The window of opportunity for many year-end tax-saving moves closes on December 31, so it’s important to evaluate your tax situation now, while there’s still time to affect your bottom line for the 2023 tax year.

Timing is Everything

Consider any opportunities you may have to defer income to 2024. Doing so may allow you to postpone paying tax on the income until next year. If there’s a chance that you’ll be in a lower income tax bracket next year, deferring income could mean paying less tax on the income as well.

Some examples:

·       Check with your employer to see if there is an opportunity to defer year-end bonuses.

·       Defer the sale of capital gain property (or take installment payments rather than a lump-sum payment)

·       Postpone receipt of distributions (other than required minimum distributions) from retirement accounts.

Similarly, consider ways to accelerate deductions into 2023. If you itemize deductions, you might accelerate some deductible expenses by making payments before year-end.

Some examples:

·       Consider paying medical expenses or bills in December rather than January, if doing so will allow you to qualify for the medical expense deduction (must be more than 7.5% of your income).

·       Prepay deductible interest by accelerating your January mortgage payment into December.

·       Make January alimony payments in December

·       Make next year’s charitable contributions in December

·       Pay state and local taxes (income taxes, property taxes, use taxes, etc.) if you’re below the $10,000 maximum allowed itemized deduction for state and local taxes

·       Purchase that piece of equipment or vehicle needed in your business and place it in service by year-end

Sometimes, however, it may make sense to take the opposite approach — accelerating income into 2023 and postponing deductible expenses to 2024. That might be the case, for example, if you can project that you’ll be in a higher tax bracket in 2024; paying taxes this year instead of next might be outweighed by the fact that the income would be taxed at a higher rate next year.

Factor in the Alternative Minimum Tax (AMT)

Although the number of taxpayers subject to the AMT is much lower than in prior years, make sure that you factor in the alternative minimum tax when deciding to accelerate any deductions. If you’re subject to the AMT, traditional year-end maneuvers, like deferring income and accelerating deductions, can have a potentially negative effect. That’s because the AMT — essentially a separate, parallel income tax with its own rates and rules — effectively disallows several itemized deductions. For example, if you’re subject to the AMT in 2023, prepaying 2024 state and local taxes won’t help your 2023 tax situation but could potentially hurt your 2024 bottom line.

Special Concerns for Higher-Income Individuals

The top marginal tax rate (37%) applies if your taxable income exceeds $578,125 in 2023 ($692,750 if married filing jointly, $346,875 if married filing separately, $578,100 if head of household). Your long-term capital gains and qualifying dividends could be taxed at a maximum 20% tax rate if your taxable income exceeds $492,300 in 2023 ($553,850 if married filing jointly, $276,900 if married filing separately, $523,050 if head of household).

Additionally, a 3.8% net investment income tax (unearned income Medicare contribution tax) may apply to some or all of your net investment income if your modified AGI exceeds $200,000 ($250,000 if married filing jointly, $125,000 if married filing separately).

High-income individuals are subject to an additional 0.9% Medicare (hospital insurance) payroll tax on wages exceeding $200,000 ($250,000 if married filing jointly or $125,000 if married filing separately).

Charitable Contribution Planning

If you are planning to donate to a charity, it’s likely better to make your contribution before the end of the year to potentially save on taxes. There are many tax planning strategies surrounding charitable giving:

·       Consider donating appreciated property (such as securities, real estate, or artwork) that has been held for more than one year, rather than cash. Note that an appraisal may be needed for certain properties. Not only do you get a deduction for the fair market value (FMV) of your appreciated stock, but you save on taxes by not recognizing the capital gains on the appreciation.

·       Opening and funding a donor-advised fund (DAF) is appealing to many as it allows for a fully tax-deductible gift in the current year and the ability to dole out those funds to charities over multiple years. Again, if you donate appreciated securities to a DAF, not only do you get a deduction for the FMV of your appreciated stock, but you save on taxes by not recognizing the capital gains on appreciation.

