The choices you make now and at the end of the year can significantly affect the taxes you have to pay next April. This is especially true for those who save for retirement, itemize deductions, or have investments outside of a retirement plan.
However, time is running out. After the new year, it will be too late to reduce your tax burden by utilizing most of the below-listed strategies.
Check out our list now and get to work!
Check Your Deductions
You can avoid a repeat of this year’s tax bill if you fail to withhold enough from your paycheck this year. Determine if you need to submit a new Form W-4 to your employer and increase your tax withholding by using the IRS’s Tax Withholding Estimator before the end of the year. Obtain a copy of your 2021 tax return and your most recent pay stub to estimate your 2023 income. If it appears that you will owe money on your next tax return, the IRS tool will inform you how much “additional withholding” to enter on Line 4(c) of Form W-4 so that you can catch up on your withholding. Then, early the following year, complete another W-4 for 2023.
The penalty is not imposed if you owe less than $1,000 minus credits and withholdings or if you paid 90% or more of your current year’s tax or 100% of your previous year’s tax.
Consider Paying Bills for 2023 Now
Unless your financial situation has changed considerably, you likely have a clear notion of whether you will itemize deductions or claim the standard deduction on your 2023 tax return. If you intend to itemize your deductions or are near the threshold, now is an excellent opportunity to prepay January mortgage payments and state taxes. Other actions to take by December 31:
Examine your medical expenses.
If you have sufficient unreimbursed medical expenses, you may be allowed to deduct them from your taxes. The maximum allowable deduction for unreimbursed medical expenditures is 7.5% of your adjusted gross income, making this tax relief inaccessible to most taxpayers. Still, you may qualify if you incurred exceptionally high medical expenses this year owing to a severe sickness or a chronic disease, such as lengthy Covid.
And you still have time to arrange appointments and treatments that will boost your deductible expenses. Dental and vision care are on the list of acceptable expenses which your insurance may not cover. Visit IRS Publication 502 for the complete overview.
Prepay property taxes.
State and local taxes can be deducted up to $10,000 for those that itemize. If you haven’t reached your year maximum and your town permits it, pay the January property tax bill in December to subtract it from your 2023 taxes.
Pay tuition in advance.
Parents of college students can reduce their 2023 tax liability by prepaying the first quarter’s tuition without itemizing. The American Opportunity Tax Credit, available to undergraduate students in their first four years of study, is valued at up to $2,500 per eligible student. The full credit is available to couples filing jointly with an adjusted gross income (MAGI) up to $160,000, while the partial credit is available to couples with a MAGI up to $180,000.
Classes for Career Advancement
If you plan to take a class next year to advance your career, consider prepaying the January cost by December 31 to claim the Lifetime Learning Credit. Up to 20% of tuition, fees, and books out-of-pocket, up to $2,000. It is not limited to undergraduate expenses, and full-time enrollment is not required. In the same way as the American Opportunity Tax Credit, married couples filing jointly with a MAGI of up to $160,000 are eligible for the full credit, and couples with MAGI of up to $180,000 are eligible for half of the credit.
Invest in a 529 Plan or an ABLE Account
Investing in a 529 plan before the end of the year will not reduce your federal tax payment, but it could cut your state tax bill. More than 30 jurisdictions permit you to deduct payments to a 529 plan from state income taxes. In most states, you must donate to your own state’s plan to receive a tax deduction, although a few states permit you to deduct contributions to any state’s plan. Check out the regulations for your state at savingforcollege.com (opens in a new tab). Many states permit grandparents and others to contribute to your child’s plan, and a minority permit them to deduct their payments.
Suppose you have a family member with special needs. In that case, ABLE accounts allow individuals with qualifying impairments the opportunity to save money and remain eligible for government assistance by up to $16,000 this year. Beneficiaries of an ABLE account can contribute more to their account. You are eligible for a tax deduction if you live in a state that offers ABLE tax breaks. However, you are not required to invest in your own state’s plan. For instance, contributions to Michigan’s ABLE account may be deducted up to $5,000 (or $10,000 for married couples). For more information, visit the National Resource Center for ABLEs’ website.
Harvest the Tax Crop
The tax legislation permits you to sell investments at a loss and use the proceeds to offset capital gains in taxable accounts. This is a compelling argument for getting rid of losing positions. Ordinary income is taxed on assets held less than a year, whereas long-term capital gains are taxed at various rates ranging from 0% to 23.8% (including the 3.8% net investment income surtax).
After matching short-term losses with short-term gains and long-term losses with long-term profits, any surplus losses can be used for the opposite type of gain. If you still incur a net capital loss, you can offset up to $3,000 of it against your regular income and carry the remainder to the following year. A wash-sale rule applies when you sell an asset at a loss or buy a similar investment within 30 days.
Capital gains tax will not apply to investors with an adjusted gross income of $41,675 for single filers and $83,350 for joint filers in 2023. You may want to consider selling winning investments tax-free and reinvesting immediately (no need to wait 30 days), thus resetting the meter.
Shareholders of mutual funds must receive any gains generated by the sale of stocks or bonds during the year. Even if you reinvest these distributions, you will have to pay tax on them if you hold the fund in a taxable account. The stock market’s dismal performance this year may lead you to believe this will not be a problem. However, some funds were still sitting on substantial returns from 2021 and may have been compelled to sell some of these winners to cover investor outflows. Consequently, you may be required to pay a capital gains distribution even if your fund lost money this year.
