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It’s time to do some tax planning for the end of the year. With two months left before 2023 comes to a close, this Letter focuses on actions you can take to cut your federal tax bill. We’ll delve into individual planning, investments, gifts, business taxes and much more.
Individual tax planning
On individual tax planning, look at the overall impact on 2023 and 2024. The goal is to lower your taxes over both years. Most people benefit by accelerating write-offs from 2024 into 2023 while deferring taxable income. Others take the opposite approach. Itemizers have the most flexibility in shifting write-offs, as shown here.
Home interest: If you pay your January 2024 mortgage bill before year-end, you can deduct the interest portion on Schedule A of your 2023 federal tax return.
State and local taxes: If under the $10,000 cap and your locale allows it, pay the property tax bill due in January 2024 in December of this year so you can deduct it.
Charitable gifts and donations: Bunch into 2023 charitable gifts you would usually give over multiple years. Heed the timing rules for charitable donations and other tax-deductible items. Put checks in the mail by year-end to lock in a 2023 deduction. For charges made with bank credit cards, you can claim the write-off in the year you charged the expense.
Medical: Think about incurring additional medical expenses before year-end if your medicals are near or have topped the 7.5%-of-adjusted-gross-income threshold. Check out IRS Publication 502. The list of eligible medicals is broader than you may think.
Electric Vehicles: Don't forget about the tax credit for buying an EV. Many new EVs qualify for a credit of up to $7,500. The break is up to $4,000 if buying a used EV.
- Some high-cost EVs aren’t eligible. The manufacturer’s suggested retail price can’t exceed $55,000 for sedans and $80,000 for vans, SUVs and pickup trucks.
- There is also an income limit. Modified adjusted gross income can’t exceed $300,000 for couples, $225,000 for household heads or $150,000 for singles. For used-EV buyers, the modified AGI thresholds are $150,000, $112,500 and $75,000, respectively.
If you wait until 2024 to buy an EV, you can opt to monetize the credit by transferring it to the dealer at the time of purchase, thus lowering the amount you will pay for the car. This allows you to take immediate advantage of the credit instead of having to wait until you file your federal income tax return.
If pondering home upgrades, go green to claim one of two tax credits.
The residential clean-energy property credit is for people who install an alternative energy system in their home that relies on a renewable energy source, such as solar, wind, geothermal, or fuel cell or battery storage technology. Think solar panels, solar-powered water heaters, geothermal heat pumps, wind turbines, fuel cells, etc. The credit is equal to 30% of the cost of materials and installation.
The smaller energy-efficient home improvement credit applies to insulation, boilers, central air-conditioning systems, water heaters, heat pumps, exterior doors, windows and the like that meet certain energy efficiency ratings. This credit for 30% of the cost of these eco-savings upgrades used to have a $500 lifetime limitation, but no more. There is now a general $1,200 aggregate yearly credit limit, but some specific upgrades have lower monetary caps, while others have larger ones. If planning for multiple upgrades, think about staggering them over 2023 and 2024.
Pocket tax-free cash by doing a short-term rental of your home. The proceeds from a personal residence that is rented out 14 days or less in a year are non-taxable and aren’t reported on your return, no matter the rent charged
Donations and gifts
Make the most of your generosity when donating to charitable organizations. Contribute appreciated property, such as stocks or shares in mutual funds. If you've owned property for more than a year, you can deduct its full value in most cases, if you itemize. Neither you nor the charity pays tax on the appreciation.
Don't donate assets that have dropped in value. if you do, the loss is wasted.
Use your annual gift tax exclusion. You can give each person up to $17,000 this year, $34,000 if you are married, without paying gift tax, filing a gift tax return or tapping your lifetime estate and gift tax exemption. Also, recipients aren’t taxed on gifts. Any unused amount is gone forever. You can't give extra next year to make up for it.
Here's an example. Say you're married with two kids and one grandchild. The two of you can give each of your children and your grandchild up to $34,000 ($102,000 total) this year in excludible gifts. Gifts over the exclusion amount will trigger the filing of a gift tax return for 2023. But you won’t owe federal gift tax unless your lifetime gifts exceed $12,920,000.
