2023 Year-End Individual Tax Planning Guide
Overview
With 2023 soon coming to a close, there is still time to take advantage of tax-saving ideas to lower your 2023 tax bill before December 31. This guide offers potential tax-saving opportunities for you to consider.
Key Considerations
Estimated Taxes/Adjusting Withholding
Your 2022 tax return is a great starting point for 2023 year-end tax planning. Did you owe money to the IRS or a state, or did you receive a big refund? If, after reviewing your 2022 return, you had a balance due, consider adjusting paycheck withholding on Form W-4 or nonwage income withholding on Form W-4P or Form W-4R for the remainder of 2023 and/or make estimated tax payments to avoid an estimated tax penalty and another balance due when your 2023 return is filed. You may be able to avoid the penalty by increasing your tax withholding and/or making one or more estimated tax payments so that withholding plus estimated payments equals 90% of the tax shown on the 2023 return when filed or 100% of the tax shown on the 2022 return, whichever is less. But note that the estimate must equal 110% of the 2023 tax if the AGI shown on your 2022 return exceeds $150,000 ($75,000 if you are married and filing a separate return).
Also factor in the 3.8% net investment income tax (NIIT), the receipt of unemployment benefits, distributions from IRAs and §401(k) plans, sales of investment property, etc., when adjusting withholding or making estimated payments. In addition, factor in any IRA required minimum distribution (RMD) that you will receive in 2023.
Note that with the $10,000 deduction limit on state and local taxes (SALT) in place, accelerating the fourth estimated state income tax payment into December 2023 to increase the current-year SALT deduction may be less important. However, accelerating or deferring the state estimated tax payment may make a difference in being able to benefit from a higher itemized deduction versus the standard deduction, so the timing of the payment still should be considered.
Also factor in the 3.8% net investment income tax (NIIT), the receipt of unemployment benefits, and any early distributions or COVID-19-related distributions from IRAs and §401(k) plans that you may have spread under the three-year rule when adjusting withholding or making estimated payments. In addition, factor in any IRA required minimum distribution (RMD) that you had to resume in 2023.
Note that with the $10,000 deduction limit on state and local taxes (SALT) in place, accelerating the fourth estimated state income tax payment into December 2023 to increase the current-year SALT deduction may be less important. However, accelerating or deferring the state estimated tax payment may make a difference in being able to claim a higher itemized deduction versus the standard deduction, so the timing of the payment still should be considered.
Basic Numbers You Need to Know
Adjusted Gross Income (AGI)
Because many tax benefits are tied to or limited by AGI — IRA deductions and certain tax credits, for example — a key aspect of tax planning is to estimate both 2023 and 2024 AGI. Also, when considering whether to accelerate or defer income or deductions (discussed further below), be aware of the impact this may have on AGI and the ability to maximize itemized deductions that are tied to AGI, such as medical expenses. Your 2022 tax return and 2023 pay data and other income and deduction-related documents are a good starting point for estimating your AGI.
Tax Rates (Tax Brackets)
Another important number is your “tax bracket,” i.e., the rate at which the last dollar of income is taxed. Although the income thresholds for the tax brackets are indexed for inflation, if income increases faster than the inflation adjustment, you may be pushed into a higher bracket, and thus subject to a higher marginal tax rate. If so, the potential benefit from any tax-saving opportunity is increased (as is the cost of overlooking the opportunity).
The Standard Deduction
Another key number is the standard deduction. The standard deduction is important for planning the timing of one's itemized deductions as itemized deductions must exceed the standard deduction to maximize the tax value of the deductions. For 2023, the standard deduction is: $27,700 for married filing jointly and qualifying surviving spouses; $20,800 for head of household; and $13,850 for all other taxpayers.
For 2023, the additional standard deduction for older taxpayers and the blind is $1,500 each and $1,850 for older taxpayers and the blind if unmarried and not a qualifying surviving spouse.
Income, Deductions and Credits
Deferring the Receipt of Income Until 2024
If you expect your AGI to be lower in 2024 than in 2023 or anticipate being in the same or a lower tax bracket in 2024, you may benefit by deferring the receipt of income until 2024. Deferring income is advantageous so long as the deferral does not bump you into a higher tax bracket in the succeeding year(s). Deferring income may be disadvantageous, however, if the deferred income is deferred compensation under a nonqualified deferred compensation plan subject to §409A, a special provision that makes the income includible in gross income and subject to additional tax.
If you are self-employed and file Schedule C (e.g., as a sole proprietor or single-member LLC) and operate on a calendar year, cash basis accounting method, consider delaying 2023 year-end billings to clients so that payments will not be received until 2024.
Accelerating the Receipt of Income into 2023
In limited circumstances, you may benefit by accelerating income into 2023. For example, if you anticipate being in a higher tax bracket in 2024 than in 2023 or need additional income in 2023 to take advantage of an offsetting deduction or credit that will not be available in future tax years, it may make sense to accelerate the receipt of income. However, accelerating income into 2023 may be disadvantageous if you expect to be in the same or lower tax bracket for 2024.
If you are self-employed, for example, it may be disadvantageous to accelerate income into 2023, even if you will be in a higher bracket in 2024, if the acceleration causes you to cross a threshold that would result in an offsetting reduction in the §199A qualified business income deduction. The §199A deduction phase-out thresholds for 2023 begin at $364,200 for married individuals filing joint returns, $182,100 for married individuals filing separate returns, and $182,100 for all other returns.