·       Qualified charitable distributions (QCDs) up to $100,000 are another option for certain older taxpayers (age 70-1/2 or older) who don’t typically itemize on their tax returns. If you don’t have a required minimum distribution (RMD) from your retirement accounts (see below), this will help reduce future RMDs and taxable income. If you do have an RMD requirement from your retirement accounts, this could be an even better strategy for you to reduce your current taxable income.

Note that it’s important to have adequate documentation of all claimed donations, including a letter from the charity for donations of $250 or more.

Required Minimum Distributions (RMDs)

Unfortunately, you cannot keep retirement funds in your account indefinitely. RMDs are the minimum amount you must annually withdraw from your retirement accounts once you reach a certain age (generally now age 73). Failure to do so can result in significant penalties (special rules apply if you’re still working and participating in your employer’s retirement plan). You must make the withdrawals by the date required — the end of the year for most individuals.

As described above, there are also opportunities to distribute retirement funds to a qualified charity to satisfy the RMD without incurring taxes. Missed RMDs are subject to steep excise tax penalties (25%), although recent rules greatly reduce the penalty (to 10%) if the missed RMD is taken within two years.

Digital Assets and Virtual Currency

Digital assets are defined under the U.S. income tax rules as any digital representation of value that may function as a medium of exchange, a unit of account, or a store of value. Digital assets may include virtual currencies such as Bitcoin and Ether, Stablecoins such as Tether and USD Coin (USDC), and non-fungible tokens (NFTs).

The sale or exchange of virtual currencies, the use of such currencies to pay for goods or services, or holding such currencies as an investment, generally have tax impacts –– and the IRS continues to increase its scrutiny in this area. The trading and use of digital assets must be disclosed on your tax returns and, since they are considered property rather than investments, different tax rules apply to their sales and exchanges.

Energy tax credits

From electric vehicles to home car chargers to solar panels, “going green” continues to provide tax incentives. The Inflation Reduction Act of 2022 included new and newly expanded tax credits for solar panels, electric vehicles (EV), and energy-efficient home improvements. The rules are complex but there is still time for these credits to be beneficial in the current and next year. The most notable change to the EV credits is the requirement that the vehicle has final assembly in North America. If you are planning an EV purchase, please ask the dealer whether the vehicle you’re eyeing is on the list of qualifying vehicles, which has changed significantly in the past years. See if they can advance the credit to you as an offset to the vehicle purchase price (you’ll have to sign a form to assign the credit to the dealer.)

Bump Up Withholding to Avoid 2024 Underpayment

If it looks as though you will owe federal income tax for the year, consider increasing your withholding on Form W-4 for 2024 with your employer (also consider doing the same on the appropriate state withholding forms). The biggest advantage in doing so is that withholding is considered as having been paid evenly throughout the year instead of when the dollars are taken from your paycheck. This strategy can be used instead of making quarterly estimated tax payments.

If you’re collecting social security, a pension, or taxable IRA distributions, update your Form W-4P with the appropriate payor to ensure you’ve paid in enough to avoid underpayment penalties.

Beneficial Ownership Interest (BOI) Reporting

The Corporate Transparency Act (CTA) requires the disclosure of the beneficial ownership information of certain entities to the Financial Crimes Enforcement Network (FinCEN) starting in 2024. This is not a tax filing requirement, but an online report to be completed if applicable to FinCEN. There are severe penalties for businesses who willingly do not comply with the requirements. The details of this reporting requirement are still being written, so it’s best to get in touch with your business attorney to determine whether your corporation, partnership, or LLC must file this report.

Additional Tax and Financial Planning Considerations

We recommend you review your retirement plans at least annually. That includes making the most of tax-advantaged retirement saving options, such as traditional individual retirement accounts (IRAs), Roth IRAs, and company retirement plans. It’s also advisable to take advantage of health savings accounts (HSAs) that can help you reduce your taxes and save for medical-related expenses. Once you become eligible or sign up for Medicare, you are no longer entitled to make HSA contributions.

