Year-End Tax Planning Tips for Individuals

As the holidays approach, it's time to consider tax planning moves that will help lower this year's tax bill, as well as set you up for tax savings in future years. The good news is that it appears there won't be any significant unfavorable federal tax changes that will take effect next year. Assuming that's an accurate prediction, here are seven year-end tax planning ideas for you to consider. 

1. Game the Standard Deduction

This is a tried-and-true year-end tax planning strategy. If your total itemizable deductions for 2023 will be close to your standard deduction allowance, you could make additional expenditures for itemized deduction items between now and year end to surpass your standard deduction. Those extra expenditures will allow you to itemize and reduce your 2023 federal income tax bill. Next year, you can claim the bigger standard deduction allowance (thanks to the annual inflation adjustment) if you don't itemize.

Basic standard deduction allowances for 2023 and 2024

Note: Slightly higher standard deductions are allowed to those who are 65 or older or blind.

The easiest itemizable expense to prepay is your mortgage payment due in January. Accelerating that payment into this year will give you 13 months' worth of itemized home mortgage interest deductions in 2023. Ask your SSB tax advisor to determine whether you're affected by limits on mortgage interest deductions under current law. 

Next, look at state and local income and property taxes that are due early next year. Prepaying those bills between now and year end can lower this year's federal income tax bill, because your total itemized deductions will be that much higher. However, under current law, the amount you can deduct for all state and local taxes is limited to a maximum of $10,000 ($5,000 if you use married filing separate status).

However, beware: Prepaying state and local taxes can be unhelpful if you'll owe the alternative minimum tax (AMT) for this year. Under the AMT rules, no deductions are allowed for state and local taxes. So, prepaying these taxes before year end may do little or no tax-saving good for people who are subject to the AMT. While the Tax Cuts and Jobs Act (TCJA) eased the AMT rules, so most people are no longer at risk, take nothing for granted. Check with your SSB tax advisor about possible exposure.  

Other ways to increase your itemized deductions for 2023 include:

• Making bigger charitable donations to IRS-approved charities this year and smaller donations next year to compensate, and
• Accelerating elective medical procedures, dental work and expenditures for vision care if you think you can qualify for a medical expense deduction. You can claim an itemized deduction for medical expenses to the extent they exceed 7.5% of your adjusted gross income (AGI). 

2. Manage Gains and Losses in Your Taxable Investment Accounts  

The stock market has experienced plenty of ups and downs this year. You might have already collected some gains and suffered some losses. And you might have some unrecognized gains and losses from stock and mutual funds that you still hold.

If you hold investments in taxable brokerage firm accounts, consider the tax-saving advantage of selling appreciated securities that have been held for over 12 months. The federal income tax rate on net long-term capital gains (LTCGs) recognized this year is 15% for most individuals, although it can reach the maximum 20% rate at high income levels. (See "2023 Tax Rates and Brackets for Individuals," below.)

An additional 3.8% net investment income tax (NIIT) can also kick in for higher income taxpayers. So, the actual federal tax rate on LTCGs can be 18.8% (15% plus 3.8%), or 23.8% (20% plus 3.8%) at higher income levels. However, that's significantly lower than the 40.8% maximum rate that can potentially apply to short-term capital gains (37% plus 3.8%).  

If you're holding some investments that are currently worth less than you paid for them, consider harvesting those capital losses between now and year end. Harvested losses can shelter capital gains from the sale of appreciated stocks this year. Sheltering short-term capital gains with harvested losses is a tax-smart move because net short-term gains are taxed at higher federal income tax rates that can reach 37%, plus another 3.8% if the NIIT applies.

If harvesting losing stocks would cause your 2023 capital losses to exceed your 2023 capital gains, the result would be a net capital loss for the year. The net capital loss can be used to shelter up to $3,000 of 2023 higher-taxed ordinary income ($1,500 if you're married and file separately). Ordinary income can include salaries, bonuses, self-employment income, interest income and royalties. Any excess net capital loss is carried forward to next year—and beyond, if you don't use it up next year.

In fact, having a capital loss carryover to next year and beyond could turn out to be beneficial. The carryover can be used to shelter both future short-term capital gains and LTCGs next year and beyond. That can give you extra investing flexibility in those years because you won't have to hold appreciated securities for over a year to get a lower tax rate. You'll pay 0% to the extent you can shelter gains with your loss carryover.

