8 Tips to Tax-saving for Year-end Planning
As the year draws to a close, it’s a crucial time to evaluate your financial situation and implement strategic measures that can potentially lower your tax liability. Understanding the nuances of tax regulations and taking advantage of available deductions and credits can significantly impact your bottom line. Whether you’re an individual taxpayer or a business owner, proactive year-end tax planning can pave the way for a more financially secure future. Here are comprehensive tips and strategies to consider as you navigate the year-end tax landscape.
Explore 8 Year-end Tax-Saving Tips
Take action before December 31 to amplify your tax advantages. Regardless of whether you’ve had a prosperous year, recovered from recent setbacks, or are still striving to gain traction, strategic actions before the year’s end can lead to substantial tax savings.
1. Consider Deferring Your Income
Income typically incurs taxation in the year it’s received. However, why settle for paying taxes now when you can defer them to a later date?
For salaried employees, deferring wage or salary income might be challenging. However, if your company follows the practice of paying year-end bonuses in the following year, you might have the option to delay receiving the bonus until the next year.
Those who are self-employed, freelancers, or engaged in consulting work have more flexibility. Postponing invoicing until late December, for instance, ensures that payments won’t be received until the subsequent year.
Whether employed or self-employed, another tactic is to delay capital gains until 2024 instead of realizing them in 2023.
However, it’s prudent to defer income only if you anticipate being in the same or a lower tax bracket the following year. You wouldn’t want to face a larger tax bill in the future due to increased income pushing you into a higher tax bracket. If that’s a foreseeable scenario, accelerating income into 2023 might be wise, allowing you to pay taxes on it sooner in a lower bracket rather than facing higher taxes later in a higher bracket.
2. Accelerating Last-minute Tax Deductions
In the same way that deferring income could benefit you in the upcoming year, exploring opportunities to minimize your tax bill by accelerating deductions this year is equally important.
Making charitable contributions is an excellent avenue for deductions, and the timing is within your control. The tax years 2020 and 2021 presented special deductions for charitable donations, even for individuals opting for the standard deduction. For 2021, the allowable amount stands at up to $600 per tax return for those filing jointly and $300 for other filing statuses. In 2020, you could deduct up to $300 per tax return of qualified cash contributions.
To maximize the tax advantages of your generosity, consider donating appreciated stock or property instead of cash. Particularly if you’ve held the asset for over a year, this move provides a dual tax benefit: you can deduct the property’s market value at the time of the gift, and you evade paying capital gains tax on the accrued appreciation.
Ensuring documentation is crucial for any contribution, irrespective of the amount, unlike the past rule where a receipt was only mandatory for contributions of $250 or more. Other expenses that can be expedited for deductions include:
- estimated state income tax bills due in January,
- property tax bills due in the early part of the following year,
- or medical bills from doctors or hospitals.
However, hastening deductions might not be advisable if you fall under the alternative minimum tax bracket, as discussed below.
If you’re eligible to itemize rather than claim the standard deduction, take advantage of valuable tax deductions. The IRS notes that roughly 75% of taxpayers opt for the standard deduction, potentially missing out on valuable deductions that could be itemized.
If your qualifying expenses surpass the standard deduction, which for 2023 stands at $13,850 for single filers and $27,700 for those married filing jointly, maximizing deductions and itemizing is likely in your best interest.
Determining whether to itemize or claim the standard deduction need not be a hassle. TurboTax simplifies this process based on your responses to straightforward questions about your deductible expenses.
If you’re on the cusp of itemizing or not, strategize your year-end approach around bunching. This involves timing expenses to balance lean and prosperous years. In one year, pile up as many deductible expenses as possible, utilizing the aforementioned tactics. The objective is to exceed the standard deduction amount and claim a larger deduction.
In alternating years, limit deductible expenses to stay below the standard deduction threshold since you receive credit for the full standard deduction regardless of your actual expenditure. During lean years, focus on postponing deductible expenses to the following year when they’ll hold more value.
3. Caution Regarding the Alternative Minimum Tax (AMT)
While accelerating tax deductions can seem advantageous, it might backfire if you’re already subjected to the Alternative Minimum Tax (AMT) or inadvertently trigger it.
Initially designed to prevent affluent individuals from leveraging legal deductions to reduce their tax obligations, the AMT has gradually begun affecting middle-class taxpayers.
The AMT is calculated separately from your standard tax liability and follows different regulations. You’re required to pay the higher of the two tax bills.
This becomes a concern towards year-end because specific expenses, deductible under regular tax rules and potential candidates for expedited payments, do not hold the same deduction under the AMT.
For instance, state and local income taxes and property taxes are not deductible under the AMT. Therefore, if you anticipate being under the AMT in 2023, refrain from paying the installments due in January 2024 in December 2023.
4. Offload Underperforming Investments to Counteract Gains
A pivotal year-end tactic is termed “loss harvesting,” involving the sale of underperforming investments like stocks and mutual funds to realize losses. These losses can then be used to counterbalance any taxable gains you’ve incurred throughout the year, with losses offsetting gains on a dollar-for-dollar basis.