IRAs and Retirement Plans

Make sure you’re taking full advantage of tax-advantaged retirement savings vehicles. Traditional IRAs and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds on a deductible (if you qualify) or pre-tax basis, reducing your 2023 taxable income. Contributions to a Roth IRA (assuming you meet the income requirements) or a Roth 401(k) aren’t deductible since they are made with post-tax dollars, so there’s no tax benefit for 2023, but qualified Roth distributions are completely free from federal income tax, which can make these retirement savings vehicles appealing.

For 2023, you can contribute up to $22,500 to a 401(k) plan ($30,000 if you’re age 50 or older) and up to $6,500 to a traditional IRA or Roth IRA ($7,500 if you’re age 50 or older). The window to make 2023 contributions to an employer plan typically closes at the end of the year, while you generally have until the April tax return filing deadline (April 15, 2024) to make 2023 IRA contributions.

If you started a small business in 2023, talk to your financial or tax advisor about setting up a small business retirement plan before year-end. Most plans must be set up before year-end, but contributions may not be required every year, and they don’t have to be made until the due date of the return (plus extensions). Some small business retirement plans can be set up at tax return time (e.g., SEP-IRA), but they have less contribution flexibility and more stringent rules than other plans (e.g., a solo 401(k)).

Roth IRA Conversions

Year-end is a good time to evaluate whether it makes sense to convert a tax-deferred savings vehicle like a traditional IRA or a 401(k) account to a Roth account. When you convert a traditional IRA to a Roth IRA, or a traditional 401(k) account to a Roth 401(k) account, the converted funds are generally subject to federal income tax in the year that you make the conversion (except to the extent that the funds represent nondeductible after-tax contributions).

If a Roth conversion does make sense, you’ll want to give some thought to the timing of the conversion. For example, if you believe that you’ll be in a better tax situation this year than next (e.g., you will pay tax on the converted funds at a lower rate this year), you might think about acting now rather than waiting. Whether a Roth conversion is appropriate for you depends on many factors, including your current and projected future income tax rates and whether you have the funds to pay the taxes outside of the IRA. Ask your financial or tax advisor whether a Roth Conversion is appropriate for this year or next.

Other Ideas

·       Life changes –– Any major changes in your life such as marriages or divorces, births or deaths in the family, job or employment changes, starting a business, and significant expenditures (real estate purchases, college tuition payments, etc.) can significantly impact the taxes you owe, so be sure to discuss them with your tax or financial advisor.

·       Capital gains/losses –– Consider tax benefits related to using capital losses to offset realized gains –– and move any gains to the lowest tax brackets, if possible. Also, consider selling portfolio investments that are underperforming before the end of the year. Net capital losses can offset up to $3,000 of the current year’s ordinary income. The unused excess net capital loss can be carried forward to use in subsequent years.

·       Estate and gift tax planning –– Make sure you’re appropriately planning for estate and gift tax purposes. There is an annual exclusion for gifts ($17,000 per donee in 2023, $34,000 for married couples) to help save on potential future estate taxes. If your estate/trust is worth over $5 million, it’s imperative to discuss your options with a dedicated estate planning attorney to review lifetime gift and generation-skipping transfer (GST) opportunities to use and plan additional exclusions and exemption amounts.

·       State and local taxes –– Remote working arrangements or moving your residency could potentially have state and local tax implications to consider. Be sure to discuss your working arrangements with your tax advisor.

·       Education planning –– Save for education with Section 529 education savings plans. There can be state income tax benefits to do so, and there have been changes in the way these funds can be used for private K-12 school expenses, paying down some student loans, or contributing leftover funds to Roth IRAs.

·       Updates to financial records –– Determine whether any updates are needed to your insurance policies or beneficiary designations. This should be checked at least once a year, and year-end is a good time to do so.

·       Estimated tax payments –– With underpayment interest rates being on the rise (currently at 8% for federal), you must review withholding and estimated tax payments and assess any requirements for any additional payments. The 4^th quarter 2023 estimated income tax payment is due by January 16, 2024.

Hopefully one or more of the above tips helps you save a few dollars on your tax bill. By necessity, many of the tips are abbreviated, so be sure to check with your financial or tax advisor to ensure that they’re appropriate for your tax situation, both currently and in the future.

