2023 Year-End Tax Planning Tips for for Individuals

You may be able to reduce your 2023 taxes if you act quickly!

This is a brief overview of several year-end tax saving strategies for individuals. Some are straightforward, while others require more analysis and review to tailor them to your particular tax and financial situation.

Individual income tax rates

Your so-called “ordinary” income (e.g., compensation, interest income, most retirement income, and net short-term capital gains) is taxed at increasing tax rates that apply to different ranges of income. In 2023, there are seven ordinary income tax brackets as follows: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

Although all tax brackets have been retained, the income limits for each have been adjusted for inflation. Determining the overall tax impact on a particular individual or family in 2023 will be similar to 2022 in many ways due to the changes that were put in place by the Tax Cuts and Jobs Act (TCJA), such as: an increase in the standard deduction, loss of personal and dependency exemptions, the elimination or limitation of certain itemized deductions, increases in the child tax credit, higher income phase-outs for the child credit, a new credit for certain qualifying dependents, and others.

Minimize Tax on Capital Gains

Generally, when you sell stock or mutual fund shares, the shares you purchased first are considered sold first. That’s usually good news since it’s often beneficial to qualify for the lower long-term capital gain rate by selling shares that have been held more than one year. However, there may be situations where you’re better off selling shares other than those that have been held the longest. For example, the newer shares may have a higher cost-basis (because you paid a higher price for them) which would result in a smaller taxable gain or even a loss that can be netted against the gain. When you want to sell shares other than those you purchased first, you must properly notify your broker as to the specific shares you want sold.

Realize Losses on Stock

You can take losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, and then buy back the same securities at least 31 days later. Or, if you own a fund (such as an index fund), you can sell it, and buy a similar fund right away while still claiming the loss. This works great with index funds, because as long as you buy a fund of the same index, it contains all the same securities.

Maximize Certain “Above the Line” Deductions

“Above-the-line” deductions reduce both your “adjusted gross income” (AGI) and your modified adjusted gross income (MAGI), while “itemized” deductions (i.e., below-the- line deductions) do not reduce either AGI or MAGI. Deductions that reduce your AGI (or MAGI) can potentially generate multiple tax benefits, for example by:

  1. Reducing your taxable income and allowing you to be taxed in a lower tax bracket;
  2. Freeing up deductions (and tax credits) that phase out as your AGI (or MAGI) increases (e.g., child credit; certain IRA contributions; certain education credits; adoption credit, etc.); and
  3. Reducing your MAGI below the income thresholds for the 3.8% Net Investment Income Tax (i.e., 3.8 % NIIT only applies if MAGI exceeds $250,000 if married filing jointly; $200,000 if single).

Many of the popular “above-the-line” deductions were retained under the TCJA, such as deductions for IRA and Health Savings Account (HSA) contributions, health insurance premiums for self-employed individuals, qualified student loan interest, and business expenses for a self-employed individual.

Tax-Free Qualifying Transfers from IRAs To Charities Retained

The popular rule allowing taxpayers who have reached age 70½ to make a tax-free transfer of up to $100,000 from their IRAs directly to a qualified charity has been retained. You must be at least 70 1/2 on the date of the gift. If you turn 70 1/2 on December 5th, for example, you must wait until that day or later to make the transfer and get the break. If married, you and your spouse can each give up to $100,000 yearly from IRAs directly to charity. Qualified charitable distributions (QCD) can also count as your required minimum distributions, but they are not taxable, and they are not added to your adjusted gross income, so they won’t trigger a Medicare premium surcharge. Since this tax break effectively allows a qualifying taxpayer to exclude all or a portion of their otherwise taxable RMDs from taxable income, it has the same effect as allowing an “above-the-line” deduction for the charitable contribution. The money from the IRA must go directly to a charitable organization.

IRA owners who are age 70 ½ or older can now use a qualified charitable distribution (QCD) from their traditional IRA to fund a charitable gift annuity or a charitable remainder trust that will pay them an income for life and provide future support to their chosen charities. Here are a few things to know about this new QCD option.

Up to $50,000 can be distributed from a traditional IRA to establish a charitable gift annuity or a charitable remainder trust. The money must be transferred directly from the IRA to the charity or trust.

  • This option can be used in only one tax year during your lifetime.
  • The QCD amount can satisfy all or part of your RMD for the year if you are age 70 ½ or older.
  • The income payments from the annuity or trust can be paid only to you and/or your spouse.
  • The income will be subject to ordinary income tax.

