Introduction
As the year comes to an end, it is imperative to review your financial situation and look into tax planning strategies that can help minimize your tax liability and maximize your savings. Proper year-end tax planning can indeed make all the difference in not only the ability to reduce taxable income but also increase deductions and set up plans far in advance for goals one has for their finances in the future. This guide covers key year-end tax planning strategies that can ensure you are reaping all financial opportunities available to you.
Reduce Your Taxable Income
Tax-Loss Harvesting
Tax-loss harvesting is selling those investments that have declined in value and using those losses to offset gains from other investments. This technique will help minimize your taxable income and, accordingly, enable you to claim up to $3,000 of capital losses against other kinds of income. When your losses are more than $3,000, you may carry over the losses to succeeding tax years.
Contribute to Tax-Advantaged Accounts
Boosting your contributions to tax-advantaged accounts is a great way to reduce your taxable income.
401(k) and 403(b) Plans: Contributions to retirement plans are pre-tax, reducing your taxable income. In tax year 2023, the contribution limit is $22,500, and an additional catch-up contribution of $7,500 for those ages 50 and older.
HSAs: HSA contributions are deductible; withdrawals for qualified medical expenses are tax-free. For 2023, the contribution limit is $3,850 for individual and $7,750 for family accounts. Additional catch-up contribution amounts apply: an extra $1,000 if you're 55 or older during the calendar year.
Traditional and Roth IRAs: A traditional IRA offers deductibility of contributions, while a Roth IRA provides tax-free growth and withdrawals. In 2023, the contribution limit for IRAs is $6,500, with a catch-up contribution of $1,000 available for those who are 50 years and above.
Max Out Charitable Deductions
Bunch Charitable Contributions
Bunching of charitable contributions means you bring forward several years' worth of contributions and merge them into one tax year, which brings you over the threshold for the standard deduction, allowing one to itemize and maximize their charitable deductions.
Donate Appreciated Assets
Donations of appreciated assets, like stocks or mutual funds, may have a double tax benefit: You won't have to pay capital gains tax on the appreciation, and you get to deduct the fair market value of the donated asset.
QCDs—Qualified Charitable Distributions: This tactic is accessible for those 70½ years or older. You can gift as much as $100,000 directly from your IRA to a qualified charity. The distribution would count toward your RMD and not be added to your taxable income.
Minimising Future Tax Exposure
Roth IRA Conversions
Converting a traditional IRA to a Roth IRA permits long-term tax benefits, including tax-free growth and withdrawals. This is very good if you think that you might be in a higher tax bracket during your retirement years. Calculate the amount to convert, as you will not want to move yourself into a higher tax bracket.
Annual Exclusion Gifts
This means that the annual gift tax exclusion enables one to gift up to $16,000 per donee per year without incurring gift taxes. As a result, this strategy can help reduce the size of your taxable estate while providing for financial support of your loved ones.
Estate and Gift Tax Exemption
In 2024, the exemption to federal estate and gift taxes is $12.92 million per individual. Effective use of this exemption through strategic gifting and estate planning might significantly reduce the amount due in the form of estate taxes and ensure that the transfer of your wealth to your heirs or other intended beneficiaries happens smoothly.
Gaining Control Over Your Investments
Harvesting Gains and Losses
Keep in mind that your overall taxable income can be reduced by balancing gains with losses on your investment portfolio. Just be sure not to incur a wash-sale, which disallows claiming a loss for selling a security if you bought the same or substantially identical security within 30 days of the sale.
Reviewing NQSOs
Timing Your Exercises: If possible, reduce the tax impact by carefully timing the exercise of nonqualified stock options. Timing NQSO exercises when your income is low or the market is low can bring down the taxable amount.
Review and Adjust Portfolio
Year-end is the time for reviewing your investment portfolio. Ensure that your investment portfolio is aligned with your financial goals and risk tolerance. Consider the tax impact of adjustments.
Retirement Account Strategies
Maximize Retirement Contributions
Contributing up to the maximum into retirement accounts has great tax advantages and supports retirement savings. At a minimum, contribute enough to a 401(k) plan to match what your employer provides, if any.
Required Minimum Distributions
With traditional IRAs, you must take the first required minimum distribution by April 1 of the year after the year you reach age 73. Be sure to take enough to avoid the penalty for inadequate withdrawal, which is 50% of the amount not withdrawn. You may want to ask your IRA custodian to withhold taxes from your RMDs. This way, you can more easily pay your income taxes.
Other Things to Think About
Flexible Spending Accounts (FSAs)
FSAs can help save taxes by allowing the use of pre-tax dollars for medical and dependent care expenses. Just be careful not to lose it with the "use it or lose it" rule; check with your employer to see if it has a grace period or carryover option.
State and Local Tax Deductions (SALT)
Do not prepay state and local taxes if you expect to be subject to the Alternative Minimum Tax. The SALT deduction already is limited to $10,000, and prepaid amounts may not have the same tax benefit under the AMT.
Kiddie Tax Rules
The kiddie tax hits a child's unearned income above $2,500 at the parents' rate. This rule thus has to be kept in mind while shifting investment income to children; otherwise, it will result in the loss of intended tax benefits.
Conclusion
Tax planning at the end of the year is a prerequisite for managing one's financial health. By implementing these strategies, you will have control over your tax situation, after-tax income, and the planning of your future goals. Always consult a tax advisor to personalize these strategies to your situation and ensure compliance with the current tax laws.