If you would like to review your current investment portfolio or discuss any other tax or financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so are your financial plan and investment objectives.

Among the many provisions in the multi-trillion-dollar legislative package being debated in Congress, is a provision that would eliminate a strategy that allows high-income investors to pursue tax-free retirement income: the so-called “back-door Roth IRA”. The next few months may present the last chance to take advantage of this opportunity.

Roth IRA Background

Since its introduction in 1997, the Roth IRA has become an attractive investment vehicle due to the potential to build a sizable, tax-free nest egg. Although contributions to a Roth IRA are not tax deductible, any earnings in the account grow tax-free as long as future distributions are qualified. A qualified distribution is one made after the Roth account has been held for five years and after the account holder reaches age 59½, becomes disabled, dies, or uses the funds for the purchase of a first home ($10,000 lifetime limit) or for qualified higher education expenses.

Unlike other retirement savings accounts, original owners of Roth IRAs are not subject to required minimum distributions at age 72 — another potentially tax-beneficial perk that makes Roth IRAs appealing in estate planning strategies (but beneficiaries are subject to distribution rules.)

However, as initially passed, the 1997 legislation rendered it impossible for high-income taxpayers to enjoy Roth IRAs. Individuals and married taxpayers whose income exceeded certain thresholds could neither contribute to a Roth IRA nor convert traditional IRA assets to a Roth IRA.

A Loophole Emerges

Nearly 10 years after the Roth’s introduction, the Tax Increase Prevention and Reconciliation Act of 2005 ushered in a change that relaxed the conversion rules beginning in 2010; that is, as of that year, the income limits for a Roth conversion were eliminated, which meant that anyone could convert traditional IRA assets to a Roth IRA (of course, a conversion results in a tax obligation on deductible contributions and earnings that have previously accrued in the traditional IRA.)

One perhaps unintended consequence of this change was the emergence of a new strategy that has been heavily utilized ever since: High-income individuals could make full, annual, nondeductible contributions to a traditional IRA and convert those contribution dollars to a Roth. If the account holders had no other IRAs (see note below) and the conversion was executed quickly enough so that no earnings were able to accrue, the transaction could potentially be a tax-free way for otherwise ineligible taxpayers to fund a Roth IRA. This move became known as the “back-door Roth IRA”.

Employees working for companies which had retirement plans that allowed post-tax contributions into their 401(k)’s, along with “in-service distributions”, could replicate the back-door strategy in a potentially much bigger way, which became known as the “mega-back-door Roth IRA”

Note: When calculating a tax obligation on a Roth conversion, investors have to aggregate all of their IRAs, including SEP and SIMPLE IRAs, before determining the amount. For example, say an investor has $100,000 in several different traditional IRAs, 80% of which is attributed to deductible contributions and earnings. If that investor chose to convert any traditional IRA assets — even recent after-tax contributions — to a Roth IRA, 80% of the converted funds would be taxable. This is known as the “pro-rata rule.”

Current Roth IRA Income Limits

For 2021, you can generally contribute up to $6,000 to an IRA (traditional, Roth, or a combination of both); $7,000 if you’ll be age 50 or older by December 31. However, your ability to make contributions to a Roth IRA is limited or eliminated if your modified adjusted gross income, or MAGI, falls within or exceeds the parameters shown below.

Note that your contributions generally can’t exceed your earned income for the year (special rules apply to spousal Roth IRAs).

Now or Never … Maybe

While no one knows for sure what may come of the legislative debates, the current proposal would prohibit the conversion of nondeductible contributions from a traditional IRA (or 401(k)) after December 31, 2021. If you expect your MAGI to exceed this year’s thresholds and you’d like to fund a Roth IRA for 2021, the next few months may be your last chance to use the back-door strategy.

You can make 2021 IRA contributions up until April 15, 2022, but if the legislation is enacted, a Roth conversion involving nondeductible contributions would have to be executed by December 31, 2021.

Keep in mind that a separate five-year rule applies to the principal amount of each Roth IRA conversion you make, unless an exception applies.