Help your kids or grandkids with college. Here are two ways to help your kids or grandkids with their college education. First, you can pay tuition directly to the school. The payment is nontaxable to the student, it doesn’t count against the $17,000 gift tax exclusion, and it reduces your estate.
Second, you can contribute to a 529 college savings account. You can shelter from gift tax up to $85,000 in contributions per beneficiary this year ($170,000 if your spouse agrees). If you put in the maximum, you’ll be treated as gifting $17,000 (or $34,000) to that beneficiary in 2023 and in each of the next four years — 2024 through 2027
IRAs and plans
Required minimum distribution (RMD) rules for traditional IRAs. Pay attention to the rules. People 73 and older must take annual payouts. To arrive at the 2023 RMD, start with your IRA balances as of December 31, 2022, and use the tables in IRS Publication 590-B. The amounts can be taken from any IRA you pick.
If 2023 is your first RMD year, you have until April 1, 2024, to take the RMD, though the amount is still based on your total IRA balance as of December 31, 2022. If you opt to defer your first RMD to 2024, you will be taxed in 2024 on two payouts. The deferred one for 2023 and the RMD for 2024. This will increase your 2024 taxable income.
Similar rules apply to 401(k)s. However, people who work past age 73 can generally delay taking RMDs from their current employer’s 401(k) until they retire. Additionally, if you have multiple 401(k)s, an RMD must be taken from each account.
Charitable donations made directly from a traditional IRA can save taxes. People 70½ and older can transfer up to $100,000 yearly from IRAs directly to charity. Qualified charitable distributions (QCDs) can count as RMDs, but they’re not taxable and they’re not added to your adjusted gross income. The QCD strategy is a good way to get tax savings from charitable gifts for taxpayers not itemizing because of higher standard deductions.
In a QCD, the money must generally go to a 501(c)(3) charitable organization. But the SECURE 2.0 law provides an easing to this rule. IRA owners can do a one-time (not annual) qualified charitable distribution of up to $50,000 through a charitable remainder annuity trust, a charitable remainder unitrust, or a charitable gift annuity. Many private colleges with charitable gift annuity programs are now touting this QCD option, so you may hear about it from your alma mater.
Be sure to get a receipt from the charity to substantiate your donation.
Max out your 2023 401(k) and IRA contributions. You have until Dec. 31 to put money in 401(k)s and other workplace retirement plans, and until April 15, 2024, to contribute to an IRA for 2023. You can stash up to $22,500 in a 401(k), $30,000 if age 50 or up. The 2023 pay-in cap for IRAs is $6,500, plus $1,000 more if 50 or older.
Is it the right time to convert a traditional IRA to a Roth IRA? You’ll have to pay tax on the converted amount, but future earnings are tax-free.
There are many factors to consider in making your decision. Here are some of them.
- First, the income tax rates for 2023 and later years are key. If you expect the rate you will pay in retirement to be the same or higher than the rate on the conversion, then switching to a Roth can pay off taxwise, provided you don't have to tap IRA funds to pay the tax bill on the conversion. If your income tax rate in retirement will be lower, tax-free Roth payouts are less advantageous. Federal income tax rates are low right now. But the lower tax rates expire after 2025 unless Congress acts.
- Second, Roths don’t have required minimum distributions, unlike traditional IRAs. Keep in mind, though, that if you are 73 or older at the time of the conversion, you must first take your RMD from your traditional IRA for the year of the switch.
- Third, converting can pay off if you expect your IRA assets will soar in value. The same rationale applies if you have IRA assets that now are depressed in value.
- Fourth, income from the conversion will increase your adjusted gross income, thus potentially triggering higher Medicare premiums two years down the line.
Note you don’t need to convert the entire amount to a Roth in one swoop. You can transfer the money in increments over time and space out the tax hit.
Your investment portfolio provides plenty of tax-saving opportunities.
See if you qualify for the 0% rate on long-term capital gains and qualified dividends. If taxable income other than long-term capital gains and dividends doesn’t exceed $44,625 on single returns, $59,750 for head-of-household filers or $89,250 on joint returns, then your 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.
Here are three scenarios to illustrate the rules. For the following examples, you have a married couple with $12,000 of qualified dividends and long-term capital gains, which are included in taxable income.
