The key to any year-end planning strategy is to minimize taxes. This is generally done by either reducing income or increasing deductions. In recent years, the strategy to defer income or accelerate deductions has also been impacted by the possibility of increased tax rates due to proposed legislation while also considering the impact of inflation.
The IRS recently released the inflation-adjusted tax brackets for 2024 and they reflect the inflation that has continued to be visible in the U.S. economy even if at a reduced rate as compared to last year (approximately 5% vs 8%). As an example, the highest marginal tax bracket of 37% applies to joint filers with taxable income exceeding $693,750 in 2023, and this threshold has increased to $731,200 for 2024. As a result, it’s possible that income deferred until 2024 may be taxed at a lower marginal tax rate due to the impact of the inflation-adjusted 2024 tax brackets on a person’s marginal tax bracket.
Due to several related provisions in the TCJA, generally effective for 2018 through 2025, more individuals claim the standard deduction in lieu of itemizing deductions. It has also increased the importance of planning the timing of certain itemized deductions for some taxpayers.
For instance, you may want to “bunch” charitable donations in a year you expect to itemize deductions. (There is more on charitable deductions below.) Similarly, you might adjust the timing of certain medical expenditures to provide the maximum medical deduction. The deduction for those expenses is limited to the excess above 7.5% of your adjusted gross income (AGI). If it is not likely that you will be deducting medical and dental expenses in 2023, you might choose to postpone non-emergency expenses to 2024.
Note that the TCJA made other significant changes to itemized deductions. This includes a $10,000 annual cap on deductions for state and local tax (SALT) payments and suspension of the deduction for casualty and theft losses (except for qualified disaster-area losses).
Tip: The standard deduction for 2023 is generally $13,850 for single filers and $27,700 for joint filers and will be $14,600 and $29,200, respectively, in 2024. (an additional $1,850 standard deduction is allowed for a taxpayer age 65 or older.)
YEAR-END MOVE: If you come out ahead by itemizing, you may want to accelerate certain deductible expenses into 2023. For example, consider the following possibilities.
- Donate cash or property to a qualified charitable organization (see more below).
- Pay deductible mortgage interest if it otherwise makes sense for your situation. Currently, this includes interest on acquisition debt of up to $750,000 for your principal residence and one other home.
- Make state and local tax (SALT) payments up to the annual SALT deduction limit of $10,000.
- Add home improvements that qualify for mortgage interest deductions as acquisition debt. This includes loans made to substantially improve a qualified residence. Note that interest on a home equity line of credit (HELOC) or a home equity loan is only tax deductible if the funds are used to buy, build or improve your residence.
- Schedule non-emergency physician or dentist visits in 2023 if you expect to qualify for a medical deduction this year. Only unreimbursed expenses above 7.5% of your adjusted gross income (AGI) are deductible.
The tax law allows you to deduct charitable donations within generous limits if you meet certain recordkeeping requirements.
YEAR-END MOVE: Step up charitable gift-giving before January 1. As long as you make a donation in 2023, it is deductible in 2023, even if you charge it in 2023 and pay it in 2024.
- If you make monetary contributions, your deduction is limited to 60% of your AGI. Any excess above the 60%-of-AGI limit may be carried over for up to five years.
- If you donate appreciated property held longer than one year (i.e., it would qualify for long-term capital gain treatment if sold), you can generally deduct an amount equal to the property’s fair market value (FMV) on the donation date, up to 30% of your AGI. But the deduction for short-term capital gain property is limited to your initial cost.
- Consider a qualified charitable distribution (QCD). If you are age 70½ or older, you can transfer up to $100,000 of IRA funds directly to charity, free of tax.
Tip: Any excess above the 30%-of-AGI limit may be carried over for up to five years.
Alternative Minimum Tax
The complex alternative minimum tax (AMT) calculation features several technical adjustments, inclusion of “tax preference items” and subtraction of an exemption amount (subject to a phase-out). After comparing AMT liability for the year to regular tax liability, you effectively pay the higher of the two.
YEAR-END MOVE: Have your tax professional assess your AMT status. When it makes sense, you may shift certain income items to 2024 to reduce AMT liability for 2023. For instance, you might postpone the exercise of incentive stock options (ISOs) that count as tax preference items.
