In October, we begin working on final income and tax projections for our clients and suggest strategies to help minimize their taxes before the year ends. Even though we have about three months left, the implementation of some strategies will require preparation and time – so it is good to be proactive and don’t miss any opportunities to cut your federal tax bill.
Remember that tax planning isn’t just about cutting this year’s tax bill – it’s about reducing your lifetime tax bill.
As I share with you a few tax strategies that have worked well for our clients, think about how they might fit your own situation and consult with your advisors before taking action.
To get started, I’ll go over a few tried-and-true foundational strategies.
Itemize Your Deductions
Due to the high standard deduction, many retirees stopped itemizing their deductions after the Tax Cuts and Jobs Act (TCJA). However, by being strategic with your deduction, you can still find a way to reduce your tax bill.
For example, if you can, pay your January 2025 mortgage payment before the end of December. This would allow you to include the interest portion as a deduction on your 2024 Schedule A.
State and Local Taxes are limited to $10,000 but if you are under this cap and if allowed in your area, consider prepaying your property taxes due in January in December to include them in this year’s deductions.
If you are charitably inclined, consider bunching multiple years of charitable donations into 2024 to exceed the standard deduction. For example, if you usually donate $5,000 each year, consider donating $15,000 in 2024 instead. This way, you exceed the standard deduction and can itemize, maximizing your tax benefits this year. Then, take the standard deduction for the next two years.
If your medical expenses are close to or exceed 7.5% of your adjusted gross income, it may be beneficial to pay for additional treatments or procedures before the year ends to maximize your deductions. For instance, if you know you’ll need surgery soon, why not get it done this year rather than putting it off?
Tax Credits
Nowadays, going green can be highly rewarding thanks to various government tax credits. Unlike deductions, tax credits directly reduce your tax bill dollar-for-dollar, making them especially powerful. If you’re considering a new car, look into buying an electric vehicle (EV). You could qualify for up to $7,500 in credits for a new EV or up to $4,000 for a used one. Be sure the vehicle meets the criteria and the price doesn’t exceed $55,000 for sedans or $80,000 for SUVs, pickups, and vans. Another option you can do is to transfer the credit to the dealer at the time of purchase to reduce the car’s price.
You can also earn credits by making your home more energy efficient. The Residential Clean Energy Property Credit lets you deduct 30% of the cost for installing solar panels, solar water heaters, and other eco-friendly systems. Additionally, consider reaching out to your electric company to see if they offer programs to help offset installation costs or provide solar incentives.
There’s also the Energy-Efficient Home Improvement Credit, which covers insulation, boilers, doors, windows, and similar improvements. Previously capped at $500 for a lifetime, this credit now offers up to $1,200 annually. If you’re considering several upgrades, spread them out over 2024 and 2025 to maximize your benefit.
Defer Income
If your company offers a deferred compensation plan, consider using it. These plans let you set aside part of your salary into a tax-deferred account, allowing it to grow tax-free. While you’ll pay taxes when you eventually withdraw the funds, the contributions are not taxed when deferred, allowing for years of tax-free compounding.
Another way to lower your tax bill is to delay any extra income until next year. For instance, ask your employer to postpone a year-end bonus or wait to get paid for freelance work. You can also hold off on selling investments to defer capital gains or, if selling your home, try to push the closing into next year if possible.
Essentially, defer any income or gains if you expect your tax rate to be lower or unchanged next year.
Charitable Giving
When it comes to charitable giving, you need to be strategic as making the wrong decision could result in more money going to an inefficient government than to the causes you care about.
First, avoid donating assets that have decreased in value. Doing so will result in wasting your loss that could offset gains elsewhere in your portfolio.
Second, instead of donating cash, consider gifting appreciated assets like stocks or mutual fund shares. If you’ve held the assets for more than a year, you can usually deduct their full market value if you itemize deductions. Plus, you will avoid capital gains tax, leaving more money to support your favorite charity.