- In the first example, the couple has $70,000 of taxable income. The full $12,000 of gains and dividends is taxed at the 0% rate.
- Let's now assume the couple has taxable income of $95,000. $6,250 of the gains and dividends ($89,250 - (95,000 - $12,000)) gets the favorable 0% tax rate, and $5,750 is taxed at 15%.
- If the couple instead has $115,000 of taxable income, the 0% rate doesn't apply, and the full $12,000 of gains and dividends is taxed at 15%.
The 0% federal rate isn’t all gravy. Zero-percent-rate capital gains and dividends might not be taxed at the federal level, but they do hike adjusted gross income (AGI). The extra AGI can cause more of your Social Security benefits to be taxed. Also, your state income tax bill may jump, since many states tax capital gains as ordinary income.
If you’re not eligible for the 0% rate, there is always the 15% or 20% rate.
The 20% rate, on long-term capital gains and qualified dividends, starts at $492,301 for singles, $523,051 for heads of household and $553,851 for couples filing jointly.
The 15% rate is for filers with incomes between the 0% and 20% breakpoints.
Take steps to limit the sting of the 3.8% surtax on net investment income — dividends, taxable interest, capital gains, passive rents, annuities, royalties, and income from a passive activity if the taxpayer doesn’t materially participate.
The tax applies to single filers with modified adjusted gross incomes above $200,000 and joint filers over $250,000. Modified AGI for this purpose is AGI plus tax-free foreign-earned income. The tax is due on the smaller of NII or the excess of modified AGI over the thresholds. Buying municipal bonds is helpful since tax-free interest is exempt from the 3.8% bite and does not affect the owner's AGI.
Know the rules on capital losses if you have some duds you want to sell. Capital losses offset capital gains plus up to $3,000 of other income. Excess losses are then carried over to the next year and can help offset future capital gains. If you have capital loss carryforwards, cull your portfolio for capital gains. That’s because your net gains — up to the carryover amount — won’t be taxed at all.
Tax loss harvesting is one way that investors can lower their tax bill. The strategy involves selling stocks or other holdings in your taxable accounts that have declined in value for the purpose of generating capital losses to offset gains from the sale of winners. Investors commonly do this closer to the end of the year, when they have a better idea of the amount of total capital gains they will have.
But beware of the sneaky wash-sale rule. It prohibits a capital loss write-off on the sale of securities if you purchase substantially identical securities up to 30 days before or after the sale. The recognized loss isn’t gone forever — it’s only suspended. That’s because the loss is added to the tax basis of your replacement securities.
The wash-sale rule can catch you by surprise. You have a wash sale if you sell securities at a loss, and you, your spouse, or a corporation that you control, buys substantially identical securities within the 60-day period. You also have a wash sale if you have your IRA purchase stock after you sell the same stock at a loss in your taxable investment account, or if you happen to sell mutual fund shares at a loss less than 30 days after the date a dividend is reinvested to buy more shares.
People who sell cryptocurrency at a loss needn’t worry about the wash-sale rule. The definition of securities for purposes of the wash-sale rule doesn’t include crypto. So, for example, if you own crypto that sharply falls in value, you can sell it, recognize a capital loss, and buy the same digital currency the same day or soon after.
Think about investing in REITs or publicly traded partnerships. You could get a nice tax break. The 20% deduction for pass-through income (qualified business income) also applies to holders of interests in real estate investment trusts and PTPs. Individuals can deduct on their federal return 20% of their qualified REIT dividends — distributions that aren’t otherwise taxed under the favorable rules for capital gains and dividends — and 20% of their allocable share of a PTP’s qualified income.
Be wary of buying a mutual fund late in the year for your taxable portfolio. If you are thinking about investing in a dividend-paying mutual fund near year-end, check its dividend distribution schedule.
Buying a fund shortly before the record date this year means you will get the dividend payout for 2023, which you will owe tax on when you file your return next year. However, you aren't better off financially because the fund's share price falls by the amount of the distributed dividend. To avoid this, think about buying the mutual fund after the dividend record date.
Boost your federal income tax withholding if you expect to owe tax for 2023. It can help avoid an underpayment penalty. You’re off the hook for the fine if you prepay, via tax payments or withholding, at least 90% of your 2023 total tax bill or 100% of what you owed for 2022 (110% if your 2022 AGI exceeded $150,000). Note that tax withheld at any point in the year is treated as if evenly paid throughout the year. Here are a few ways to increase your withholding for 2023.
