Year-End Tax Planning Strategies for 2023
As the end of the year approaches, our clients’ thoughts inevitably turn to taxes. You can take advantage of some tax planning strategies in this last month of 2023 to reduce your tax liability. Although there were not many changes from 2022 to 2023, here is an overview of some strategies you may want to consider. There are others, depending on your facts.
Make a Qualified Charitable Distribution (QCD) From Your IRA if Eligible
A qualified charitable distribution (QCD) allows each individual who is 70 1/2 years old or older to donate up to $100,000 to one or more charities directly from a taxable IRA. Spouses are treated separately. The qualified charitable distribution can satisfy all or a portion of the account holder’s RMD without having the distribution counted as taxable income. This essentially makes charitable contributions “tax deductible” when you do not itemize deductions.
Consider Bundling Charitable Contributions
Several significant changes to the tax code, including increasing the standard deduction and capping state and local taxes at $10,000, have resulted in many taxpayers no longer obtaining a tax benefit from their charitable contributions. There is still a way to get a tax benefit from donations: bundling several years of charitable contributions into one year. For example, if you usually donate $3,000 per year to your favorite charity, instead consider donating $12,000 (4 years at once) which may allow you to itemize deductions and get benefit in the current year.
Convert Traditional IRA to a Roth IRA
Roth IRA earnings grow tax-free, withdrawals are tax-free and Roth IRAs don’t have required minimum distributions (RMDs) to primary beneficiaries. Conversion of some or all of your IRA to a Roth will be taxable income in the year of conversion. Depending on your circumstances, the long-term economics may outweigh any tax you will pay on conversion. There are some hidden tax ramifications when converting to a Roth, so it’s a good idea to check with us to see if a conversion makes sense.
Contribute to a Retirement Plan
A SEP IRA is an employer-sponsored retirement plan that can be set up by sole proprietors, LLCs, partnerships, and corporations. A solo 401(k) is an option when there are no employees. The primary benefit is an annual contribution limit much higher than those for traditional IRAs. For 2023, you can contribute up to 25% of compensation for the year or $66,000, whichever is less. A SEP IRA can be set up after year-end; a Solo 401(k), whether Roth or regular, must be established before year-end.
….Or a Defined Benefit Plan
A defined benefit plan is an employer-sponsored retirement plan that pays benefits based on length of employment and salary history. Defined benefit plans may guarantee either a monthly payment or a set lump-sum payment.
Employers typically make all contributions and can get tax deductions for their contributions. The amounts that can be contributed can be significant. An actuary is required for calculations and the plan must be established before year-end.
You don’t have to fully fund a defined benefit plan by year-end to claim a deduction on your 2023 return. You have until the due date of your business tax return (including extensions) to do so.
Take Advantage of the Large Lifetime Estate Tax Exemption
For 2023, the estate tax lifetime exemption is $12,920,000 and will rise to $13,610,000
in 2024. This may be a good time for wealthy individuals to be proactive and make
lifetime gifts using some or even all their exemption amounts. The current estate tax
exemption will revert to approximately $7,000,000 in 2026, assuming Congress doesn’t
take action.
You can also make annual exclusion gifts up to $17,000 per person in 2023 and $18,000 per person in 2024 without filing a gift tax return (in most situations). Note for grandparents: direct payment of tuition or medical expenses is NOT treated as a gift.
Don’t underestimate the power of the annual gift tax exclusion. For example, a married couple with four children and six grandchildren could gift $340,000 in 2023 ($17,000 per spouse, per donee, multiplied by ten donees) without utilizing a single dollar of their lifetime exemption.
Consider Year-End Bonuses or Distributions for S Corp Shareholders
If your S Corporation fared well this year, you might want to distribute some of those profits to S-Corp owners. The question is whether to make that extra payment in the form of a bonus or distribution.
It is crucial to ensure owners are paying themselves reasonable compensation. Distributions, unlike bonuses, aren’t subject to payroll taxes. It is also important to consider how a distribution versus paying a bonus will affect a shareholder’s qualified business income deductions (QBI).
This decision has many moving parts, but we can help run the numbers.
Claim Bonus Depreciation
Starting in 2023, the bonus depreciation deduction will be reduced by 20% annually until it disappears in 2027. Consider purchasing assets and placing them in service before year-end to still take advantage of the 80% depreciation deduction.
Fund a 529 Plan
A 529 plan provides an excellent tax-advantaged opportunity to save for education. Contributions to a 529 plan are not tax deductible on your federal return but may be deductible on your state income tax return (Illinois is an example if an Illinois plan like Bright Start is used). The real benefits are the money grows tax-free while withdrawals are also tax-free when used to pay for qualified education expenses (tuition, room, board).
You can pre-fund a 529 plan with five years of contributions. That allows an individual to contribute up to $85,000 in 2023 ($170,000 for a couple). We’ll need to prepare a gift tax return to report the gift in the year of pre-funding.
Plan for Excess Business Loss Limitation
Excess business loss limitation currently applies through 2028 and limits the amount of trade or business losses taxpayers can utilize to offset nonbusiness income. For 2023, the amount is $289,000 ($578,000 for joint filers) and estimated to increase to $305,000 ($610,000 for join filers) in 2024. Net trade or business losses exceeding the annual threshold amount are carried forward as a net operating loss (NOL) to the subsequent tax years. Failure to understand and incorporate this limitation into annual tax compliance and planning can lead to unexpected and significant tax penalties and interest due when extending or filing a tax return.
Take Advantage of Residential Clean Energy Property Credit (RCEPC)
The Residential Clean Energy Property Credit applies to the following types of property:
- Solar electric property expenditures (solar panels)
- Solar water heating property expenditures (solar water heaters)
- Fuel cell property expenditures
- Small wind energy property expenditures (wind turbines)
- Geothermal heat pump property expenditures
- Battery storage technology expenditures
Generally, there is no overall limit on the amount of credit available for RCEPC and the credit equals 30% of qualified expenditures. However, there are some limitations on the amount of credit available for fuel cell property based on the capacity of qualified fuel cell property.
Contact Us
If you are looking for ways to reduce your tax liability before the end of the year, Friedman + Huey is here to help. Give us a call today so we can discuss your specific situation and devise a plan to help you keep more money in your pocket.
