However, you are limited to only $3,000 ($1,500 if married filing separately) of net capital losses that can offset other income, such as wages, interest and dividends. Any remaining unused capital losses can be carried forward into future years indefinitely.
Be aware of the “wash sale” rule. If you sell an investment at a loss and then buy it right back, the IRS disallows the deduction. The “wash sale” rule says you must wait at least 30 days before buying back the same security in order to be able to claim the original loss as a deduction. The deduction is also disallowed if you bought the same security within 30 days before the sale. However, while you cannot immediately buy a substantially identical security to replace the one you sold, you can buy a similar security, perhaps a different stock, in the same sector. This strategy allows you to maintain your general market position while utilizing a tax break.
Always double-check brokerage firm reports. If you sold a security in 2023, the brokerage firm reports the basis on an IRS Form 1099-B in early 2024. Unfortunately, sometimes there could be problems when reporting your information, so we suggest you double-check these numbers to make sure that the basis is calculated correctly and does not result in a higher amount of tax than you need to pay.
Long-term Capital Gains Tax Rates
Tax rates on long-term capital gains and qualified dividends changed for 2023. You may qualify for a 0% capital gains tax rate for some or all of your long-term capital gains realized in 2023. In 2023, the 0% rate applies for individual taxpayers with taxable income up to $44,625 on single returns, $55,800 for head-of-household filers and $89,250 for joint returns. If this is the case, then the strategy is to figure out how much long-term capital gains you might be able to recognize to take advantage of this tax break.
The 3.8% surtax on net investment income stays the same for 2023. It starts for single people with modified AGI over $200,000 and for joint filers with modified AGI over $250,000.
NOTE: The 0%, 15% and 20% long-term capital gains tax rates only apply to “capital assets” (such as marketable securities) held longer than one year. Anything held one year or less is considered a “short-term capital gain” and those are taxed at ordinary income tax rates.