In addition to eliminating the conversion of nondeductible contributions from traditional IRAs to Roth IRAs, the proposed legislation includes a similar prohibition on the conversion of after-tax 401(k) contributions (so-called mega-back-door Roth conversions), as well as other retirement-related provisions affecting those with large account balances ($10 million and higher) and high incomes (more than $400,000 for single taxpayers and more than $450,000 for joint filers).

Don’t wait until the last minute to make these contributions or conversions. Brokerage firms are extremely busy during the last half of December, and will be especially so if tax legislation is passed this year. Now is the time to be thinking about doing this if it fits within your financial plan.

If you would like to review your current investment portfolio or discuss your Roth IRA options, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

As the year comes to and end, it is good to know the limits for 2021 contributions to IRA’s and employer retirement plans.  Many IRA and retirement plan limits are indexed for inflation each year. While some of the limits remain unchanged for 2021, other key numbers have increased.

IRA contribution limits

The maximum amount you can contribute to a traditional IRA or a Roth IRA in 2021 is $6,000 (or 100% of your earned income, if less), unchanged from 2020. The maximum catch-up contribution for those age 50 or older remains $1,000. You can contribute to both a traditional IRA and a Roth IRA in 2021, but your total contributions cannot exceed these annual limits.

Income limits for deducting traditional IRA contributions

If you (or if you’re married, both you and your spouse) are not covered by an employer retirement plan, your contributions to a traditional IRA are generally fully tax deductible. If you’re married, filing jointly, and you’re not covered by an employer plan but your spouse is, your deduction is limited if your modified adjusted gross income (MAGI) is between $198,000 and $208,000 (up from $196,000 and $206,000 in 2020), and eliminated if your MAGI is $208,000 or more (up from $206,000 in 2020).

For those who are covered by an employer plan, deductibility depends on your income and filing status.

If your filing status is single or head of household, you can fully deduct your IRA contribution up to $6,000 ($7,000 if you are age 50 or older) in 2021 if your MAGI is $66,000 or less (up from $65,000 in 2020). If you’re married and filing a joint return, you can fully deduct up to $6,000 ($7,000 if you are age 50 or older) if your MAGI is $105,000 or less (up from $104,000 in 2020).

Income limits for contributing to a Roth IRA

The income limits for determining how much you can contribute to a Roth IRA have also increased.

If your filing status is single or head of household, you can contribute the full $6,000 ($7,000 if you are age 50 or older) to a Roth IRA if your MAGI is $125,000 or less (up from $124,000 in 2020). And if you’re married and filing a joint return, you can make a full contribution if your MAGI is $198,000 or less (up from $196,000 in 2020). Again, contributions can’t exceed 100% of your earned income.

Employer retirement plan limits

Most of the significant employer retirement plan limits for 2021 remain unchanged from 2020. The maximum amount you can contribute (your “elective deferrals”) to a 401(k) plan remains $19,500 in 2021. This limit also applies to 403(b) and 457(b) plans, as well as the Federal Thrift Plan. If you’re age 50 or older, you can also make catch-up contributions of up to $6,500 to these plans in 2021. [Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.]

The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) remains $13,500 in 2021, and the catch-up limit for those age 50 or older remains $3,000.

Note: Contributions can’t exceed 100% of your earned income.

If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit ($19,500 in 2021 plus any applicable catch-up contributions). Deferrals to 401(k) plans, 403(b) plans, and SIMPLE plans are included in this aggregate limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and a 457(b) plan, you can defer the full dollar limit to each plan — a total of $39,000 in 2021 (plus any catch-up contributions).

The maximum amount that can be allocated to your account in a defined contribution plan [for example, a 401(k) plan or profit-sharing plan] in 2021 is $58,000 (up from $57,000 in 2020) plus age 50 or older catch-up contributions. This includes both your contributions and your employer’s contributions. Special rules apply if your employer sponsors more than one retirement plan.

Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans in 2021 is $290,000 (up from $285,000 in 2020), and the dollar threshold for determining highly compensated employees (when 2021 is the look-back year) remains $130,000 (unchanged from 2020).

If you would like to review your current investment portfolio or discuss 2021 IRA contributions, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.