If you are currently required to take Required Minimum Distributions (RMD) from your IRA accounts and historically have made charitable contributions, you may want to consider making a Qualified Charitable Distribution (QCD) from your RMD.

Required Minimum Distribution Planning

Generally, taxpayers aged 73 and older are required to take withdrawals from their retirement accounts by year-end or pay a fine equal to 25% (or 10% if corrected in a timely manner for IRAs) of the shortfall. Similar requirements also exist for beneficiaries of inherited IRA accounts regardless of their age.

It’s important that retirees have a distribution strategy for RMDs to avoid having them become a “ticking time bomb” – bumping you into a higher tax bracket.

The basic retirement withdrawal sequence is generally recommended as follows:

  • Taxable accounts, such as brokerage accounts
  • Required minimum distributions (RMDs) from Tax-deferred retirement accounts (Traditional IRAs, 401(k) s, 403(b)s or 457 plans)
  • Tax-exempt retirement accounts (Roth IRAs and Roth 401(k) plans)

There are various strategies for paying taxes on your RMD. For instance, you could pay estimated tax payments, or you could simply increase withholdings on one or more of your retirement plan distributions. For many individuals we suggest they increase their withholdings rather than paying quarterly estimates. First of all, you may no longer need to remember to make the payments and you can time when the payment is made. Our recommendation in many cases is to have the withholdings done as late in the year as possible so the funds are available for investment throughout the year. Withholdings are treated as paid in evenly throughout the year by the IRS, so there is no penalty for making the payments via year-end withholdings.

Consider a Health Savings Account (HSA)

HSAs allow you to pay for certain medical expenses on a pretax basis. If you meet certain requirements for 2023, your HSA contribution can be up to $7,750 for family coverage and $3,850 for single coverage (plus an additional $1,000 if you’re 55 or older) and can be made regardless of your income level. These contributions are 100% tax deductible above-the-line, so you benefit even if you don’t itemize or are subject to high-income itemized deduction phase outs. You can then take tax-free withdrawals to pay uninsured medical expenses. A provision of the CARES Act now allows withdrawals to be made tax-free to pay for the cost of over-the-counter medications, retroactive to January 1, 2020. Withdrawals not used for medical expenses are taxable and if taken before age 65 are subject to a 20% penalty tax. After age 65, withdrawals are taxed as ordinary income. In the meantime, they can build tax-free. It is also important to note that 2023 deductible HSA contributions can be contributed until April 15, 2024.

Consider Contributing to 401(k) Plans that Accept Roth 401(k) Contributions

Earnings on funds in a Roth IRA grow tax-free (as opposed to merely tax deferred as in a traditional IRA or 401(k) plan). However, higher-income taxpayers are ineligible to make Roth IRA contributions. Currently, taxpayers covered by a 401(k) plan will be able to designate some or all of their 401(k) contributions as Roth 401(k) contributions. Thus, they will be able to take advantage of tax-free growth in their retirement account just like those who are able to contribute to Roth IRAs. The 2023 contribution limit for Roth 401(k) plans is $22,500 ($30,000 if age 50 or older), which is much higher than the $6,500 ($7,500 if age 50 or older) limit on Roth IRA contributions.

One Caution: Unlike “regular” 401(k) contributions, contributions that you designate as Roth 401(k) contributions are taxed to you the year they’re made. But the benefit of tax-free earnings and distributions on those contributions (provided they’re held in the plan for a certain amount of time) will often outweigh the tax-deferral on a regular 401(k) plan contribution. This is especially true if your tax rate is higher when you withdraw the money from your 401(k) plan than it was when the funds were contributed (which could be the case given the current federal deficit picture).

Convert Traditional IRA to Roth IRA

If your traditional IRA has dropped in value or you expect to pay higher federal income tax rates in future years, you might want to consider converting all or part of your traditional IRA balance into a Roth IRA. Here’s why: If you convert, it will trigger a current tax hit on the amount you convert. But, with your traditional IRA balance at a depressed level (and possibly your overall income too) the tax hit will be less. After the conversion, all the income and gains that accumulate in your Roth IRA, and all withdrawals after you reach age 59 1/2, will be totally free of any federal taxes—assuming you meet the tax-free withdrawal rules. In contrast, future withdrawals from a traditional IRA could be hit with tax rates that are higher than today’s rates.