Some ways to accelerate income into 2023 include:
Year-End Bonuses: If your employer generally pays year-end bonuses early in 2024, see if you can have your bonus paid before the end of 2023.
Retirement Plan/IRA Distributions: If you have attained age 59 1/2 and participate in an employer retirement plan or have an IRA, consider taking any taxable withdrawals before 2024. You may also want to consider making a Roth IRA rollover distribution (discussed further below).
Itemized Deduction Planning
Deduction timing is an important element of year-end tax planning. However, deduction planning is complex, due to factors such as AGI levels, the AMT, filing status, and the standard deduction. In addition, an expense is deductible only in the year in which it is actually paid. Therefore, if your tax rate is going to increase in 2023, it may be a good strategy to accelerate spending into 2023 to take the deduction in 2023. Also, consider dating your checks and mailing them before the end of 2023.
Deduction planning also is affected by the standard deduction. If itemized deductions are relatively constant and are close to the standard deduction amount, little or no benefit will be gained from itemizing deductions each year. However, simply taking the standard deduction each year means the potential loss of the benefit of itemized deductions that exceed the standard deduction. To maximize the benefits of the standard deduction and itemized deductions, consider adjusting the timing of deductible expenses, i.e., “bunching,” so that they are higher in one year and lower the following year. This can be accomplished by paying deductible expenses in 2023, such as mortgage interest due in January 2024, state estimated tax payments due in early 2024 or doubling up on charitable contributions every other year.
For 2023, medical expenses, including amounts paid as health insurance premiums, long-term care insurance premiums, and dental insurance premiums are deductible only to the extent that the total medical and dental expenses exceed 7.5% of AGI for all taxpayers. “Bunching” medical and dental expenses in one calendar year also can help maximize the allowable deduction.
If you anticipate a state income tax liability for 2023 and plan to make an estimated payment typically due in January 2024, consider making the payment before the end of 2023. But recognize that the current $10,000 cap on deducting state and local taxes ($5,000 if married filing separately) may significantly impact this type of deduction planning.
Consider making charitable contributions by the end of 2023 using a credit card if the bill will not have to be paid until 2024. A pledge to make a donation is not deductible unless it actually is paid by the end of 2023.
Investments
The timing of your investment activities can result in significant tax consequences. A key point to keep in mind when planning investment activity in 2023 is the extent to which you may have capital loss carryovers from your 2022 tax return.
The following general rules apply for most capital asset transactions in 2023:
Capital gains on property held for one year or less are taxed at an individual's ordinary income tax rate.
• apital gains on property held for more than one year are taxed at more favorable capital gains tax rates, depending on the taxpayer's regular income tax bracket.
For 2023, the maximum capital gains rate is 20% for a taxpayer with taxable income above $553,849 in the case of married filing jointly or as a surviving spouse, $276,899 in the case of a married individual filing a separate return, $523,049 in the case of an individual who files as head of household, or $492,299 in the case of any other individual. For taxpayers in the lower tax brackets, the capital gains rate is 0% or 15%, depending on your income and filing status.
Timing of Sales/Capital Gains and Losses. Pay attention to the holding period of your investments because long-term capital gains (i.e., gains from assets held for more than one year) are taxed at preferential rates not exceeding 20%, whereas short-term capital gains are taxed at ordinary income tax rates. To avoid recognizing capital gains altogether, you should consider donating appreciated property to charity rather than selling it, especially if doing so may result in overall itemized deductions exceeding your standard deduction for 2023.
Consider timing the sale of assets to have offsetting capital gains and losses. Capital losses may be fully deducted against capital gains and offset up to an additional $3,000 of ordinary income ($1,500 for a married individual filing separately). In general, when losses are taken, long-term losses are first matched against long-term gains, and short-term losses against short-term gains. If there are any remaining losses, they may be used to offset any remaining long-term or short-term gains, up to an additional $3,000 (or $1,500) of ordinary income. If a taxpayer sells stock at a loss, he/she must wait 31 days before repurchasing the same stock or else the wash sale rules apply, which would disallow the loss.
You should work with your investment adviser on an overall strategy as well as to better understand which of your investments may result in capital gain distributions and how all this fits with your other anticipated income sources in 2023.
Mutual Funds. Some mutual funds can generate a significant amount of short-term capital gains, which are taxed at your ordinary income tax rate. In addition, avoid purchasing mutual fund shares later in 2023, as such funds often declare capital gains distributions at year-end, and you will be taxed on the full distribution even though you may have only held the shares for a short period of time.
Interest and Dividends. Interest income earned on U.S. Treasury securities and bank certificates of deposit (CDs) with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until 2024. If there is a possibility of receiving dividends from a closely held company, weigh the timing of receipt of those dividends.
Sale of Principal Residence.Significant changes in property values in recent years may mean that you can sell your principal residence at a handsome profit over what you originally paid. However, you need to crunch the numbers to see if you may have a taxable capital gain on the sale of the residence. The tax code recognizes the importance of home ownership by allowing you to exclude gain when you sell your main home. However, you can only exclude a maximum of $500,000 if married filing jointly and $250,000 for all other taxpayers.
Sale of Rental Property. Consider the capital gains implications for your 2023 taxes when selling your rental property. Don't forget about depreciation recapture and the fact that any suspended passive losses attributable to the property are freed up in the year of disposition and are fully deductible against your income.
