It’s Time for 2023 Y/E Tax Planning

December 07, 2023

Hopefully your 2022 income taxes have been filed. How about 2023? Now is the time for planning for 2023 to know where you are and look at possible tax savings. We know you can extend the filing date of tax returns, but what you can’t extend is December 31. Many tax strategies need to be in place by December 31. Time to get it done. Here are some examples of strategies we have used and are using with our clients:

Charity and Donor Advised Funds.  90% of taxpayers use the standard deduction ($13,850 for individuals and $27,700 for couples filing jointly). It’s not a surprise as the state and local tax deduction is now capped at $10,000. So, many taxpayers get no tax break from their philanthropy. However, you may get deductions for your charitable contributions by bunching them in one year. For example, if your itemized deductions are close to the standard deduction, double up and pay for 2023 and 2024 at the same time and potentially get some tax benefit.

Another way to do this is to make a contribution to a Donor Advised Fund (“DAF”). In this case, you pay in 3 or more years of contributions in one year and get the full deduction in that year, yet the money stays in place for you to provide “grants” to charities in future years from these funds. Of course, you don’t get two deductions, there is no deduction when the money goes to the charity. This strategy is particularly beneficial in a year in which your income is higher, like one where you sell a business or a piece of property. Some of our clients have contributed 5-10 years of contributions all in one year and are sending the money out over time. BTW, the funds can be invested and appreciate while they are sitting with the DAF custodian.

One way to supercharge the tax benefits of the DAF is to use appreciated stock. Within limits, you can get credit for the full market value of appreciated securities and therefore never pay tax on those unrealized capital gains.

Qualified Charitable Distributions (“QCDs”).  If you are 70 ½ or over, you can make charitable contributions of up to $100,000 annually from your IRA to charities. This is much more tax-efficient than using after-tax dollars. These distributions are not taxable but do appear on a 1099-R form from custodians, like Schwab. For DWM clients, we annually recap these non-taxable distributions and send that information to the client and their CPA, as QCDs are not taxable. And, for those who have RMDs (“Required Minimum Distributions”) these QCD payments count towards the annual RMD amount.

Tax Loss Harvesting.  At this time of year, it’s always important to look to see if you have some unrealized capital losses. If so, consider selling all or part of them, particularly if there are solid investment reasons for doing that. It’s okay to sell losses. In fact, you can sell a holding, take the loss, and after 30 days get back in. You have to be careful to stay out of the specific security for 30 days or it is considered a “wash sale” and the sale is disregarded. There is a limit to the amount of capital losses you can deduct in a year- it is $3,000. However, losses can be carried to future years forever. And, again, if you sold a business or property in 2023, realizing losses can help tremendously.

Roth Conversions and Back Door Roths.  We love Roth IRAs. A Roth IRA can grow tax-free for decades and then, under current rules, it can grow tax-free for another 10 years after Mom and Dad pass away. Roth conversions move pre-tax money, like traditional IRAs and 401ks over to Roth accounts. The amount of the conversion is all taxable for federal tax purposes on pre-tax money. Because Required Minimum Distributions start at age 73, a great time to consider conversions is when you have stopped working and you are not yet 73, and even better if you have not yet started social security. The tax cost of future RMDs can be staggering as the pre-tax money continues to grow until 73 and thereafter. For example, at current tax rates, one of our clients who retired at age 60 with $1 million in IRAs would pay over $1.5 million tax on the IRAs from age 73 to age 95. Converting to Roth would be about half the tax but it would paid sooner.

Think of the growth of a Roth. If you had converted enough pre-tax money to have $300,000, for example, in Roth conversions at age 70 and lived another 25 years and this investment grew at 6%, you would have accumulated $1.3 million in your Roth, which your non-spouse beneficiaries could grow for another 10 years and they could have $2.3 million. We have developed and maintain a proprietary model to analyze this very important area.

