Tax planning becomes essential for individuals and businesses as the year ends. Proactively managing your finances before the calendar flips to 2025 can help minimize your tax burden and set you up for a financially secure new year.
Many clients submit their information yearly to have us optimize their 2024 and future years’ taxes. Proactively estimating and making side-by-side multi-year tax projections has permanently saved some clients thousands of dollars in taxes.
Here are some things to consider as you weigh potential tax moves between now and the end of the year.
1. Consider deferring income to next year
The old rule used to be “defer income.” The new rule is “time income.”
Consider opportunities to defer income to 2025, especially if you may be in a lower tax bracket next year.
For example, you may be able to defer a year-end bonus or delay the collection of business debts, rent, and payments for services. Doing so may enable you to postpone tax payments on the income until next year.
If you have the option to sell real property on a land contract rather than an outright sale, that can spread your tax liability over several years and be subject to a lower long-term capital gain rate (which could be as low as 0%.) On the other hand, if you’re concerned about future tax rate hikes, an outright sale or opting out of the installment method for a land contract sale can ease the uncertainty that you’ll pay higher rates on the deferred income.
If your top tax rate in 2024 is lower than what you expect in 2025 (say, because you are retiring or because of significant gains or a big raise or bonus expected in 2025), it might make sense to accelerate income instead of deferring it.
Be mindful of accelerating or bunching income, which can potentially 1) increase the taxability of social security income, 2) increase Medicare premiums, 3) raise your long-term capital gains rate from 0% to 20%, or 4) decrease your ACA health insurance premium credit.
2. Time your deductions
Once again, the old rule used to be “accelerate deductions.” The new rule is “time deductions.”
If appropriate, look for opportunities to accelerate deductions into the current tax year, especially if your tax rate will be higher this year than next.
If you own a business and are in a high tax bracket, consider accelerating business equipment purchases and electing up to a full expense deduction (via bonus depreciation or Section 179 expensing.)
If you itemize deductions, making payments for deductible expenses such as qualifying interest, state, and local taxes (to the extent they don’t already exceed $10,000), and medical expenses before the end of the year (instead of paying them in early 2025) could make a difference on your 2024 return.
For taxpayers who typically itemize their deductions, the strategy of “bunching” deductions can significantly impact them. Instead of spreading charitable contributions, medical expenses, and other deductible costs across multiple years, consider consolidating them into one year. By “bunching” these deductions, you may exceed the standard deduction threshold and maximize your itemized deductions for the year.
For example, if you typically donate $2,000 annually to charity but are not receiving a tax benefit because you are utilizing the standard deduction, consider making multiple years of contributions in 2024. This could help you exceed the standard deduction amount, allowing you to itemize your deductions and providing more tax benefits (see below.)
For those with significant medical expenses, it’s important to note that only the portion of medical expenses exceeding 7.5% of your adjusted gross income (AGI) can be deducted. If you’re close to reaching that threshold, consider scheduling medical procedures, doctor visits, or purchasing necessary medical equipment before the year ends. Remember that medical expenses are only deductible in the year they are paid, so timing matters.
3. Make deductible charitable contributions
Making charitable donations can reduce your taxable income while supporting causes that matter to you.
If you itemize deductions on your federal income tax return, you can generally deduct charitable contributions, but the deduction is limited to 60%, 50%, 30%, or 20% of your adjusted gross income, depending on the type of property you give and the type of organization to which you contribute. Excess amounts can be carried over for up to five years.
You can use checks or credit cards to make year-end contributions even if the check does not clear until shortly after year-end or the credit card bill does not have to be paid until next year.
As you consider year-end charitable giving, there are a few strategies to keep in mind:
- Qualified Charitable Distributions (QCDs): If you’re 70½ or older, you can direct up to $105,000 (2024 limit) from your IRA to a charity as a QCD. This donation counts toward your required minimum distribution (RMD) and is excluded from your taxable income (and can reduce the taxation of social security income.) QCDs cannot be counted as deductible charitable donations.
- Donor-Advised Funds (DAFs): DAFs allow you to make a significant charitable contribution in 2024 and receive the tax deduction now while deciding which charities to support over the next several years. This is a strategy to help with the bunching of itemized deductions described earlier.
- Appreciated Stock Donations: Donating appreciated stocks that have been held for over one year instead of cash generally provides a double benefit. It allows you to avoid paying capital gains tax on the appreciation while receiving a charitable deduction equal to the investment’s fair market value.
4. Bump up withholding to cover a tax shortfall
If it looks as though you will owe federal income tax for the year, consider increasing your withholding on Form W-4 for the remainder of the year to cover the shortfall. Time may be limited for employees to request a Form W-4 change and for their employers to implement it in 2024.
The most significant advantage in doing so is that withholding is considered to have been paid evenly throughout the year instead of when the dollars are taken from your paycheck. This approach can help you avoid or reduce possible underpayment of estimated tax penalties.
Those taking distributions from their IRAs can also request that up to 100% of the distribution be paid toward federal and state income tax withholding to help avoid underpayment of estimated tax penalties.
These increased withholding strategies can compensate for low or missing quarterly estimated tax payments.
5. Save more for retirement
Deductible contributions to a traditional IRA and pretax contributions to an employer-sponsored retirement plan such as a 401(k) can reduce your 2024 taxable income. Consider doing so if you still need to contribute up to the maximum amount allowed.
For 2024, you can contribute up to $23,000 to a 401(k) plan ($30,500 if you’re age 50 or older) and up to $7,000 to traditional and Roth IRAs combined ($8,000 if you’re age 50 or older). The window to make 2024 employee contributions to an employer plan generally closes at the end of the year, while you have until April 15, 2025, to make 2024 IRA contributions.