Net Investment Income Tax (NIIT). An additional 3.8% tax is levied on certain unearned income of higher income taxpayers. The net investment income tax is levied on the lesser of net investment income or the amount by which modified AGI (MAGI) exceeds certain dollar amounts — $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separate returns, and $200,000 for single individuals.
Investment income is: (1) gross income from interest, dividends, annuities, royalties, and rents (other than from a trade or business); (2) other gross income from any business to which the tax applies; and (3) net gain attributable to property that is not attributable to an active trade or business. Investment income does not include distributions from a qualified retirement plan or amounts subject to self-employment tax. This rule applies mostly to passive businesses and trading in financial instruments or commodities. With this additional tax, the maximum net capital gains rate is 23.8% in 2023 for taxpayers with taxable income above $553,849 in the case of a joint return or surviving spouse, $276,899 in the case of a married individual filing a separate return, $523,049 in the case of an individual who files as head of household, or $492,299 in the case of any other individual.
Strategies to reduce exposure to the NIIT would be to exchange real property through a like-kind exchange to defer recognition of any gain until a future year when MAGI may be lower, or, if planning on selling your principal residence that has a gain over the exclusion amounts ($250,000/$500,000 depending on filing status), postponing the sale until after 2023 if your income will be lower in 2024.
Defer Taxes by Investing in Qualified Opportunity Funds (QOFs). A taxpayer who invests in Qualified Opportunity Zone property through a Qualified Opportunity Fund (QOF) within 180 days of realizing a gain can temporarily defer tax on the amount of eligible gains if he/she invests, and, in some situations, can permanently exclude 10% or 15% of invested eligible gain. A taxpayer can defer tax on “eligible gains” invested in a QOF until the earlier of (1) an inclusion event, or (2) December 31, 2026. Eligible gains include both capital gains and qualified §1231 gains, but only if the gains: (1) would be recognized for federal income tax purposes before January 1, 2027, and (2) are not from a transaction with a related person.
The amount of time you hold the QOF investment determines the tax benefit you receive. When you make an election to defer the gain, the basis in the QOF investment becomes zero. If you hold your investment in the QOF for at least 5 years, your basis (the amount of your investment) will increase by 10% of the deferred gain. If you hold your investment in the QOF for at least 7 years, your basis will increase by an additional 5% of the deferred gain. The 10% and additional 5% basis increases have the effect of excluding a portion of invested eligible gain from federal capital gains taxation. Also, if you hold your investment in the QOF for at least 10 years, you may be able to permanently exclude post-acquisition gain resulting from appreciation of a qualifying investment when it is sold or exchanged. The exclusion occurs if you elect to increase the basis of your QOF investment to its fair market value on the date of the sale or exchange.
Qualified Dividends. Qualified dividends received in 2023 are subject to taxation at rates that are similar to the favorable capital gains rates. Therefore, qualifying dividends on stocks held for more than one year are taxed at a maximum rate of 20% (23.8% if subject to the NIIT). Qualifying dividends include dividends received from domestic and certain foreign corporations. Nonqualifying dividends are subject to ordinary income rates of up to 40.8% (37% income tax rate plus 3.8% NIIT rate).
Exclusion of Gain Attributable to Certain Small Business Stock. One hundred percent (100%) of the gain on the sale of “small business stock” under §1202 is excluded from income. The stock must be held for more than five years to qualify for the exclusion. (If the stock was acquired on or before September 27, 2010, other less favorable exclusion rules apply).
Installment Sales. Generally, a sale occurs when property is transferred. If a gain will be realized on the sale, income recognition will normally be deferred under the installment method until payments are received, so long as one payment is received in the year after the sale. Thus, if a taxpayer expects to sell property at year-end, and it makes economic sense, consider selling the property using the installment method to defer payments (and tax) until next year or later. Using the installment sale method also may defer exposure to the 3.8% NIIT.
Qualified Equity Grants. Individuals may be able to defer taxation on vested qualified stock while they have insufficient cash flow to cover their tax liability. The employee makes a special election regarding stock attributable to options exercised or restricted stock units settled in 2023 or later, so that no amount will be included in income for the first tax year in which the rights of the employee in the stock are transferable or are not subject to a substantial risk of forfeiture. In many cases, a qualified equity grant defers taxation until five years after the employee vests in the qualified stock.
Tax Credits
Residential Clean Energy Credit
For 2023, a tax credit is available to homeowners and tenants who install certain energy-efficient property on their residence, such as solar panels, solar water heaters, geothermal heat pumps, wind turbines, fuel cells, and battery storage technology with a capacity of at least 3 kilowatt hours. The amount of the credit is 30% of the cost of qualifying property installed in 2023. Fuel cell property is limited to $500 for each half kilowatt of capacity. If more than one person lives in the home, the combined credit for all residents is limited to $1,667 for each half kilowatt of fuel cell capacity. Note that you may need to subtract subsidies, rebates, or other financial incentives from your qualified property expenses because they are considered a purchase price adjustment.
The credit is nonrefundable, so it is limited to the amount you owe in taxes. However, you can apply any unused credit amount to reduce the tax you owe in future years.
The residential clean energy credit is available for property installed on or in newly constructed homes and existing homes located in the United States. The residential clean energy credit is available only for improvements to a dwelling that you use as your residence. Fuel cell property expenditures qualify only if the home is used as your primary residence (where you live the majority of the year).