Of course, conversion is not a no-brainer. You have to be satisfied that paying the upfront conversion tax bill makes sense in your circumstance. In particular, converting a big account all at once could push you into higher tax brackets, which would not be good. You must also make assumptions about future tax rates, how long you will leave the account untouched, the rate of return earned on your Roth IRA investments, and so forth. If the Roth IRA conversion idea intrigues you, please contact us for a full analysis of the tax consequences.

Retirement Account Contributions

You may want to consider increasing contributions to your Roth, traditional IRA, or other retirement savings account. The table below provides information on the contribution limits for 2023, which can be made through April 15, 2024.

Maximum IRA contribution (traditional or Roth): $6,500Maximum IRA contribution if age 50+: $7,500
Maximum 401(k) salary-deferral contribution:  $22,500Maximum 401(k) contribution if age 50+:  $30,000
Maximum 403(b) salary-deferral contribution:  $22,500Maximum 403(b) contribution if age 50+:  $30,000
Maximum SEP account contribution:  $66,000Maximum profit-sharing
account contribution: $66,000
Maximum SIMPLE IRA salary-deferral contribution:  $15,500Maximum SIMPLE
contribution if age 50+:  $19,000

Increased Standard Deduction

In 2023 the Standard Deduction increased to the following levels: Joint Return – $27,700; Single – $13,850; and Head of Household – $20,800. The increased standard deduction, combined with changes to Itemized Deductions, may make it difficult to itemize going forward. You may want to consider bunching two years of anticipated charitable contributions into one year. Alternatively, you can consider setting up a Donor Advised Fund (see below as well) into which you can make tax deductible charitable contributions and can direct the funds to your specific charities over the course of time.

Consider Year-End Donations

You can accelerate contributions planned for 2024 into 2023, but you must charge them or mail the checks by December 31st to ensure a write-off. Try to make your donations with appreciated stock that you’ve owned for over a year. This way, you can deduct the full value and never pay capital gains tax on the appreciation.

Check Your Health Flexible Spending Account (FSA)

You must clean it out by December 31 if your employer hasn’t implemented the 2 1/2-month grace period or the $610 carryover rule. Otherwise, you will forfeit any money left in your account. Also, consider electing to contribute to a health FSA for 2023. You can contribute up to $3,050 to your employer’s health FSA to cover out-of-pocket medical expenses. Amounts contributed to an FSA escape federal income tax as well as payroll taxes.

Charitable Giving with a Donor-Advised Fund

As a result of the TCJA, it might be beneficial to consider managing your charitable giving with a Donor Advised Fund (DAF). With a DAF you establish a private account with an organization that sponsors DAFs. The organization itself is a public charity, such as a community foundation, a university, or perhaps the charitable arm of a brokerage or mutual fund company. You then contribute cash or other assets to your account, which is invested so it may grow over time. Because the sponsoring organization is a public charity, you can take an immediate tax deduction for the cash and assets you contribute, even before a single grant is made. When you are ready to make grants, you simply advise the sponsoring organization of your choices. Although the sponsoring organization has legal control over your account and the authority to decline your grant recommendations, it will generally follow them as long as they adhere to the organization’s guidelines.

You can donate all of the funds in your account quickly, or you can space out your grants over time. The flexibility to make tax-deductible contributions now yet award the grants later can be very attractive in certain situations.

Let’s say, for instance, that you want to make a charitable gift by the end of the year for tax reasons, but you do not have enough time to choose the charities you want to benefit from your gift. A DAF allows you the time to make thoughtful choices while meeting your immediate financial goal of a tax deduction. Or let’s say that you want to establish a tradition of giving in your family. A DAF provides the structure to invest your gift and make grants on an ongoing basis, perhaps involving members of your family in the selection of grant recipients.

Tax Benefits of a Donor-Advised Fund (DAF)

Using a DAF offers several tax advantages.

  • You can claim a charitable tax deduction for the contributions you make to your DAF.
  • Contributions of appreciated stock or other assets that you held for longer than one year avoid capital gains tax and can generally be deducted at their fair market value.
  • Your contributions avoid estate taxes because they are no longer part of your estate.
  • Your contributions can grow tax-free within a DAF account, potentially increasing the amount available to support your favorite charities and causes.