If you want to take it a step further, consider setting up a Donor-Advised Fund (DAF). By making a large donation to a DAF in one year and get an immediate tax deduction. Then you can invest the funds inside the DAF, let it grow tax-free and give away the money to your charities over time. This strategy is particularly useful in a year with unusually high income, as it can push you into a lower tax bracket, saving thousands in taxes – just like it did for one of our clients last year, and likely will again this year.
If you have highly appreciated assets and want to manage gains and smooth out income between tax years, consider using Charitable Remainder Trusts.
Required Minimum Distributions
You also need to be mindful of the required minimum distribution (RMD) rules for traditional IRAs as the SECURE Act 2.0 has introduced significant changes to how and when RMDs must be taken.
Currently, individuals age 73 and older are required to take annual distributions. The same rules generally apply to 401(k) plans; however, if you’re still working past 73, you can usually delay RMDs from your current employer’s 401(k) until retirement.
If you turned 73 in 2024, you can delay your first RMD until April 1, 2025. But doing so means you’ll need to take two distributions in 2025 - the amount for 2024 plus the amount for 2025. Think twice before delaying, as doubling up your distributions could push you into a higher tax bracket or reduce certain income tax deductions that phase out at higher income levels.
On the other hand, delaying could be beneficial if you expect to be in a much lower tax bracket in 2025 because you plan to retire late this year.
A great way to manage income from RMDs and reduce your tax burden is by making charitable donations directly from your traditional IRA. Individuals aged 70½ and older can transfer up to $105,000 per year from their IRAs to a qualified charity through a Qualified Charitable Distribution (QCD). These distributions count towards your RMDs but are not taxed or included in your Adjusted Gross Income (AGI). QCDs are especially beneficial for taxpayers who take the standard deduction, as they still provide a tax advantage from charitable contributions.
Another option available to IRA owners is a one-time qualified charitable distribution of up to $50,000 to fund a Charitable Remainder Trust or a Charitable Gift Annuity.
Keep in mind that this is a one-time opportunity, not an ongoing annual option.
Max Out Your Retirement Accounts
Here’s an easy win - be sure to maximize your 2024 401(k) and IRA contributions. You have until December 31st to make 401(k) and other workplace retirement plan contributions, and until April 15th, 2025, for IRA contributions.
The 2024 contribution limits are $23,000 for a 401(k) or $30,500 if you’re 50 or older and $7,000 for an IRA or $8,000 if you’re over 50.
If you want an immediate tax break, a traditional IRA is the way to go. However, if you’re covered by a workplace retirement plan like a 401(k), your ability to deduct contributions begins to phase out at $77.000 for single filers and $123,000 for married couples filing jointly.
If you are eligible to contribute to a Roth IRA, you won’t get an upfront tax deduction, but your investments will grow tax-free. Additionally, unlike 401(k)s and traditional IRAs, Roth IRAs do not have required minimum distributions which makes it a great inheritance planning tool.
Max Out Your Health Savings Account
Another powerful strategy to reduce taxes both now and in the future is to utilize a Health Savings Account (HSA). If you have a High Deductible Health Plan (HDHP) and have already maxed out your 401k plan and IRAs, be sure to fully fund your HSA as well.
In 2024, you can contribute up to $8,300 for families and $4,150 for individuals, plus an extra $1,000 if you’re 55 or older.
HSAs offer a unique triple tax benefit: contributions are tax-deductible, the funds grow tax-free, and withdrawals for qualified medical expenses are also tax-free - something no other account can match.
Because of these benefits, we often advise clients to let their HSA balances grow for as long as possible instead of using them now, to maximize long-term tax savings.
On top of that, you can make a one-time, tax-free transfer from your Traditional IRA to your HSA, up to your annual HSA contribution limit. This strategy converts pre-tax IRA funds into HSA dollars without triggering taxes or penalties and can provide long-term tax benefits.