Energy Efficient Home Improvement Credit
For 2023, if you make qualified energy-efficient home improvements, you may qualify for a tax credit of up to $3,200 for the year the improvements are installed. The home must be located in the United States, and it must be an existing home that you improve or add onto, not a new home. You cannot claim the credit if you are a landlord (or other property owner who doesn't live in the home).
The energy efficient home improvement credit amount is 30% of certain qualified expenses, including:
Qualified energy efficiency improvements (such as windows, skylights, exterior doors, and insulation) installed in or on your primary residence (where you live the majority of the year);
Residential energy property expenses (such as energy-efficient heat pumps, central air conditioners, furnaces, and water heaters) installed on your primary residence or a second home; and
Home energy audits.
The maximum credit you can claim in 2023 is $1,200 for energy property costs and certain energy efficient home improvements plus $2,000 per year for qualified heat pumps, biomass stoves, or biomass boilers. However, property-specific limits apply as follows:
$250 per exterior door that meets applicable Energy Star requirements, up to $500 total.
Up to $600 for exterior windows and skylights that meet Energy Star Most Efficient certification requirements.
Up to $600 per item for central air conditioners, natural gas, propane, or oil water heaters, natural gas, propane, oil furnaces and hot water boilers, and biomass stoves or boilers.
Up to $600 per item for the cost of electrical components needed to support residential energy property, including panelboards, sub-panelboards, branch circuits, and feeders, also qualify for the credit if they meet the National Electric Code and have a capacity of 200 amps or more.
Up to $150 for home energy audits.
Note that you may need to subtract subsidies, rebates, or other financial incentives from your qualified property expenses because they are considered a purchase price adjustment.
The energy-efficient home improvement credit is nonrefundable, so it is limited to the amount you owe in taxes, and you cannot apply any excess credit to future tax years.
Clean Vehicle Credit
A tax credit – the “clean vehicle credit” – may be available if you purchase a plug-in electric motor vehicle or a fuel cell motor vehicle, and it is delivered to you in 2023. The maximum credit allowed per vehicle is $7,500. The credit is available to individuals and their businesses. Vehicles are not limited to passenger automobiles. They also include, for example, vans, sport utility vehicles, and pickup trucks.
A vehicle qualifies for the clean vehicle credit only if all the following requirements are met:
You buy the vehicle new.
You buy the vehicle for your own use, not for resale.
The seller reports required information to you and the IRS at the time of sale.
The vehicle is made by a qualified manufacturer (not required for fuel cell motor vehicles).
The vehicle is manufactured primarily for use on public streets, roads, and highways (not including a vehicle operated exclusively on a rail or rails).
The vehicle has at least 4 wheels (not required for fuel cell motor vehicles).
The vehicle has a gross vehicle weight rating of less than 14,000 pounds (not required for fuel cell motor vehicles).
The vehicle is propelled, to a significant extent, by an electric motor drawing electricity from a battery that has a capacity of at least 7 kilowatt-hours and may be recharged from an external electrical source (not required for fuel cell motor vehicles).
The vehicle's final assembly occurs in North America.
The vehicle's manufacturer suggested retail price (MSRP) is less than or equal to $80,000 for vans, SUVs, and pickup trucks, or $55,000 for other vehicles.
You use the vehicle primarily in the United States
Your modified adjusted gross income (MAGI) does not exceed certain limits ($300,000 for married couples filing jointly, $225,000 for heads of households, or $150,000 for all other filers).
You can use your MAGI from the year you take delivery of the vehicle or the year before, whichever is less. If your MAGI is below the threshold in either one of the two years, you can claim the credit. The credit is nonrefundable, so it is limited to the amount you owe in taxes, and you cannot apply any excess credit to future tax years.
The amount of the credit depends on when you took delivery of the vehicle, regardless of purchase date.
For vehicles placed in service from January 1 to April 17, 2023, the clean vehicle credit amount is:
$2,500 base amount
+ $417 for the first 5 kilowatt hours of battery capacity
+ $417 for each kilowatt hour of battery capacity beyond 5 kilowatt hours
Up to $5,000 total
The battery capacity must be at least 7 kilowatt hours to qualify for the credit. Thus, the minimum credit is $3,751 ($2,500 + ($417 x 3)), the credit amount for a vehicle with the minimum 7 kilowatt hours of battery capacity.
Vehicles placed in service April 18, 2023 and later must meet all of the same criteria listed above and also must meet critical minerals and battery components requirements. The credit amount for vehicles placed in service on April 18, 2023 and later is up to:
$0 if the vehicle meets neither the critical minerals nor the battery components requirement.
$3,750 if the vehicle meets the critical minerals requirement only.
$3,750 if the vehicle meets the battery components requirement only.
$7,500 if the vehicle meets both requirements.
Used Clean Vehicle Credit
If you buy a qualified used electric vehicle or fuel cell vehicle from a licensed dealer for $25,000 or less, you may be eligible for a used clean vehicle tax credit. The credit amount is 30% of the sale price, up to a maximum credit of $4,000. The credit is nonrefundable, so it is limited to the amount you owe in taxes, and you cannot apply any excess credit to future tax years
To qualify, you must:
Be an individual who bought the vehicle for use and not for resale;
Not be the original owner;
Not be claimed as a dependent on another person's tax return; and
Not have claimed another used clean vehicle credit in the 3 years before the purchase date.
In addition, your modified adjusted gross income (MAGI) may not exceed:
$150,000 for married filing jointly or a surviving spouse.