As with charitable gifts in general, you must itemize deductions on your tax return to claim a deduction for your contributions. Keep in mind that the deduction for charitable contributions is subject to limits based on your adjusted gross income (AGI). The limits, however, are more generous for contributing to a DAF than to a private non-operating foundation. As a result, donations to a DAF may result in a larger tax deduction.

Child Tax Credit

For 2023, the child credit for each “Qualifying Child” who had not reached age 17 by the end of the tax year is $2,000. The income phase-out thresholds remain unchanged and begin phasing out as the individual’s modified adjusted gross income (MAGI) exceeds $400,000 on a joint return and $200,000 for all other returns.

The refundable portion of the child credit also remains at $1,600. A “refundable” credit generally means to the extent the credit exceeds the taxes you would otherwise owe with your individual income tax return without the credit, the IRS will refund the excess to you.

Family Tax Credit

The family tax credit created under the TCJA remains unchanged for 2023. It is a non-refundable credit of $500 for each person the taxpayer could have claimed as a dependent under prior law but who is not a Qualifying Child (e.g., a “Qualifying Relative” as defined under prior law). This $500 credit is added to any other child tax credits and the total credits begin phasing out once a taxpayer’s MAGI exceeds $400,000 on a joint return or $200,000 for singles.

Maximize contributions to and distributions from Section 529 Education Savings Plans

Vermont allows each taxpayer a 10% tax credit on the first $2,500 they contribute to each beneficiary’s 529 plan. Hence, a married couple could contribute $5,000 for a child and receive a $500 credit. In addition, the taxpayer can contribute to their own 529 plan and receive the credit. For a family of four, this means you could contribute up to $20,000 for a $2,000 credit.

These contributions have to be made before December 31st. If your child is currently in college and you will need to make a tuition payment, you can make the contribution for the VT credit and then pay the college expenses from the 529 Plan. You should also review your Qualified Education Expenses as compared to 529 distributions. If you are otherwise eligible to take the federal American Opportunity Tax Credit, you will want to make sure that you have $4,000 of Qualified Education Expenses per child that are not covered by 529 Plan distributions to take advantage of the credit.

If you have funds in a non-Vermont 529 plan, transfers from these plans to the Vermont Higher Education Investment Plan (VHEIP) are eligible for the Vermont Tax credit. Rollovers from another state’s qualified tuition plan into the VHEIP are eligible for the income tax credit to the extent the contributions made to the plan (does not include earnings) remain in the VHEIP for the remainder of the taxable year in which the funds were rolled into the VHEIP.

529’s – looking forward to 2024

Starting in 2024, 529 account holders will be able to transfer a lifetime limit of $35,000 to a ROTH IRA for a beneficiary. Below are a few things to know about this new rollover option:

  • 529 plan must be open for at least 15 years
  • The lifetime limit for rollover is $35,000 per beneficiary
  • The ROTH IRA must be in the name of the beneficiary of the 529 plan
  • Any contributions made within the last five years are ineligible to be rolled over
  • Annual limit on the rollover is the IRA contribution limit for the year, less any other IRA contributions.
  • Rollover must be plan-to-plan or trustee-to-trustee
  • Beneficiary must have earned income

Be Generous

Make gifts sheltered by the annual gift tax exclusion, such as educational, medical, or political gifts, before year-end to lessen gift and estate taxes. The exclusion applies to gifts of up to $17,000 in 2023 ($34,000 for married couples) made to each of an unlimited number of individuals, but you cannot carry over unused exclusions from one year to the next. In order to qualify you must give the funds directly, and you do not get an income tax deduction for gifts to relatives. Any unused amount is gone forever. You can’t give extra next year to make up for it. Annual gifts over the exclusion amount will trigger filing of a gift tax return for the year. But no gift tax will be due unless your total lifetime gifts exceed $12.92 million dollars.

Davis & Hodgdon CPAs works with individuals to capitalize on all applicable deductions. Our accountants have the experience required to make sure that nothing is missed! For more information or to set up an appointment please click here or email [email protected].

Our affiliated financial planning firm, *Copper Leaf Financial has also included several year-end tax tips and strategies in their latest issue of Eye on Money.

Click here or on the image below to read it in its entirety.

Recipients should not act on the information presented without seeking prior professional advice. Additional guidance may be obtained by contacting Davis & Hodgdon CPAs at 802-878-1963 (Williston) or 802-775-7132 (Rutland).

*Copper Leaf Financial is an affiliated and separately registered entity.

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