If you receive a payout, examine your portfolio for any mutual funds, equities, or bonds that have lost value since you bought them. You will incur losses by selling them before the end of the year to offset any profits. In November or December, mutual funds usually publish an estimate of their capital gains distributions along with the distribution date. Estimates are based on a per-share basis, so you can estimate the size of your payout by determining how many shares you own.
Want to purchase a mutual fund before the end of the year? Check if the fund intends to distribute capital gains, you should delay your purchase until after the distribution date. Otherwise, you will be required to pay taxes on earnings before participating.
Max Out Your Employer’s Retirement Savings Plan
As the year draws to a close, you may be able to milk a bit of extra retirement savings money out of each paycheck. In 2023, you can contribute up to $20,500 to a 401(k), 403(b), or federal Thrift Savings Plan, plus an additional $6,500 if you are 50 or older.
Contributions made before taxes will reduce your take-home earnings and your tax burden. Roth 401(k)s allow you to make contributions that do not reduce your current tax liability but can be withdrawn tax-free upon retirement if your employer offers them. The Roth 401(k) is always an option if your employer offers both types of retirement plans (such as a pretax 401(k) and a Roth 401(k).
To increase your 401(k) contributions, contact your 401(k) administrator or your employer’s human resources department as soon as possible. The sooner the modification is made, the better: Contributions to 401(k) plans are made through payroll deduction. The deadline for self-directed contributions to a regular or Roth IRA for 2023 is April 18, 2023.
Suppose you are not on track to contribute the maximum amount to your retirement account for the year. In that case, a year-end bonus can be an excellent opportunity to increase your contributions without hurting your monthly take-home pay. In some programs, participants are not permitted to contribute their bonus. Additionally, ensure you do not exceed the annual contribution limit. Any additional contributions and earnings, both taxable, can be withdrawn until the filing deadline. You’ll have to pay taxes again when you withdraw the funds if you don’t remove the extra contribution.
Use a Side Business to Increase Your Retirement Savings
Open a solo 401(k) if you have self-employment or freelance income. You must start the account by December 31, yet you have until April 18, 2023, to make contributions and get a tax deduction for 2023. You can contribute up to $20,500 ($27,000 if you are 50 or older) to a solo 401(k), less any contributions to a 9-to-5 employer’s 401(k) for the year. You can also contribute up to 20% of your net income from self-employment. You can contribute up to $61,000 to your solo 401(k) in 2023 (or $67,500 if 50 or older), but the sum cannot exceed your self-employment income for the year.
Opening a Simplified Employee Pension (SEP) account is another alternative. However, if your freelancing income is modest, you can contribute more to a single 401(k). Contributions to a SEP cannot exceed 25% of net self-employment income or $61,000.
Establish a Donor-Advised Fund.
Investing your cash or other assets, such as stocks or real estate, in a donor-advised fund enables you to claim a tax deduction for the full amount of your donation in the year you make it and then recommend gifts to your favorite organizations. You can establish a donor-advised fund with financial-services firms like Fidelity Charitable, Schwab Charitable, or community foundations. Contributing a lump sum this year may allow you to itemize deductions instead of taking the standard deduction.
Max Out Charitable Donations (and Declutter)
If you itemize, donating clothing, cookware, or furniture you no longer need can increase your tax deductions while benefiting a charitable organization. You can utilize internet tools like TurboTax’s ItsDeductible (opens in new tab) to evaluate the item’s “fair market value” If you’re claiming a contribution of $250 or more, you’ll need a letter of appreciation from the organization (consider snapping a photo of the donation for your records). For donated objects with a value over $5,000 (art, antiques, etc.), you should provide a written appraisal. For the 2023 tax year, you can deduct up to 60% of your adjusted gross income for financial donations.
Donate IRA Funds to Charity
Each year, taxpayers aged 70.5 or older can transfer up to $100,000 tax-free from a traditional IRA to charity, provided the funds are transferred directly to the charity.
This is a wonderful benefit for IRA owners aged 72 or older, as the dividend counts as their minimum distribution requirement. Moreover, a “qualified charitable distribution” will reduce the amount of your IRA, so reducing future withdrawal requirements and your tax payment. In addition, the transfer could help keep your income below the Medicare high-income surcharge threshold and reduce the proportion of your Social Security benefits due to taxation.
If you decide to make a QCD, you should do well before New Year’s Eve. To qualify for the tax deduction, the money must be removed from the account, and the charity must pay the check by December 31.
Think about a Roth Conversion
Consider converting a portion of your conventional IRA to a Roth IRA this year, up to the top of your income tax bracket, if you anticipate that your taxes may increase in the future. You will pay taxes on the conversion (less any amount representing nondeductible IRA contributions), but the money will grow tax-free in the Roth after that. You may be subject to a higher tax bracket if you convert your whole traditional IRA balance, but you can stretch out conversions over several years.
Be wary of significant conversions if you’re within two years of enrolling in Medicare; if your adjusted gross income (including tax-exempt interest income) exceeds a specific threshold, Medicare will charge you more for Part B. For example, if your income in 2020 was $91,000 or more for a single person or $182,000 or more for a married couple filing jointly, your Medicare Part B expenses in 2023 will be greater. Your Medicare rates are based on your most recent tax return, so a conversion in 2023 could affect your Medicare premiums in 2024.