$112,500 for heads of households.
$75,000 for all other filers.
You can use your MAGI from the year you take delivery of the vehicle or the year before, whichever is less. If your income is below the threshold for either one of the two years, you can claim the credit.
To qualify for the used clean vehicle credit, a vehicle must meet all the following requirements:
Have a sale price of no more than $25,000 and be purchased from a dealer (in a state, the District of Columbia, the Commonwealth of Puerto Rico, any other territory or possession of the United States, an Indian tribal government, or any Alaska Native Corporation);
Have a model year at least two years earlier than the calendar year in which you buy it (e.g., a vehicle purchased in 2023 must be a 2021 model year or older);
Not have already been transferred after August 16, 2022, to a qualified buyer;
Have a gross vehicle weight rating of less than 14,000 pounds;
Be an eligible fuel cell vehicle or plug-in electric vehicle with a battery capacity of least 7 kilowatt hours;
Be for use primarily in the United States; and
The dealer must report required information to you and the IRS at the time of sale.
Family and Education Tax Incentives
Child Tax Credit. For 2023, families claiming the Child Tax Credit (CTC) may receive up to $2,000 per qualifying child under the age of 17 at the end of 2023. The maximum amount of the credit that is refundable is $1,600 per qualifying child even if no tax is owed. You must have earned income of at least $2,500 to take advantage of the credit's refundability. The credit phases out for taxpayers with adjusted gross incomes above $400,000 for married filing joint returns and $200,000 for all other returns.
Household and Dependent Care Tax Credit. You may be able to claim a credit for expenses such as day care, nursery school, before and after-school care, and summer camps if you paid such expenses for the care of a qualifying individual under age 13 to enable you (and your spouse, if filing a joint return) to work or actively look for work. Generally, you may not take this credit if your filing status is married filing separately
A qualifying individual includes (1) your dependent qualifying child who was under age 13 when the care was provided; and (2) your spouse who was physically or mentally incapable of self-care and lived with you for more than half of the year; or an individual who was physically or mentally incapable of self-care, lived with you for more than half of the year, and either: (a) was your dependent; or (b) would have been your dependent except that he or she receives gross income of $4,700 or more, files a joint return, or you (or your spouse, if filing jointly) can be claimed as a dependent on another taxpayer's 2023 return.
The allowable amount of the dependent care credit ranges between 20%-35% of the eligible employment-related expenses incurred by the taxpayer in 2023 – $3,000 if there is one qualifying individual with respect to the taxpayer for such tax year or $6,000 if there are two or more qualifying individuals with respect to the taxpayer for such tax year. The maximum credit for the 2023 tax year is $1,050 (35% of $3,000) if you have only one child/dependent or $2,100 (35% of $6,000) if you have more than one. The full household and dependent care credit amount is allowed only for families making less than $15,000 a year in 2023. For 2023, the child and dependent care credit is nonrefundable.
Health Care Flexible Spending Accounts (FSA). For 2023, cafeteria plans may allow employees to elect no more than $3,050 in salary reduction contributions to a health FSA. Typically, employers require the following year's election to be set before the end of the year. A plan may allow for a carryover of unused amounts of up to $610 to 2023.
Health Savings Accounts. A health savings account (HSA) is a trust or custodial account exclusively created for the benefit of the account holder and his or her spouse and dependents and is subject to rules that are like those applicable to individual retirement arrangements (IRAs). Contributions to an HSA are deductible, within limits.
529 Qualified Tuition Plans. A 529 qualified tuition plan allows you to save for future education expenses in a tax-advantaged savings plan. These plans generally are available in the form of a prepaid tuition plan that allows you to lock in future tuition at current cost or a more traditional investment account that grows tax-deferred and whose distributions used to pay qualified postsecondary education expenses such as tuition, fees, books, supplies, and room and board are income-tax-free for federal and state purposes. Many states allow for a deduction or tax credit per beneficiary for contributions to that state's 529 plan.
529 plan distributions may be made tax-free for elementary and secondary tuition of up to $10,000 per year per student. Such plans also may be used to pay up to $10,000 of student loans per beneficiary. Up to $17,000 in contributions to a 529 plan are free from federal gift taxation ($34,000 for a married couple filing jointly). Under a special rule for 529 plans, you can “front-load” five years’ worth of annual gift tax exclusions and make up to a $85,000 contribution per beneficiary in 2023 ($170,000 if gift-splitting with a spouse).
American Opportunity Tax Credit for Education. The American Opportunity Tax Credit (AOTC) is available for qualified tuition and fees paid on behalf of a student (i.e., you, your spouse, or a dependent) who is enrolled on at least a half-time basis. The maximum credit is $2,500 (100% of the first $2,000, plus 25% of the next $2,000). The credit is available for the first four years of the student's post-secondary education.
The AOTC is phased out at modified AGI levels between $160,000 and $180,000 for joint filers, and between $80,000 and $90,000 for other taxpayers. Up to 40% of the credit is refundable, which means that a taxpayer can receive up to $1,000 even if no tax is owed. “Qualified tuition and related expenses” include expenditures for “course materials” (i.e., books, supplies, and equipment needed for a course of study regardless of whether the materials are purchased from the educational institution as a condition of enrollment or attendance).
One way to take advantage of the AOTC for 2023 is to prepay Spring 2024 tuition by the end of 2023. In addition, if it is known what books the student will need for the Spring 2024 semester, those can be bought in 2023, and the costs would qualify for the credit for 2023.
