When you hear about taxes, you might think of filing your tax return in April. But there are numerous tax planning moves to strategically maximize your current and future tax liability outside the typical tax filing deadline.
Most of those opportunities expire on December 31 for the current tax year. To help you take advantage of your finances, we created this year-end tax checklist for high-earners.
1. First, Know The Standard Deduction
The foundation for understanding tax-planning strategies is knowing the standard deduction and how it works.
The standard deduction is a fixed amount you are allowed to deduct from your income each year, regardless of your actual deductible expenses. The 2018, Tax Cuts and Jobs Act (TCJA) drastically increased the standard deduction. In 2023, the standard deduction is $13,850 for an individual or $27,700 for a married couple that files a joint return.
While establishing a higher limit may initially feel like a positive move, it actually makes proactive tax planning more crucial.
Because you can claim either the standard deduction or the combined total of your actual deductions—whichever is greater. Many people fail to realize this distinction and often have “deductible” expenses that they aren’t truly benefiting from because their itemized deductions aren’t greater than the standard deduction.
Do you have enough deductions to itemize this year? You can find a list of itemized deductions on Schedule A of your tax return. Even if you don’t file your own, you can look at the form to see what you can include.
Common examples of itemized deductions are:
- Health expenses (that exceed 7.5% of your adjusted gross income)
- Home office costs
- Mortgage interest
- HELOC interest
- Charitable gifts
- State, local and property taxes (capped at $5,000 single or $10,000 couple)
2. Tips To Reduce Your Taxable Income
If you’ve had a high-income year, you might be looking for ways to reduce what the IRS taxes.
Here are some ideas:
- Make sure you max out your employer-sponsored plans. These have significantly higher contribution limits than IRAs, allowing you to defer more of your tax bill. The maximum you can contribute to your 401(k) or 403(b) plan is $22,500 per year, plus an additional $7,500 if you are at least age 50.
- Don’t forget about a Health Savings Account (HSA) if you have one. And check to see if you’re eligible for one (have a high deductible health plan) if you don’t! HSAs allow you to set aside $3,850 for yourself or $7,750 for your family in 2023. The unique thing about HSAs is you may never have to pay taxes on that money if you follow the rules.
- Enroll in your employer’s deferred compensation plan if one is available to you. With deferred compensation, you make an arrangement with your employer to pay out some of your wages at a later date, which can reduce your taxable income today.
- Take advantage of a Dependent Care Flexible Spending Account (DCFSA) if your employer offers one. A DCFSA is a tax-advantaged account to help you pay for dependent care expenses like child or adult daycare, before or after school programs, preschool, and more.
All of these contributions lower your taxable income for the year, which can have a domino effect on other areas of your plan. For example, a lower reportable income may help you avoid the net investment income tax and stay below phase-outs for certain tax deductions and credits.
There are other key opportunities to reduce your taxable income that don’t involve contributing to an account. These include:
- Taking advantage of depreciation on income-producing real estate
- Maintaining accurate and precise expense records to maximize reductions in self-employment income
You could also look to defer some income and realize it in 2023—like a year-end bonus. If it would bump you into a higher tax bracket, it might be best to defer and create a plan for next year.
3. Evaluate Your Portfolio To See What's Working (And What's Not)
You can also look to your investment portfolio for tax-saving opportunities. Tax-loss harvesting enables you to sell assets at a capital loss to offset gains you’d otherwise owe taxes on.
If your realized losses are more significant than your gains, you can use capital losses to offset up to $3,000 of ordinary income. If you still have unused losses beyond that, you can roll them over into the next tax year to offset gains and income.
Tax loss harvesting can be a great strategy, but watch out for the wash-sale rule. If you sell an asset for a loss, you can’t repurchase it within 30 days, or the loss is disallowed.
As you evaluate your portfolio, you might find that your allocations have drifted from your initial plan. That’s not uncommon, especially with the market turbulence we’ve experienced this year. If your risk levels are off, it may be time to rebalance your portfolio.
Rebalancing involves buying and selling assets to align with your risk tolerance and capacity, time horizon, and goals. However, be aware of any tax liabilities created from your rebalancing activity and do it in the most tax-efficient way possible. If you can, avoid selling any positions with short-term gains, especially if you don’t have corresponding losses to harvest.
Certain investments are more tax advantageous than others, too. Tax-exempt municipal bonds may be better for you than corporate bonds if your tax rate is high. Funds with less turnover will also have less capital gain to distribute at the end of the year. If you have taxable accounts, pay attention to how your investments affect your tax bill.
4. Strategically Realize Significant Gains
Taxes shouldn’t lead your plan, but you should consider them in every action you take.
Are you selling a vacation home? Do you have a significant amount of equity vesting at once? These liquidity events require some strategic tax planning to ensure you don’t pay more than necessary.
These elements may also impact other areas of your financial life. Before you take action, make a plan to maximize your profit with minimal tax consequences.
Just like with your investment portfolio, watch out for the holding periods plus specific requirements based on the type of equity compensation you have to maximize the tax treatment. Long-term capital gains are taxed at more favorable rates, so it might make sense to prioritize them when possible.
5. Give Deliberately
While the primary goal of charitable giving is supporting causes you care about, it’s equally critical to do so in a tax-friendly way—be deliberate with your dollars. Here are some specific things to keep in mind concerning your charitable gifts:
- Qualified charitable distributions (QCDs): If you’re atleast age 70.5, QCDs can be an excellent way to give. Typically, creating cash for gifting by selling investments can result in either capital gains (non-retirement account) or taxable income (pre-tax retirement account), and as mentioned, it can be moot to itemize donations with the standard deduction being a high hurdle. Therefore, by making qualifying gifts directly from your IRA, they are never included in your income to begin with, meaning you can take the standard deduction and still receive the tax benefits of gift-giving.
- Donor-advised fund (DAF): A DAF is a charitable investment account. You can contribute appreciated assets, cash, or even property to your DAF and take an immediate tax deduction. The funds continue to grow tax-free, and distributions to qualified charities remain tax-free. These are great vehicles to facilitate lump-sum gifts. By bunching multiple years of gifts into a single-year contribution, you can take the larger deduction now (helping you clear the standard deduction hurdle) and spread the gifts over multiple years.
- Appreciated assets: If you donate appreciated securities, you can deduct them at their market value. This means you won’t ever realize the taxable gain you’d have if you sold them first and donated the cash. Donating highly-appreciated securities is a great way to maximize your gift and avoid taxes (for both yourself and the charity).
6. Diversify The Character Of Your Income
Deferring taxes is often the most natural approach for many people. While tax-deferred accounts can be excellent for reducing your current taxable income, too much deferral can cause unnecessary tax stress when removing the funds in retirement.
Even for high-earners, Roth accounts can be helpful tools for keeping your taxes as low as possible over the long term. Just because you make too much to contribute to a Roth IRA doesn’t mean they aren’t available to you.
You can also consider a Roth conversion, contribute to a Roth 401(k) (no income limits), or even a mega backdoor Roth IRA in which you first contribute to your tax-deferred retirement plan and then convert.
There are many ways for you to incorporate Roth accounts into your plan.
Regardless of your situation, there are ways to be more tax-aware in your plan. If you have questions or are unsure of the best approach to take, give us a call. We can help you determine which strategy might be the best and most appropriate for you. Set up a time to speak with the Wingate team today.