Important: If you sold a home earlier this year for a taxable gain, you may be able to offset some or all of that taxable gain with harvested capital losses from the sale of losing securities.  

3. Donate to Charities

If you itemize deductions and want to donate to IRS-approved public charities, you can combine your generosity with an overall revamping of your taxable investment portfolio of stock and/or mutual funds. Make these charitable contributions according to the following tax-smart principles:

Underperforming stocks. Sell taxable investments that are worth less than they cost and book the resulting tax-saving capital loss. Then give the sales proceeds to a charity and claim the resulting tax-saving charitable write-off. This strategy delivers a double tax benefit: You receive tax-saving capital losses plus a tax-saving itemized deduction for charitable contributions.

Appreciated stocks. For taxable investments that are currently worth more than they cost, donate the stock directly to a charity. Donations of publicly traded shares that you've owned for over a year result in a charitable deduction equal to the current market value of the shares at the time of the gift. Plus, when you donate appreciated investments, you escape any capital gains taxes on those shares. This strategy also provides a double tax benefit: You avoid capital gains tax, and you get a tax-saving itemized deduction for charitable contributions. 

4. Give to Loved Ones

The principles behind donating tax-smart gifts to charities also apply to making gifts to relatives and other loved ones. That is, you should sell underperforming taxable investments held in your stock and mutual fund portfolios and collect the resulting tax-saving capital losses. Then give the cash proceeds to loved ones.

On the other hand, give appreciated investments directly to relatives. When they sell the shares, they'll probably pay a lower tax rate than you would.

5. Make Charitable Donations from Your IRA

IRA owners and beneficiaries who have reached age 70½ are permitted to make cash donations totaling up to $100,000 annually to IRS-approved public charities directly out of their IRAs. You don't owe income tax on these qualified charitable distributions (QCDs), but you also don't receive an itemized charitable contribution deduction.

The upside is that the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to worry about restrictions that can potentially delay itemized charitable write-offs. Contact your SSB tax advisor if you want to hear about the full benefits of QCDs. If you're interested in taking advantage of this strategy for 2023, you'll need to arrange with your IRA trustee or custodian for money to be paid out to one or more qualifying charities before year end.

6. Prepay College Bills

If paid for you, your spouse or a dependent, higher education expenses may qualify you for one of the following tax credits:

The American Opportunity credit. This credit equals 100% of the first $2,000 of qualified postsecondary education expenses, plus 25% of the next $2,000. So, the maximum annual credit is $2,500 per qualified student.

The Lifetime Learning credit. This credit equals 20% of up to $10,000 of qualified education expenses. The maximum credit is $2,000 per family.

For 2023, both higher education credits are phased out if your modified adjusted gross income (MAGI) is between:

• $80,000 and $90,000 for unmarried people, or
• $160,000 and $180,000 for married couples filing jointly.

Numerous rules and restrictions apply to these higher education credits. If you're eligible for either credit, consider prepaying college tuition bills that aren't due until early 2024 if it would result in a bigger credit this year. Specifically, you can claim a 2023 credit based on prepaying tuition for academic periods that begin in January through March of next year.

7. Convert a Traditional IRA into a Roth IRA

The optimal scenario for a Roth conversion is when you expect your tax rate to be the same or higher during your retirement years than it currently is. However, there's a current tax cost for converting. That's because a conversion is treated as a taxable liquidation of your traditional IRA followed by a nondeductible contribution to the new Roth account.

While the current tax bill from a Roth conversion is unwelcome, it could turn out to be a relatively small price to pay to hedge against higher future tax rates. If you delay converting your account until a future year, the tax cost could be higher if tax rates increase.   

After the Roth conversion, all income and gains that accumulate in the account and all qualified withdrawals will be federal-income-tax-free. In general, qualified withdrawals are those taken after:

• You've had at least one Roth account open for more than five years, and
• You've reached age 59½, become disabled or died.

With qualified withdrawals, you (or your heirs if you die) avoid having to pay higher tax rates that might otherwise apply in future years.

For More Ideas

Assuming the current rate regime will remain in place for next year, the year-end tax planning picture is straightforward for 2023. Consult with your SSB tax advisor to discuss these and other federal (and state) tax planning moves that may apply to your current situation.

©  2023