Various income limitations exist for eligibility to make traditional and Roth IRA contributions. Regardless of your income, however, you can make a non-deductible IRA contribution. Such a contribution can be subsequently converted to a Roth IRA at little or no tax cost for many (this is known by many as the “back-door” Roth.) If a Roth IRA conversion doesn’t make sense, the non-deductible contribution adds cost basis to your traditional IRA, reducing future taxation of IRA distributions or Roth conversions. Note that Roth contributions are not deductible and Roth-qualified distributions are not taxable.
Speaking of Roth Conversions, if you expect your tax rate to be higher in future years, or you’re in a low tax bracket in 2024, converting some or all your traditional (pre-tax) IRA or 401(k) funds into a Roth IRA in 2024 may be beneficial. While this conversion triggers taxes now, it can reduce future tax liabilities, as qualified withdrawals from a Roth IRA are tax-free.
Owners of small businesses with retirement plans may have until the due date of their tax returns (plus extensions) to make some retirement plan contributions. Check with your tax advisor for your particular small-business retirement plan.
Some small business retirement plans must be set up by 12/31/2024 to allow for a deduction for the 2024 tax year.
If you have a small business, check with your tax advisor to ensure your retirement plan deductions are correctly balanced with the qualified business income deduction, assuming your small business is eligible.
6. Take required minimum distributions
If you are 73 or older, you generally must take required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans (special rules may apply if you’re still working and participating in your employer’s retirement plan.)
If you reach 73 in 2024, you must begin taking minimum distributions from your retirement accounts (traditional IRAs, 401(k)s, etc.) by April 1, 2025. However, delaying the 2024 RMD until 2025 will require you to include both the 2024 and 2025 RMDs into 2025 income.
You must make the withdrawals by the required date—the end of the year for most individuals. The penalty for failing to do so is substantial: 25% of any amount you failed to distribute as required (10% if corrected promptly).
In 2024, the IRS finalized somewhat complicated regulations relating to RMDs from inherited IRAs after December 31, 2019.
In general, under the SECURE Act, unless an exception applies, the entire balance of a traditional or Roth IRA must be fully distributed by the end of the 10th year after the year of death.
In addition, depending on the age of the original IRA owner, heirs must take an RMD every year until the 10th year, when the remaining account balance must be distributed. These rules require careful and sometimes complex, multi-year planning for large inherited IRAs, so it’s essential to consult your tax advisor.
Review your accounts to ensure you’ve met your RMD requirement for the year, and if applicable, consider making charitable contributions through a QCD.
7. Weigh year-end investment moves
I often tell folks, “You should not let the tax tail wag the investment dog.” That means that you shouldn’t let tax considerations drive your investment decisions.
With that in mind, lower-income taxpayers may be subject to a 0% long-term capital gains rate for up to about $47K of taxable income for single filers and $94K for joint filers. For “kids” under 26, up to $2,600 of long-term capital gains are taxed at 0% if filed on their own tax returns (not filed with parents’ returns.)
Regardless, it’s worth considering the tax implications of any year-end investment moves that you make. For example, if you have realized net capital gains from selling securities at a profit, you might avoid being taxed on some or all those gains by selling losing positions (also known as tax loss harvesting.)
Any capital losses over and above your capital gains can offset up to $3,000 of ordinary income ($1,500 if your filing status is married filing separately) or be carried forward to reduce your taxes in future years.
Wash sale rules prevent investors from selling an investment at a loss and re-purchasing the same or substantially similar security within 30 days in any of their or spouse’s accounts (including retirement accounts). Doing so invalidates the loss for the current year, and the loss deduction is suspended until the new security is ultimately sold. If you wait 31 days to repurchase the same (or substantially similar security), the wash sale rules do not apply.
Digital assets like Bitcoin are not subject to wash sales rules, so there’s no harm in harvesting a loss and then immediately re-purchasing the same digital asset if desired.
8. Contribute to 529 Education Savings Plans
If you’re planning to save for education expenses, the end of the year is an excellent time to consider contributions to a 529 education savings plan. There is no federal tax deduction for 529 plan contributions, but the account grows tax-free if the funds are used for qualifying educational purposes.
Many states offer a limited tax deduction or credit for 529 plan contributions (some states even allow for a deduction for a 529 plan rollover from another state’s 529 plan.) In many states, contributing to a 529 plan you don’t own (say for a sibling, grandkid, nephew, niece, cousin, or friend) also allows for a state tax deduction.
There’s a five-year “super-funding” strategy for those needing to accelerate their college funding. This strategy allows you to contribute up to five years’ worth of gifts to a 529 plan in a year ($90,000 for individuals, $180,000 for married couples). A gift tax return must be filed, but it may not be taxable if this is the only gift made to that person in the current year. This can be a great way to accelerate your child’s education savings.
With the ability to 1) fund private K-12 education, 2) repay some student loans up to $10,000, and 3) rollover some leftover 529 plan funds to a Roth IRA after college graduation, worries about overfunding a 529 education savings plan are far less than they used to be.
In summary, year-end tax planning is a valuable opportunity to control your finances and reduce your taxable income for the year. Reviewing your financial situation, consulting with your tax advisor, and implementing these year-end strategies will ensure that you enter 2025 knowing you’ve made proactive decisions to optimize your tax savings.
Don’t hesitate to contact us if you would like to discuss a tax plan that fully utilizes all available strategies.
If you would like to review your current investment portfolio or discuss any other 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, 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 and your financial plan and investment objectives are different.
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