- You can give your employer a new W-4 to have more tax taken from wages.
- Fill out W-4V to have federal tax withheld from your Social Security benefits. You can elect to have 7%, 10%, 12% or 22% of your monthly benefits taken out.
- IRA owners taking RMDs can use this income tax withholding strategy: Have more tax withheld from a year-end distribution from your traditional IRA. By default, IRA custodians withhold 10%, but you can ask for more to be withheld.
Don’t forget about the 0.9% Medicare surtax on earned income. It kicks in for joint filers with earnings over $250,000, $200,000 for single filers and household heads. Employers must begin to withhold the tax from worker paychecks in the period when wages first exceed $200,000, regardless of the employee’s marital status. This can lead to under-withholding for a couple if each spouse earns under $200,000, but their combined wages total more than $250,000. The same goes for an employee with a self-employed spouse if the couple’s combined earnings will exceed $250,000.
There are generous write-offs for business asset purchases this year. Businesses can save lots on taxes with first-year 80% bonus depreciation. Firms can deduct 80% of the cost of new and used qualifying business assets, with lives of 20 years or less, that they buy and place in service by Dec. 31, 2023. Purchase and place assets in service this year if you want the 80% break. It falls to 60% next year, 40% in 2025, 20% in 2026 and ends after 2026.
Expensing is available. In 2023, businesses can expense up to $1,160,000 of new or used business assets. This limit phases out once more than $2,890,000 of assets are put into service during 2023. Note that the amount expensed can’t exceed the business’s taxable income. Bonus depreciation doesn’t have this rule.
There are lots of breaks for buyers of business vehicles under the tax laws. For new and used cars first put in use in 2023, if bonus depreciation is taken, the first-year cap is $20,200. The second-and third-year caps are $19,500 and $11,700. After that, $6,960. If no bonus depreciation is claimed, the first-year cap is $12,200.
Buyers of heavy SUVs also get write-offs. Up to $28,900 of the cost of SUVs with vehicle weights over 6,000 pounds can be expensed in 2023. 80% of the balance gets bonus depreciation, and the rest may qualify for regular five-year depreciation.
Up to 100% of the cost of a big truck used in business can be expensed, subject to the rule that total expensing can’t exceed taxable income from the business.
See if you can take advantage of the 20% deduction for pass-through income. The self-employed and owners of LLCs, S corporations and other pass-through entities can deduct 20% of their qualified business income, subject to limitations for individuals with taxable incomes of more than $364,200 for joint filers and $182,100 for all others. If you’re close to or just above the income limits, consider accelerating deductions or deferring income so that you can come in under the dollar thresholds for the year.
Gig workers, freelancers and other independent contractors (but not employees) can claim this write-off from their earnings.
Also, Schedule E rental income may be eligible for the 20% deduction in some cases. But applying the QBI rules to income from rentals of real property is thorny. IRS regulations say the rental activity must generally rise to the level of a trade or business, a standard that is based on each taxpayer's particular facts and circumstances. Alternatively, there is a safe harbor if at least 250 hours a year of qualifying time are devoted to the activity by the taxpayer, employees or independent contractors. Taxpayers who use the safe harbor must meet strict recordkeeping requirements.
This first appeared in The Kiplinger Tax Letter. It helps you navigate the complex world of tax by keeping you up-to-date on new and pending changes in tax laws, providing tips to lower your business and personal taxes, and forecasting what the White House and Congress might do with taxes. Get a free issue of The Kiplinger Tax Letter or subscribe.
Joy is an experienced CPA and tax attorney with an L.L.M. in Taxation from New York University School of Law. After many years working for big law and accounting firms, Joy saw the light and now puts her education, legal experience and in-depth knowledge of federal tax law to use writing for Kiplinger. She writes and edits The Kiplinger Tax Letter and contributes federal tax and retirement stories to kiplinger.com and Kiplinger’s Retirement Report. Her articles have been picked up by the Washington Post and other media outlets. Joy has also appeared as a tax expert in newspapers, on television and on radio discussing federal tax developments.
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