z)9)Smart Tax Filing Strategies

Smart Tax Filing Strategies

1: Maximize Your Retirement Contributions

Maximizing your retirement contributions is one of the best ways to minimize your tax liability. This is because retirement plans offer useful tax advantages that are not available if you were to simply put your money in a savings account.  There are several accounts to consider, depending on your unique circumstances:

401(k), 403(b), and 457 Plans: These accounts allow you to contribute up to $22,500 for 2023 and $23,000 annually for 2024 ($30,500 if over age 50). Not only that, but pre-tax contributions will not show up as part of your annual income.  This is a great way to defer taxes until your retirement years when you could potentially be in a lower tax bracket.  Self-employed individuals can put away even more with a solo 401(k) plan.

Traditional IRA: Contributing to a traditional IRA is another way to reduce your tax liability if your income is within certain limits. You can contribute up to 6,500 for 2023 and $7,000 for 2024, with a $1,000 catch-up contribution limit for those over age 50. Unlike the qualified retirement plans listed above, contributions to a traditional IRA can be made up until the April 15th tax filing deadline.

Roth IRA: This is an attractive savings vehicle for many reasons, including no Required Minimum Distributions (RMDs), tax-free withdrawals after age 59½, and the ability to pass wealth tax-free to your heirs. The contribution limits are the same as traditional IRAs.  However, Roth IRAs have income restrictions and you may not be able to open an account outright if you are above certain limits.

2: Consider Roth Conversions

If you are outside of the income eligibility threshold for Roth IRAs but still want to take advantage of the Roth tax benefits, a Roth conversion could be the right strategy for you.  It works by paying the income tax on your pre-tax traditional IRA and converting the funds to a Roth IRA.  This strategy can be especially powerful to new retirees who find themselves in a lower tax bracket before Social Security and/or Required Minimum Distributions start.

You could also consider the mega backdoor Roth and backdoor Roth IRA strategies:

Mega Backdoor Roth: With this strategy, you would convert a portion of your 401(k) plan to a Roth. This involves first maximizing the after-tax, non-Roth contributions in your plan, then rolling it over to either a Roth 401(k) or your Roth IRA.  With the mega backdoor Roth, you convert a portion of your 401(k) plan to Roth dollars.

Backdoor Roth IRA: In this case, you would make an after-tax (non-deductible) contribution to a traditional IRA. You then immediately convert the funds to a Roth IRA to prevent any earnings from accumulating.  This strategy makes sense if you do not already have an IRA set up yet.

All three Roth conversion strategies will allow the contributions to grow completely tax-free and allow you to avoid future RMDs, which is helpful if you expect to be in a higher tax bracket in the future.

3: Contribute To A Health Savings Account

An efficient but underutilized way to maximize your savings and minimize your taxes is to contribute to a Health Savings Account (HSA).  HSAs offer triple tax savings: contributions are tax-deductible, earnings grow tax-free, and you can withdraw the funds tax-free to pay for medical expenses.  Unused funds roll over each year and will become an IRA at age 65, at which point you can withdraw funds penalty-free for non-medical expenses.  You must be enrolled in a high-deductible health plan in order to qualify for an HSA.

4: Contribute To A Donor-Advised Fund

If you itemize your tax deductions because of charitable contributions, you may want to consider investing in a donor-advised fund (DAF).  You can contribute a lump sum all at once and then distribute those funds to various charities over several years.  With this strategy, you can itemize deductions when you make the initial contribution and then take the standard deduction in the following years, allowing you to make the most out of your donation tax-wise.

5: Make A Qualified Charitable Donation

If you own a qualified retirement account and are at least 70½, you can use a qualified charitable distribution (QCD) to receive a tax benefit for your charitable giving.  Since this is an above-the-line deduction, it can be used in conjunction with other charitable tax strategies.  A QCD is a distribution made from your retirement account directly to your charity of choice.  It can also count toward your RMD when you turn age 73, but unlike RMDs, it will not count toward your taxable income. Individuals can donate up to $100,000 in QCDs per year, which means a married couple can contribute a combined amount of $200,000!

6: Utilize Tax-Loss Harvesting

Tax-loss harvesting involves selling investments at a loss in order to offset the gains in your portfolio.  By realizing a capital loss, you are able to counterbalance the taxes owed on capital gains.  The investments that are sold are usually replaced with similar securities in order to maintain the desired asset allocation and expected return.

With the ups and downs of the market in 2023, chances are you have some capital losses that can be utilized.  For example, if you are expecting a large capital gain this year, sell an underperforming stock, and harvest the losses to offset your gain.

7: Understand Long-Term Vs. Short-Term Capital Gains

Understanding the tax implications of long-term versus short-term capital gains can go a long way in reducing your tax liability.  For instance, in 2023 a married taxpayer would have paid 0% capital gains tax on their long-term capital gains if their taxable income falls below $89,250.  That rate jumps to 15% and 20% for taxable incomes that exceed $89,250 and $553,850, respectively.  Understanding where you fall on the tax table is an important part of minimizing your liability.

8: Take A Qualified Business Income Deduction

Business owners involved in partnerships, S Corporations, or Sole Proprietorships can take a Qualified Business Income Deduction (QBID) to help reduce taxable income and maximize tax savings.  This allows for a maximum deduction of 20% of qualified business income, but limits apply if your taxable income exceeds a certain threshold.  To qualify for this deduction, consider reducing or deferring income so that you can remain below the phase out threshold.  A wonderful way to do this is to maximize your retirement contributions to tax-advantaged accounts (as discussed in point #1).

9: Consider Estate Tax-Planning Techniques

Estate tax-planning techniques can also be an effective way to reduce current-year tax liability. For 2024, the lifetime exemption for assets that can be given gift-tax free is estimated at $13.61 million for individuals and $27.22 for married couples (12.92 million for 2023).

The annual gift tax exclusion is estimated to increase to $18,000 per recipient in 2024, up from $17,000 in 2023.  This is the annual amount taxpayers can give tax-free without using any of the above-mentioned lifetime exemption.  Not only that, but the annual exclusion applies on a per-person basis, so each taxpayer can give $18,000 per person to any number of people per year.

10: Make Sure Your Advisory Team Is Working Together

Beyond consulting with a tax professional, you will want to be sure your entire financial team is working together to provide cohesive oversight and guidance.  This should include professionals like CPAs, financial advisors, investment advisors, and estate attorneys.  Your finances do not exist in a bubble and so neither will your tax-minimization strategies.  When your advisory team works together, strategies are easier to identify and execute, and proactive tax solutions become much easier to implement, reducing stress and your tax bill.

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