Tips on Minimizing Hefty Tax Bills For Different Income Tax Brackets
Don’t let time run out on these end-of-year tax plays. Not having a tax projection done can be a costly mistake. Besides giving you peace of mind in April, in order for you to pay the lowest percentage of taxes over your lifetime you have to plan and utilize every opportunity. Sometimes this means paying more dollars in tax in the current year to seize and maximize that lower rate.
For Lower Income Tax Brackets
While your income is low, it may make sense for you to realize more income now and better utilize your low tax rates.
Roth 401K and Roth IRA contributions: Contributing to a Roth 401k or Roth IRA may cost you more in taxes today, but it allows those dollars to grow tax-free. If you can do this early in your career and give your retirement dollars a long time to grow, the tax savings will be enormous.
0% federal tax on capital gains: Many people are unaware that the IRS actually allows for a 0% tax on capital gains (Example: Gain from sale of stock). If your taxable income is below $44,625 Single $89,250 Married-Filed-Jointly, you may want to realize additional gains this year by selling stock to take advantage of these low rates. Keep in mind you may still need to pay state & local taxes on these sales but selling at the 0% federal tax bracket is an opportunity you can’t afford to pass up.
Lower your tax bracket when your income is low in retirement: Sometimes this situation occurs not when you are starting your career but when you are ending it. In the years between retirement and age 72, when Required Minimum Distributions start, there are opportunities to take advantage of these low tax brackets as well.
Lower your tax withholdings in January: If you are getting a large refund, adjust your withholdings on your paycheck for the next year. Adjusting early in the year keeps more money in your pocket each month. Do not give the IRS an interest-free loan.
For Middle Income Tax Brackets
As you start making more money and entering higher tax brackets, this is the time to start looking for deductions.
Maximize your employee benefits: Have you maximized your employee benefits (including catch-up at age 50), H.S.A., and other benefits? When you are a W-2 employee, the best place to look for deductions is at work. Many companies will also offer some sort of match on retirement contributions. By not putting enough or anything into your workplace retirement plan, you may be leaving money on the table.
Tax loss harvesting: One place you might go looking for additional deductions is your brokerage account. While no one likes to lose money on their investments, Capital losses can offset up to $3,000 of ordinary income each year. If your income is high you may want to harvest losses for two reasons:
Taking losses now allows you to put off paying tax in favor of paying down the road when it might be cheaper, potentially 0% or 15% federally.
To stay out of the 20% highest capital gains bracket ($492,301 Single, $553,851 Married-Filed-Jointly for 2023)
Non-Deductible IRA contribution: If you are already doing the items above and want to put more away for retirement, you might consider funding a non-deductible IRA. You (and your spouse) can put up to $6,500 (for 2023) into an IRA each year. This puts after-tax dollars into an IRA which could later be converted to a Roth IRA, which can grow tax-free. Keep in mind that the IRS views all of your IRAs as one IRA. Any distribution or conversion must be done proportionally to your taxable and non-taxable balances. If you have taxable amounts in your IRA, you may owe tax on any conversions.
Raise your tax withholdings in January: If you owed a lot in April last year, it may be an indicator that you need to adjust your withholdings for the coming year or make estimated payments. The IRS requires you to pay the tax due at least quarterly. January is a good time to adjust your withholdings because you have the entire year for the changes to take effect. This means you can make the smallest change to your net pay and still yield the desired effect at year-end.
For Higher Income Tax Brackets
When you find yourself with a surplus of money, living generously may yield additional tax savings.
Charitable contributions using stocks: While contributing to charity generally does not save you more than you spend on your taxes if you have the heart to give there are efficient tax strategies that can allow your donation to go further. As changes to itemized deductions have vastly limited the amount of benefit many people can get from making charitable contributions, with careful planning, there are ways you may still save big.
Contributing long-term appreciated stock may allow you to gain a charitable contribution for the fair market value of the stock and never pay the capital tax from the sale.
Utilizing a donor-advised fund may allow you to bunch several years of donations into a single year. This could allow you to take larger deductions over several years.
If you are over age 70.5 and not itemizing your deductions it may make sense for you to contribute straight out of your IRA with a Qualified Charitable Distribution. These donations get paid straight from your IRA and are not taxed.
$16,000 gifts to your children: If you are planning to transfer a large estate to your children upon your death it may make sense for you to utilize the annual gift limits and give each year to potentially lower taxes on your estate. These gift limits are annual and adjust with inflation. Current limits are $16,000 per year per individual. This means a husband and wife could give $16,000 each to a child for a total of $32,000. If that child is married, they could also give their child’s spouse the same amount without filing a tax return.
To be clear, you can give all the way up to your lifetime limit in a given year without paying taxes, but giving more than $16,000 requires you to file a gift tax return and reduce your lifetime estate.
When it comes to taxes, Benjamin Franklin said it best when he said “failing to plan is planning to fail”. If you have not done so already, get your tax plan going before the end of the year.