Consider a Roth Conversion
Consider whether it’s a good time to convert your traditional IRA to a Roth IRA. While you’ll pay taxes on the converted amount, future growth and withdrawals will be tax-free. Key factors include current and future income tax rates - if you expect your retirement rate to be the same or higher, a Roth conversion can be beneficial. Roth IRAs also don’t have RMDs, unlike traditional IRAs.
Keep in mind that the conversion amount increases your adjusted gross income, which could raise Medicare premiums two years from now.
Harvest Capital Losses
With the strong performance in the stock market this year, my guess is you likely don’t have many unrealized losses to harvest and offset your gains. However, the situation can change before year-end, so keep an eye on your positions, and if you see a loss, consider realizing it. This will offset capital gains, or up to $3,000 can be used against your ordinary income, with the excess carried forward to future years.
But be cautious of the wash-sale rule, which disallows a capital loss if you buy substantially identical securities within 30 days before or after the sale.
However, the disallowed loss is not lost forever - it’s just suspended and added to the cost basis of the new shares.
Sell High-Turnover Mutual Funds
Although we are proponents of index investing, I understand that active funds can be useful in certain situations. However, if you hold high-turnover mutual funds in your taxable account consider selling them. Since these funds frequently buy and sell stocks, they generate taxable gains that are passed on to you, potentially increasing your tax liability.
Harvest Capital Gains
You might also consider realizing some gains. Why? Because if you’re a single filer with income below $47,025, head-of-household with income under $63,000, or a joint filer with income under $94,050, you could qualify for the 0% rate on long-term capital gains and qualified dividends. This means you won’t pay taxes on the gains and reset your cost basis, which could lower future tax liabilities for you or your heirs.
However, watch your Adjusted Gross Income (AGI) closely. Even if you qualify for the 0% rate, additional gains can push your AGI higher, moving you into a higher bracket and negating the benefit. This could also trigger the Social Security tax torpedo, making more benefits taxable, and may increase your state tax bill, as some states treat capital gains as ordinary income. That’s why we run detailed projections to keep a safe buffer and avoid pushing clients into a higher bracket.
Manage Net Investment Income
If your Modified Adjusted Gross Income (MAGI) exceeds $200,000 as a single filer or $250,000 for joint filers, take action to reduce the 3.8% surtax on net investment income like dividends, interest, capital gains, and passive rents. Along with the strategies I’ve already mentioned, you can also invest in municipal bonds, as their tax-free interest is not subject to the 3.8% surtax.
Real Estate Investment Trusts
If you are interested in investing in real estate, think about investing in Real Estate Investment Trusts (REITs). They’re easy to invest in and offer a potential tax break.
You can deduct 20% of qualified REIT dividends on your federal return, as long as they aren’t already taxed at capital gains or dividend rates.
Similar tax benefits apply to Publicly Traded Partnerships as well, making them another option for tax-efficient income.
Purchase Qualified Small Business Stock (QSBS)
If you are open to investing in a qualified small business like start-ups, early-stage companies, venture capital funds or crowdfunding platforms like StartEngine or Wefunder, consider buying QSBS.
While it will not offer any tax benefits this year, it can be highly effective in the long run. This is because you can potentially avoid paying federal capital gains tax on up to $10 million of gain or 10 times your basis in the stock, whichever is greater and also avoid the 3.8% net investment income tax if the stock meets the criteria under Section 1202 of the Internal Revenue Code.
Final Thoughts
Year-end tax planning is not just about saving a few dollars here and there. It’s about strategically positioning yourself for long-term financial success and minimizing the amount you give to Uncle Sam over your lifetime. Each of the strategies I discussed today has its nuances, and what works best will depend on your unique financial situation. Before making any moves, be sure to sit down and run the numbers to see which strategies align with your overall financial goals.
Remember, the clock is ticking, and some of these opportunities won’t be available after December 31st - so take action now and request your free one-page financial plan!
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