If your losses surpass your gains, you can utilize up to $3,000 of excess loss to offset other income.
Should your excess losses exceed $3,000, the surplus can be carried over to the following year. You can apply these losses to counteract any gains in 2023, along with up to $3,000 of other income. Losses can be carried forward annually for as long as you live.
5. Maximize Retirement Contributions
Few investments rival the benefits of tax-deferred retirement accounts, considering their ability to grow substantially over time through tax-free compounding.
Among these accounts, employer-sponsored 401(k) plans often offer the most advantageous terms, frequently including employer-matched contributions.
Strive to boost your 401(k) contributions to hit the maximum allowable limit ($22,500 for 2023, rising to $30,000 if you’re aged 50 or above). If achieving the maximum contribution isn’t feasible, aim to contribute at least an amount that aligns with employer-matched contributions.
Additionally, contemplate contributing to an IRA (Individual Retirement Account).
Ordinarily, you have until the filing deadline of April 15, 2024, to make IRA contributions, but the earlier you deposit funds into the account, the sooner they can begin growing tax-deferred.
Deductible contributions not only foster tax deferral but also reduce your taxable income for the current year.
For 2023, the maximum IRA contribution stands at $6,500, with an additional $1,000 allowed for individuals aged 50 or older. Utilize tools like the IRA Calculator to ascertain your eligible contribution amount.
If you’re self-employed, a viable retirement option could be a Keogh plan. These plans necessitate establishment by December 31, although contributions can be made until the tax filing deadline (including extensions) for your 2023 return. The contribution limit hinges on the type of Keogh plan chosen.
6. Steer Clear of the Kiddie Tax
The “kiddie tax” regulations, formulated by Congress, were designed to prevent families from transferring the tax burden on investment income from the parents’ high tax bracket to a child’s lower bracket.
For the year 2023, the kiddie tax imposes taxes on a child’s investment income exceeding $2,500 at the rates applicable to the parents. This tax typically applies until the year the child reaches age 24 if they’re a full-time student and provide less than half of their support.
Exercise caution if planning to gift stocks to a child for college expenses. If the resulting gain is substantial and the child’s unearned income surpasses $2,500, you might find yourself paying taxes at rates equivalent to your own.
7. Review IRA Distributions
Generally, you’re required to commence regular minimum distributions from your traditional IRA by April 1 of the year following the one in which you turn 73 (or 70 1/2 if this milestone was reached before January 1, 2020). Although minimum distribution requirements were waived for 2020, they are once again mandatory for 2021 and onward.
Failing to withdraw the appropriate amount triggers a severe penalty imposed by the IRS: a 50% excise tax on the deficient withdrawal, determined based on your age, life expectancy, and account balance at the start of the year.
Subsequent withdrawals must be made annually by December 31 to avoid this penalty. Consider requesting your IRA custodian to withhold tax from the withdrawal, as voluntary withholding allows you to specify the amount and circumvents the hassle of quarterly estimated tax payments.
Important to note: Roth IRAs offer the advantage that the original owner isn’t obligated to withdraw funds from these accounts. Required minimum distributions apply solely to traditional IRAs.
8. Utilize Flexible Spending Accounts (FSAs)
Flexible spending accounts, often known as flex plans, are employee benefits that numerous companies offer, enabling employees to allocate a portion of their earnings into a specialized account used for child care or medical expenses.
The benefit lies in funds deposited into the account being exempt from both income and Social Security taxes. However, there’s a drawback: the well-known “use it or lose it” principle. At the year’s outset, you must determine the amount to contribute to the plan, and any unused funds by year-end are forfeited.
As the year draws to a close, verify if your employer has implemented an IRS-sanctioned grace period, allowing employees to spend funds allocated for 2023 as late as March 15, 2024. If not, you can resort to traditional methods and schedule last-minute visits to the drugstore, dentist, or optometrist to utilize the remaining funds in your account.
The Consolidated Appropriations Act (CAA), enacted on December 27, 2020, was designed as a stimulus measure to aid those impacted by the pandemic. The CAA permits employers to extend grace periods for healthcare FSAs and dependent care FSAs for up to 12 months into the subsequent plan year, applicable to plan years concluding in 2020 and 2021.
However, as of now, there isn’t an extension of the time frame to utilize FSA funds for 2023.
Conclusion
Year-end tax planning is a proactive approach to managing your finances and optimizing your tax situation. By employing these strategies and staying informed about tax laws, you can potentially reduce your tax liability, maximize savings, and position yourself for a more financially secure future. Remember, tax planning should be tailored to your unique financial circumstances, so consider seeking guidance from a qualified tax professional or financial advisor to develop a personalized tax strategy that aligns with your goals. Embracing these year-end tax tips can pave the way for a more prosperous financial journey in the upcoming year and beyond.
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