The Lifetime Learning Credit for Education. The Lifetime Learning Credit (LLC) is available for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses — including courses to acquire or improve job skills. There is no limit on the number of years you can claim the credit. The LLC is a nonrefundable credit.
For 2023, the maximum credit is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the AOTC, eligible students include the taxpayer, the taxpayer's spouse, or a dependent. For 2023, the LLC is phased out ratably for taxpayers with modified AGI between $80,000 and $90,000 ($160,000 and $180,000 for joint returns). If your modified AGI is $90,000 or more (or $180,000 or more for joint returns), you cannot claim the credit.
Coverdell Education Savings Accounts. The aggregate annual contribution limit for a Coverdell education savings account is $2,000 per designated beneficiary of the account. For 2023, the limit is phased out for individual contributors with modified AGI between $95,000 and $110,000 and joint filers with modified AGI between $190,000 and $220,000. The contributions to the account are nondeductible, but the earnings grow tax-free.
Coverdell account holdings can be distributed tax-free if used for qualified higher education expenses (tuition, fees, books, supplies, equipment required for enrollment or attendance, and expenses for special needs services) and/or qualified elementary and secondary education expenses (tuition, fees, academic tutoring, special need services, books, supplies, computer equipment, room and board, uniforms, transportation, and supplementary items or services).
Student Loan Interest Deduction. Taxpayers may be eligible for an above-the-line deduction for student loan interest paid on any “qualified education loan.” The maximum deduction is $2,500. The deduction for 2023 begins to phase out for higher-earning taxpayers with modified AGI exceeding $75,000 ($155,000 for joint returns) and is completely phased-out for taxpayers with modified AGI of $90,000 or more ($185,000 or more for joint returns).
The Kiddie Tax. For 2023, a child's unearned income (e.g., investment income and capital gains) above $2,500 are generally taxed at the parent's marginal tax rate; a child's unearned income (e.g., investment income and capital gains) above $1,250 but not more than $2,500 are taxed at the child's tax rate. For 2023, the amount that is used to reduce the net unearned income reported on the child's return that is subject to the “kiddie tax,” is $1,250. The same $1,250 amount is used to determine whether a parent may elect to include a child's gross income in the parent's gross income and to calculate the “kiddie tax.” For example, one of the requirements for the parental election is that a child's gross income is more than $1,250 but less than $12,500.
The kiddie tax applies to: (1) children under 18 who do not file a joint return; (2) 18-year-old children who have unearned income in excess of the threshold amount, do not file a joint return, and whose earned income, if any, does not exceed one-half of the amount of the child's support; and (3) children between the ages of 19 and 23 if, in addition to the above rules, they are full-time students.
Including a child's income on the parent's return will increase the parent's AGI and taxable income, thus resulting in a higher tax and possible reductions in credits and other amounts that are tied to AGI.
Achieving a Better Life Experience (ABLE) Accounts. This is a type of savings account for individuals with disabilities and their families. For 2023, taxpayers can contribute up to $17,000 (tied to the annual gift tax exclusion). Distributions are tax-free if used to pay the beneficiary's qualified disability expenses.
Annual Gift Tax Exclusion. The most common method used for tax-free giving is the annual gift tax exclusion, which, for 2023, allows a person to give up to $17,000 per donee without reducing the giver's estate and lifetime gift tax exclusion amount. A person is not limited to the number of donees to whom he or she may make such gifts. Further, because the annual exclusion is applied on a per-donee basis, a person can leverage the exclusion by making gifts to multiple donees (family and non-family). Thus, for example, if an individual makes $17,000 gifts to 10 donees, he or she may exclude $170,000 from gift tax. In addition, because spouses may combine their exclusions in a single gift from either spouse, married donors may double the amount of the exclusion to $34,000 per donee.
For 2023, the first $175,000 of gifts to a noncitizen spouse (other than gifts of future interests in property) are excluded from gift tax. A person may not carry over his or her annual gift tax exclusion amount to the next calendar year. Qualifying tuition payments and medical payments do not count against this limit.
Retirement Planning
Maximize Retirement Savings. If you are not contributing the maximum amount permitted to your §401(k) account for 2023, you still have time to increase contributions for the remainder of 2023 to lower your AGI to take advantage of some of the tax breaks described herein. Maximizing pre-tax retirement contributions is a good tax-saving move.
Traditional IRA. Individuals who are not active participants in an employer retirement plan may make deductible contributions to an IRA. The deadline for 2023 contributions is April 15, 2024. The annual deductible contribution limit for an IRA for 2023 is $6,500. A $1,000 “catch-up” contribution is allowed for taxpayers who are age 50 or older by the close of 2023, making the total limit $7,500 for these individuals. Individuals who are active participants in an employer pension plan also may make deductible contributions to an IRA, but their contributions are limited in amount depending on their AGI.
For 2023, the AGI phase-out range for deductibility of IRA contributions is between $73,000 and $83,000 of modified AGI for single persons (including heads of households), and between $116,000 and $136,000 of modified AGI for married taxpayer filing jointly. Above these ranges, no deduction is allowed. A married taxpayer filing a separate return may not deduct IRA contributions if his/her modified AGI is $10,000 or more. In addition, an individual is not considered an “active participant” in an employer plan simply because the individual's spouse is an active participant for part of a plan year.
