What are some key tax-saving strategies available to taxpayers that could potentially minimize taxes? As the end of the 2023 tax year approaches, time is limited to take advantage of the available tax breaks detailed below.
Evaluate Opportunities for Roth Conversions
Investors with traditional IRAs might consider converting to a Roth IRA. Investors who move money from their traditional IRA will pay taxes on the funds at ordinary state and federal rates and deposit the remaining funds into a Roth IRA where it can grow tax-free. Future withdrawals can be made on a tax-free basis provided investors meet certain criteria, such as a five-year waiting period following the conversion, and must occur after the age of 59 ½.
Complete Required Minimum Distributions
The required minimum distributions (RMD) age limit for individual retirement account (IRA) owners, including beneficiaries of an IRA, changed for the 2023 calendar year, increasing from age 72 to age 73. This means IRA owners turning 73 in 2023 will not need to begin taking RMD until April 1, 2024. This may create confusion for IRA owners born in 1951, who were previously notified of a 2023 RMD responsibility. To rectify the discrepancy, the IRS has mandated financial institutions notify affected IRA owners of the RMD delay by April 28, 2023. To mitigate further misunderstanding, the IRS also suggested financial institutions remind IRA owners who turned age 72 in 2022 of their RMD obligation due April 1, 2023.
Taking an RMD can push a taxpayer into a higher tax bracket for that tax year, which may be mitigated by:
- Taking the RMD by December 31 of the previous tax year
- Donating the RMD through a qualified charitable distribution to reduce adjusted gross income
- Avoiding the RMD altogether by converting an IRA to a Roth or purchasing a deferred income annuity
After the initial April 1 RMD, subsequent RMD must be withdrawn by December 31 of each calendar year to avoid a tax penalty. Additionally, an IRA account owner with an RMD obligation may withdraw more than the RMD amount, free of penalty.
The RMD can be met through withdrawal from a single account or a combination of accounts. Retirement accounts subject to RMD requirements include the following account types:
- Traditional IRA
- Savings Incentive Match Plan for Employees (SIMPLE) IRA
- Simplified Employee Pension Plan (SEP) IRA
- Profit-sharing Plans
- 401(k), 403(b) and 457(b) Plans
Review Contributions to Tax-Advantaged Retirement Accounts
Consider increasing contributions to retirement plans by contributing the maximum amount. In 2023, individuals are allowed to contribute up to $22,500 to a 401(k) plan, and individuals aged 50 and older can contribute an additional $7,500 for a total of $30,000. Contributing to a retirement plan is a great way to save money for retirement while reducing taxable income.
Contribute to a Health Savings Account (HSA)
HSA contributions can lower taxable income. In addition, interest earnings on contributions are tax-free. Because HSA contributions can be made with pre-tax funds, individuals can deduct the amount contributed from annual taxable income in the year the contribution was made.
HSA account holders 55 years of age and older are entitled to make an additional
catch-up contribution valued at $1,000 on top of the above contribution caps.
Review Tax Withholdings and Estimated Tax Payments
The end of the year is a good time to look at the amount of tax that has been withheld from any income, pension, or Social Security, as well as any estimated payments made throughout the year. It is possible that more tax has been withheld than necessary.
The 2023 Form 1040-ES on the IRS website will help in completing the calculations. Located in the 2023 Form 1040-ES instructions are the tax rate schedules to use for projecting 2023 estimated tax liability. Of course, it is always prudent to check with a tax advisor to ensure the correct withholding amount.
Persons facing a penalty for underpayment of federal estimated taxes might consider increasing withholding amounts going forward. Doing so may reduce or eliminate potential penalties and interest.
Proactive Tax-Gain and Tax-Loss Harvest
Tax-loss harvesting only applies to taxable investment accounts. Retirement accounts, such as IRAs and 401(k) accounts, grow tax-deferred and are not subject to capital gains taxes.
Investments that decreased in value could be sold at a loss, using the loss to offset any realized gains on a similar investment. It is important to proactively monitor losses throughout the year so that losses can be taken as they occur. For an individual taxpayer and a married couple filing jointly, up to $3,000 per year in realized capital losses can be used to offset capital gains tax or taxes owed on ordinary income.
Consider Charitable Giving
Taxpayers who take the standard deduction cannot deduct their charitable contributions.
Consider an Annual Gift to Family
Making an exclusion gift before the year is up will save on gift and estate taxes. A gift up to $17,000 per person ($34k for married couple filing jointly) is allowed for an unlimited number of individuals. These transfers also may save family income taxes where income-earning property is given to family members in lower-income tax brackets not subject to the kiddie tax.
For clarification or more information, consult a certified tax advisor.
Author, William Vandegrift, EA
Tax Manager
Spiegel Accountancy
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.