Tip: The AMT rate for both single and joint filers for 2023 is 26% on AMT income up to $220,700 (or $110,350 if married and filing separately) and 28% on AMT income above this threshold. Note that the top AMT rate is still lower than the top ordinary income tax rate of 37%.
Electric Vehicle Credits
If you are in the market for a new vehicle, be aware of the tax benefits of purchasing a plug-in electric vehicle (EV).
YEAR-END MOVE: Consider all the tax and non-tax angles. Notably, the Inflation Reduction Act (IRA) increases the tax credits for some taxpayers buying EVs in 2023 but disallows any credit for others.
Generally, the maximum credit allowed for EVs purchased in 2023 is $7,500. The vehicle must be powered by batteries with materials sourced from the U.S. or its free trade partners and it must be assembled in North America.
However, the credit cannot be claimed by a single filer with a modified adjusted gross income (MAGI) above $150,000 or MAGI of $300,000 for joint filers. Also, the credit is not available for most passenger vehicles that cost more than $55,000. The threshold is $80,000 for vans, sports utility vehicles (SUVs) and pickup trucks.
In addition, starting in 2023 the IRA authorizes a credit of up to $4,000 for used vehicles if you are a single filer with an MAGI of no more than $75,000; $150,000 for joint filers. If buying a used vehicle, it must cost $25,000 or less and be at least two years old.
Furthermore, you cannot claim any credit if you lease an EV instead of buying it. And the credit for EVs is nonrefundable, so you may want time year-end purchases accordingly.
See Federal Tax Credits for Plug-in Electric and Fuel Cell Electric Vehicles Purchased in 2023 or After for additional details.
Tip: The IRA eliminates the prior rule phasing out the credit based on the number of vehicles produced by a specific manufacturer, beginning in 2023.
Higher Education Credits
The tax law provides tax breaks to parents of children in college, subject to certain limits. This often includes a choice between one of two higher education credits.
YEAR-END MOVE: When appropriate, pay qualified expenses for next semester by the end of this year. Generally, the costs will be eligible for a credit in 2023, even if the semester does not begin until 2024.
Typically, you can claim either the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC), but not both. The maximum AOTC of $2,500 is available for qualified expenses for four years of study for each student, while the maximum $2,000 LLC is claimed on a per-family basis for all years of study. Thus, the AOTC is usually preferable to the LLC.
Both credits are phased out based on your MAGI. The phase-out for each credit occurs between $80,000 and $90,000 of MAGI for single filers and between $160,000 and $180,000 of MAGI for joint filers.
Tip: The list of qualified expenses includes tuition, books, fees, equipment, computers, etc., but not room and board.
- Minimize “kiddie tax” problems by having your child invest in tax-deferred or tax-exempt securities. For 2023, unearned income above $2,500 that is received by a dependent child under age 19 (or under age 24 if a full-time student) is taxed at the top tax rate of the parents.
- Install energy-saving devices at home that result in either of two residential credits. For example, you may be able to claim a credit for installing solar panels. Generally, each credit equals 30% of the cost of qualified expenses, subject to certain limits.
- Avoid an estimated tax penalty by qualifying for a safe-harbor exception. Generally, a penalty will not be imposed if you pay 90% of your current year’s tax liability or 100% of your prior year’s tax liability (110% if your AGI exceeded $150,000) via withholding and/or estimated payments. The IRS considers withholding to have been withheld ratably throughout the year even if made in December.
- Pay expenses qualifying for the dependent care credit. Generally, the maximum credit is $600 for childcare costs of one under age-13-child or $1,200 for two or more qualified children.
- Empty out flexible spending accounts (FSAs) for healthcare or dependent care expenses if you will forfeit unused funds under the “use-it-or-lose it” rule. However, your employer’s plan may provide a carryover to 2024 of up to $610 of unused funds or a 2½-month grace period.
- If you own property damaged in a federal disaster area in 2023, you may qualify for faster-than-usual casualty loss relief by filing an amended 2022 return. The TCJA suspended the deduction for casualty losses for 2018 through 2025 but retained a current deduction for disaster-area losses.
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Maxwell Locke & Ritter can help you with any questions you might have regarding year end tax planning for investors and estate and gift planning. Please contact us if you have questions about these updates.