You may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if the joint modified AGI is $218,000 to $228,000 ($0 – $10,000 if married filing separately) for 2023. Above this range, no deduction is allowed.
IRA Rollovers. For 2023, you may make only one IRA-to-IRA rollover per year. (Direct trustee-to-trustee rollovers are not affected.) A second attempted rollover will be treated as a withdrawal and taxed at regular rates, plus a possible 10% early withdrawal penalty.
Spousal IRA. If an individual files a joint return and has less compensation than his or her spouse, the IRA contribution is limited to the lesser of (1) $6,500 for 2023 plus age 50+ catch-up contributions ($1,000 for 2023), or (2) the total compensation of both spouses reduced by the other spouse's IRA contributions (traditional and Roth).
Roth IRA. This type of IRA allows individuals to make nondeductible contributions of up to $6,500 ($7,500 if making a $1,000 eligible catch-up contribution) for 2023. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after contribution and the individual has reached age 59 1/2. Distributions may be made earlier due to disability or death. The maximum contribution is phased out in 2023 for persons with an AGI from $218,000 to $228,000 for married taxpayers filing jointly, $138,000 to $153,000 for single taxpayers (including heads of households), and between $0 and $10,000 for a married taxpayer filing separately who lived with the spouse during the year.
A Roth IRA must be established and funded by April 15, 2024, for the contribution to be considered a 2023 contribution.
“Backdoor” Roth IRA. If your income is too high to make a Roth IRA contribution and you do not have a traditional IRA, you can establish a traditional IRA and make a nondeductible contribution. You can then convert the traditional IRA to a Roth IRA, but you will have to pay income tax on a percentage of the converted amount. The percentage of the converted amount that is taxable is the percentage of the funds in all of your traditional IRAs, SEP, and SIMPLE plans combined that consists of pre-tax dollars.
Roth IRA Conversions. Funds in a traditional IRA (including SEPs and SIMPLE IRAs), §401(a) qualified retirement plan, §403(b) tax-sheltered annuity, or §457 government plan may be rolled over into a Roth IRA. No penalties will apply if all the requirements for such a transfer are satisfied. Also, consider Roth IRA conversions before the lower tax rates passed in 2017 expire at the end of 2025, at which time rates could move higher unless Congress acts.
§401K Plans. The §401(k) elective deferral limit is $22,500 for 2023. If your employer's §401(k) plan allows for catch-up contributions for 2023 and you reach age 50 by December 31, 2023, an additional $7,500 may be contributed to the §401(k) account, for a total maximum 2023 contribution of $30,000 ($22,500 in regular contributions plus $7,500 in age 50+ “catch-up” contributions). Despite a change in the law, individuals whose wages exceed $145,000 in 2023 are not required to make their catch-up contributions for 2024 as Roth contributions.
A sole proprietorship or single-member LLC that establishes a §401(k) plan for 2023 has until April 15, 2024, to make employee contributions for 2023.
SIMPLE Plan Contribution. The SIMPLE plan deferral limit is $15,500 for 2023. If your SIMPLE plan allows for catch-up contributions for 2023 and you will be 50 years old by December 31, 2023, an additional $3,500 may be contributed.
Catch-Up Contributions for Other Plans. If you will be 50 years old by December 31, 2023, an additional $7,500 can be contributed to a §403(b) plan, SEP, or eligible §457 government plan.
IRA Required Minimum Distributions (RMDs) If you turned 72 in 2022, you'll need to take your first RMD by April 1, 2023, and another one by the end of 2023. Due to a change to the age that you have to start taking RMDs, if you turn 72 in 2023, you won't have to take an RMD until 2024 (when you turn 73), and the first must be taken by April 1, 2025. If a portion of your retirement account includes an annuity, you may be able to decrease the amount of your required distribution by aggregating distributions from the IRA and the annuity.
IRA Donations to Charity. If you are 70 ½, you can make direct contributions from your IRA to charity of up to $100,000 during 2023, but you can't claim a charitable contribution deduction. Conversely, the amounts are not included in your taxable income and can be used to satisfy your RMD. You also may elect a one-time contribution from your IRA of up to $50,000 to charity through a charitable gift annuity, charitable remainder unitrust, or charitable remainder annuity trust funded only by qualified charitable distributions.
Tax Breaks for Small Business Owners and Self-Employed Individuals
There are a variety of tax provisions that are available to you as a self-employed individual or if you are a small business owner of an entity such as a single-member LLC or an S-corporation:
Qualified Business Income Deduction (QBI Deduction). Individual taxpayers with qualified business income from a pass-through entity (partnership, S corporation, LLC or single-member LLC) or a sole proprietorship may be entitled to a 20223 deduction equal to the lesser of the deductible amount of the QBI (generally 20% subject to the W-2 wage basis limit) or 20% of net taxable income from the business. Deductions may also be allowed for 20% of qualified REIT dividends and qualified publicly traded partnership income. Special rules apply for these additional items. The deduction applies to reduce taxable income and is available even if the taxpayer does not itemize deductions. (The QBI deduction does not impact the calculation of the self-employment tax).
For 2023, if taxable income does not exceed a threshold of $364,200 (joint filers), $182,100 (married filing separately), or $182,100 (all other taxpayers), the deduction is generally the lesser of 20% of QBI or 20% of taxable income. If taxable income exceeds the threshold amount, the deduction is subject to a wage basis limit that is phased-in ratably, and only a portion of the income from a specified trade or business is eligible, the W-2 wage limitation applies, and specified service trades or businesses are excluded. However, if taxable income exceeds the threshold amount by $100,000 or more for married taxpayers filing jointly, or by $50,000 or more for other filers, the wage basis limit applies in full, and income from a specified trade or business is not eligible for the QBI deduction.