A related strategy is to consider Back Door Roths. Roth IRA contributions are limited to those with an income below $153,000 (or $218,000 for joint). However, there is no income eligibility for a non-deductible IRA. Depending on your age, you can make a $6,500 or a $7,500 non-deductible IRA contributions and then convert to Roth tax-free, as long as you have no other IRA accounts. If you have other IRA accounts, it gets a little more complicated but there may be ways to move your IRA to a 401k or 403b and then create a situation for a tax-free “Back Door Roth.”

Unspent 529s Converted to Roth IRAs.  What do you do when the kids are through college or even post-graduate work, and there is still money left in the 529(s)? Yes, you can take it out and pay tax on the earnings on your contributions along with a 10% additional tax on any early (before age 59 ½) distributions. But, if the 529 has been maintained for 15 years, how about converting $35,000 of it into a non-taxable Roth account for the beneficiary? Starting in 2024, the 529 to Roth transaction is tax-free and the Roth money grows tax-free “forever.”

Again, there are very specific rules. The $35,000 is a lifetime amount and not an annual amount. The amount converted from a 529 plan in a given year is subject to the regular IRA contribution amount for a year, such as $6,500. The amount converted must “bake” for 5 years in the 529 before rollover. Good news, though, there are no Roth modified AGI limits that apply.

New Rules for Inherited IRA Distributions for non-spouses. In June, we outlined the new rules for non-spouse beneficiaries inheriting IRAs from a death in 2020. In short, the full amount must be distributed within 10 years of the death of the decedent. In addition, except for Roth IRAs, other IRAs must generally have annual periodic distributions during the 10-year period based on the expected life of the beneficiary. Penalties for non-compliance can be 50% of the required distribution.

Section 179 and Bonus Depreciation.  If you have a small business or a farm, consider purchasing a “heavy SUV” or a piece of equipment and putting it “into service” by 12/31. Section 179 can provide deprecation for the entire business portion of the asset. However, the Section 179 deduction is limited to the taxable income for the business or farm. Bonus depreciation, which in 2023 can be available up to 80% of the cost of new or used equipment, is deductible even if your business doesn’t make a profit. 

Health Savings Accounts. For those with high-deductible health plans, contributions to health savings can save income taxes and either fund medical expenses or grow as a retirement supplement for years to come. The maximum amount deductible for 2023 is $3,850 for single and $7,750 for families. Those 55 and older can contribute an additional $1,000. Contributions for 2023 must be made by April 15, 2024.  

Tax-free gifts.  The limit is $17,000 per recipient. Husband and wife can make a $34,000 tax-free gift to any one recipient. There is no gift tax or reporting of such transactions. And these gifts can be made to as many people as you want.

Electric Vehicles.  Many new EVs qualify for a credit of up to $7,500. Used EVs max is $4,000. If you wait until 2024 to buy an EV, you can opt to monetize the credit by transferring it to the dealer at the time of purchase, and reducing the net cash paid, instead of claiming it on your tax return.

Your Action is Needed! 

Step 1- Have your CPA or total wealth manager put together an income tax projection for you for 2023. Review your 2022 information line by line and adjust for what is expected in 2022, including income, investments, capital gains, deductions, and withholdings.

Step 2- Look at the above strategies and perhaps others to see where you can cut taxes. Your CPA should do more than prepare returns, they should be focused on helping you reduce your taxes. At this time of year, most of our clients have already received one or possibly two income tax projections from us and we are working with them and their CPAs to finalize strategies. Penalties for underpayment are steeper and it’s important, if possible, to avoid them by paying 110% of last year’s income tax or 90% of the current year tax.

Step 3- Get the strategies implemented. Most of the above need to be done by December 31. Christmas and December 31 will be here before you know it.

Happy Tax Planning. Let us know if you have any questions. We’re here to help and add value.

Detterbeck Wealth Management is a fee-only financial planning / wealth management company with offices located in Palatine, IL (Chicago area) and Charleston, SC areas serving clients locally and across the country. To contact us about setting up an appointment, please see our contact us page