With the holidays rapidly approaching, this is the time of year when everyone’s favorite subject starts to come back into focus: tax planning! Year-end tax planning can have a major impact on the amount a taxpayer may have to pay (or get back) next April. And every year, too many taxpayers leave it too late in the year for to take advantage of some useful strategies. Waiting until December might see a strategy implemented too late, and not take effect until 2025.
But fear not! We have a checklist of some important strategies to consider now, and to act on with plenty of time before the end of the year.
Strategies to Reduce Income
If 2024 was a high-income year, there are some ways to reduce taxable income. This can be a benefit in lowering your effective tax rate, or even keeping Medicare Part B premiums low(er) or staying below some additional tax thresholds. Here are a few to consider:
- Increase 401(k)/403(b) deferrals
- Increasing the amount of deferral to a retirement plan not only has the benefit of lowering taxable income this year, but it also increases the funds working in the market for future years.
- At a minimum, if there is a match available, take advantage of it. If you can afford to defer more, there can be some meaningful tax savings.
- Make an IRA contribution
- There are income limits for deducting an IRA contribution, but the good news here is that the deadline for contributing to an IRA for 2024 is actually April 15th, 2025.
- Contribute to an HSA/FSA
- If your employer offers these types of plans, they can be a useful tool.
- An HSA carries triple tax advantages:
- Deduction for the contribution.
- Tax-free growth on the account.
- Tax-free withdrawals when the funds are used for qualified medical expenses.
- HSA contributions can also be made up until April 15th, 2025 and count towards your 2024 taxes.
- Business owner? Consider making a profit-sharing contribution to a retirement plan.
- This can look like a SEP IRA contribution if you miss the deadline for setting up a 401(k) for 2024.
- And if you need to put your 2024 return on extension, you might even be able to complete this contribution before October 15th of next year.
- Take advantage of available credits and deductions
- Some credits are obvious, like the child tax credit, but things like energy-efficient improvements to your home can come with tax credits that can prove meaningful.
- Deductions come in many forms, but two big ones are charitable deductions (if you itemize your deductions) and 529 contributions (depending on the state you live in).
- If you itemize your deductions, charitable giving to a Donor Advised Fund can be done with appreciated securities (thereby avoiding the capital gains tax on those shares) or cash, and it can help lower taxable income.
- If the amount you give to charity each year hovers right around the standard deduction, consider “bunching” your deduction, and give more than a years’ worth of charitable giving to a Donor Advised Fund, which is controlled by you, and you can make distributions to your preferred charities over time.
- 529 contributions are not federally deductible, and not every state has a state tax deduction, but if you live in a state that has one, it can result in savings of some hundreds of dollars.
- If you itemize your deductions, charitable giving to a Donor Advised Fund can be done with appreciated securities (thereby avoiding the capital gains tax on those shares) or cash, and it can help lower taxable income.
- Required to take a distribution (RMD) from your IRA in a high-income year? Consider a Qualified Charitable Distribution (QCD).
- A Qualified Charitable Distribution does not show up on your tax return, thereby lowering your taxable income. The maximum QCD for 2024 is $105,000, and it must go directly to a qualified charity (it cannot go to a Donor Advised Fund).
- Tax-loss harvesting
- In a year with high capital gains, or high ordinary income, realizing losses in your portfolio can lower capital gains income, or offset ordinary income up to $3,000 each year.
Strategies to INCREASE Income
You might be thinking, why would someone want to INCREASE their taxable income? In uncharacteristically low income years, it can benefit to have a higher income, to take advantage of lower tax brackets.
- Roth Conversions
- If retirement income (through Social Security, pensions, and Required Minimum Distributions) are going to be higher in later years than the first few years, a Roth Conversion can take advantage of a lower tax bracket, while potentially improving taxes in future years.
- By having a bucket of Roth IRA dollars, there is greater flexibility in controlling taxable income in later years.
- Capital gain harvesting
- Below certain income thresholds, capital gains are not taxed federally (most states tax all income at the same rate, whether it is ordinary or capital gain income). When there is an opportunity to rebalance a portfolio and do so with little to no tax impact, it could be prudent to take advantage.
- Exercise stock options
- With Incentive Stock Options (ISOs) or Non-qualified Stock Options (NSOs), there might be opportunities to recognize income in 2024 rather than delaying until 2025 (if 2025 is queuing up to be a high-income year).
- If retirement income (through Social Security, pensions, and Required Minimum Distributions) are going to be higher in later years than the first few years, a Roth Conversion can take advantage of a lower tax bracket, while potentially improving taxes in future years.
Make Sure Tax Payments Match Your Tax Liability
- With the Fed’s rate increases this last 12 months, interest has been high. That has had a positive impact on many bank account balances, and it’s hurt for those who have needed to borrow (through a personal loan, car loan, or mortgage). But there are some people who haven’t yet felt the pain of the high interest rates, and that is taxpayers who are going to owe underpayment penalties and interest for 2024. The IRS’ interest rate on underpaid taxes hit as high as 8 percent!
- So how can you try to avoid making that payment? Make sure that your payments match your expected taxes owed.
- This can be done in two ways:
- Adjusting withholding from your paycheck. This, if possible, is always a good option, because taxes withheld are assumed to have been paid equally throughout the year, which lowers potential penalties the most.
- Make estimated payments. The IRS and most states have very easy online payment systems to make sure that you can quickly make estimated tax payments. For 2024, the deadline for 4th quarter estimated payments is January 15th, 2025. There could be some meaningful savings by paying expected taxes before then, rather than waiting until April 15th.
- Another important note: if your 2024 tax return goes on extension, you have only received an extension to file your return, not an extension of when the taxes are due. If you owe and you don’t pay until after April 15th, that can be a painful underpayment penalty (plus interest).
This is by no means an exhaustive list, and it only scratches the surface of tax planning that should be done throughout the year. If you have any questions, or want to confirm that you are making the most out of your tax planning, the EVOadvisers team is here to help!