Calculating the QBI deduction is a fact-intensive inquiry. If you claim the deduction and understate the amount of tax required to be shown on the return by 5% or more, you may be subject to up to a 40% substantial understatement of tax penalty.
Home Office Deduction. For self-employed individuals and small business owners (but not employees), expenses attributable for using the home office as a business office are deductible if the home office is used regularly and exclusively: (1) as a taxpayer's principal place of business for any trade or business; (2) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business; or (3) in the case of a separate structure not attached to the residence, in connection with a trade or business.
Depreciation and Section 179 Expense Election. If the taxpayer is in business and purchases equipment, he/she may depreciate such equipment or make a “§179 election,” which allows the taxpayer to expense (i.e., currently deduct) otherwise depreciable business property (but not investment property). For 2023, the allowable deduction is $1,160,000 (with a phase-out beginning at $2,890,000).
Bonus Depreciation. Business or investment property placed in service in 2023, including certain used property, may be eligible for an 80% bonus depreciation deduction (separate from §179 expensing). The bonus depreciation rate will decrease to 60% for property placed in service in 2024. To take advantage of this deduction, taxpayers engaged in a business may want to consider accelerating the placing in service of property or the decision to purchase assets for use in the business before the end of 2023. Taxpayers may not take a bonus depreciation deduction for the same expense that is deducted under §179.
NOL Carryback/Carryforward Period. Generally, a net operating loss (NOL) arising in 2023 may not be carried back and must be carried forward.
Capitalization v. Expensing for Materials and Supplies and Repairs. Under regulations, a deduction is allowed for materials and supplies that have an acquisition or production cost of $200 or less. A de minimis safe harbor provides that, for repairs to be deductible, among other requirements, the unit of property must cost $5,000 or less per invoice or item substantiated by the invoice for taxpayers with applicable financial statements and $2,500 or less per invoice for taxpayers without applicable financial statements.
Self-Employed Health Insurance Premiums. Self-employed individuals are allowed to claim 100% of the amount paid during the tax year for insurance that constitutes medical care for themselves, their spouses, and their dependents as an above-the-line deduction, without regard to the general 7.5% of AGI floor.
SEP IRA Contributions. For 2023, self-employed individuals generally can make a SEP contribution that cannot exceed the lesser of 25% of compensation or $66,000. The SEP contribution is an above-the-line deduction that reduces the AGI subject to tax. Note that the self-employment tax is calculated before SEP contributions are calculated.
A SEP IRA must be established by the due date of the return (plus any extensions) for the tax year to which the qualifying contribution is made. Thus, an individual can wait until after the close of 2023 to establish and determine their SEP contribution for 2023.
Employing Family Members. Wages for the services of one spouse who works for the other spouse are subject to income tax withholding and Social Security and Medicare taxes but not to the Federal Unemployment Tax Act (FUTA). You can hire your children to work in your business as well. Payments are subject to income tax withholding, regardless of the child's age. However, payments for the services of a child under age 18 are not subject to Social Security and Medicare taxes if the business is a sole proprietorship or a partnership in which each partner is a parent of the child. In addition, payments to a child under age 21 are not subject to FUTA.
Payments for the services of a child are subject to income tax withholding as well as Social Security, Medicare and FUTA taxes if they work for: (1) a corporation, even if it's controlled by the child's parent, or (2) a partnership, even if the child's parent is a partner, unless each partner is a parent of the child. Wages that you pay to a parent are subject to income tax withholding and Social Security and Medicare taxes but are not subject to FUTA tax. In addition to being able to deduct wages paid to a family member as a business expense, a key tax benefit is that any child, regardless of age, can contribute to an IRA provided he/she has earned income.
Your children can also contribute to a Roth IRA. If your child is a minor (under age 18 in most states; under age 19 or 21 in others), you will need to open a custodial account.
REPORTING REMINDERS
Form 1040: You must file your 2023 income tax return on or before April 15, 2024, and an automatic six-month extension is available until October 15, 2024.
FinCEN Form 114: If you hold any financial interest, in or signature or other authority over, a foreign financial account exceeding $10,000 at any time during the 2023 calendar year, you must file a Report of Foreign Bank and Financial Accounts (FBAR) with the Department of the Treasury. The report must be filed electronically. The due date for the 2023 FBAR is the same as the tax filing deadline for Form 1040/1040-SR, i.e., April 15, 2024, with an automatic six-month extension to October 15, 2024.
Penalties: The tax code imposes penalties for late-filed returns, failing to file returns, and failing to pay tax, as well as penalties for failing to disclose foreign bank accounts. The tax code also imposes a host of penalties concerning the accuracy of returns. Many penalties are subject to inflation adjustments.
Cryptocurrency/Digital Asset Transactions: You must report certain transactions involving cryptocurrency and other digital assets on the appropriate income line or schedule and also must answer a question on page 1 of the Form 1040/1040-SR.
Information About this Publication
This information was sourced from Bloomberg Industry Group, Inc. For more information or to speak with an expert regarding your tax compliance needs, please contact Brandon Caroprese at bcaroprese@caroprese.com or via telephone at 973-475-8090.