Brian Lamborne is a sophisticated planning strategies attorney at Northwestern Mutual.
With the end of 2023 rapidly approaching, it’s important to close out your finances for the year on a positive note. In part, that means ensuring you’ve taken advantage of opportunities to minimize your taxes for both 2023 and the years ahead. While we don’t have a crystal ball, and upcoming federal elections could determine the fate of proposed tax legislation, the good news is that the current tax planning environment is relatively stable. This means you should be able to take some actions now with confidence.
4 Year-End Tax Planning Strategies
As you think about year-end financial housekeeping, these four tried-and-true year-end tax strategies should be top of mind for high-income and high-net-worth taxpayers:
Strategy 1: Timing income and deductions properly
Generally, people seek to maximize deductions and minimize income each year to help defer taxes. The benefits of tax deferral tend to be positive when tax rates stay the same or are going down. However, this strategy can be reversed when you expect to be in a higher income tax bracket in the future.
Here are two income and deduction timing tactics to consider for 2023:
Tax-loss harvesting — You might be able to offset taxable income by harvesting capital losses. While it appears the markets will end 2023 on a positive note, there is still a chance you may have capital losses somewhere in your portfolio. Consider working with your financial advisor to examine your portfolio for potential capital losses that could help offset current or future capital gains and even ordinary income.
Speaking of offsetting future tax liability, if you had significant losses in 2022 or other prior years, you may have tax-loss carryforwards that can be applied to your 2023 tax bill. Contact your financial advisor and/or accountant to determine if this applies to your situation and what actions, if any, you may need to take.
Capital gain harvesting — Depending on your other income streams, capital gain harvesting could also be an option for you. If you are married filing jointly and your overall 2023 taxable income is below $89,250, or if you are single and your income is below $44,725, you can pay a 0 percent tax rate on capital gain income. This can be a useful strategy if you are a pass-through business owner with an expected net operating loss from your business this year but expect the business to return to profitability in future years.
Strategy 2: Charitable giving
Here are three tried-and-true charitable giving tactics that you can leverage in 2023:
Qualified charitable distributions — If you are an IRA owner who is at least 70½, a qualified charitable distribution, or QCD, can allow you to send distributions directly from your IRA to a qualified charity without impacting your adjusted gross income (AGI). Better yet, QCDs (which can be up to $100,000) count toward your required minimum distribution (RMD). This is a tax-efficient way to make a charitable contribution, especially if you are taking the standard deduction.
Bunching charitable deductions — When filing your taxes, you have the option of taking the standard deduction or itemizing, whichever is more favorable to you each year. Because the Tax Cuts and Jobs Act (TCJA) nearly doubled the standard deduction when it passed in 2018 and limited the state and local tax itemized deduction, most Americans, including many high-income and high-net-worth taxpayers, now take the standard deduction. Bunching allows you to pool or “bunch” multiple years of charitable deductions together in one tax year so you can exceed the standard deduction in that year. Then, in off-years when you are not donating, you can use the standard deduction instead, allowing you to maximize your deductions over many years. It’s worth noting that this strategy works well when paired with the use of donor-advised funds.
Donate appreciated publicly traded securities — With the markets up this year, you may have an opportunity to donate appreciated stocks or other publicly traded securities in-kind. This serves two important purposes: 1) It gives you a tax deduction equivalent to the fair market value, assuming the assets go to a public charity and do not exceed 30 percent of your AGI (or 20 percent of AGI if giving to a private foundation); and 2) you’ll pay no tax on your gains.
Strategy 3: Retirement planning
If you are preparing for or are in retirement, you should consider these three tax-efficient planning options in 2023:
Maximize retirement contributions — If you have not maximized your retirement contributions for 2023, consider bumping up your contribution amounts. For 401(k)s and 403(b)s, you can contribute $22,500 plus a $7,500 catch-up contribution if you are age 50 or older. For SIMPLE IRAs, you can contribute $15,500 plus a $3,500 catch-up contribution if you are age 50 or older. For 401(k)s, 403(b)s and SIMPLE IRAs, your contributions must be made before Dec. 31, 2023.
Traditional and Roth IRAs have a contribution maximum of $6,500 plus a $1,000 catch-up contribution if you are age 50 or older. However, you have until April 15, 2024, to make this contribution.
If you or your spouse actively participates in a qualified plan through an employer, there are AGI phaseouts that may limit your ability to contribute. Before filing your tax return, check with your tax or financial advisor as to whether you are eligible and how much you may contribute.
RMDs — If you haven’t already, make sure to take your RMD(s) from your IRA(s) or qualified plan(s) before Dec. 31, 2023. Failing to do so can result in a 25 percent excise tax based on the amount you should have taken. If you turned 73 in 2023, you can delay your first RMD until April 1, 2024, but you’ll have to take two RMDs in 2024. While under previous law those who turned 72 were required to begin RMDs, those who turn 72 in 2023 do not have to begin taking RMDs until they turn 73, in 2024.
Speaking of RMDs, if you inherited an IRA and the original IRA owner died in 2019 or earlier, you’ll also have to take an RMD from that account (even if you are not yet retired). If you inherited an IRA and the original owner died in 2020 or later, it gets more complicated, so you’ll definitely want to read our recent article on inherited IRA distribution rules.
Roth conversions — With the TCJA sunsetting at the end of 2025, income tax rates will increase for most taxpayers in 2026 if Congress doesn’t intervene. This makes now a potentially opportune moment to consider a Roth conversion. While Roth conversions do trigger ordinary income tax in the year of the conversion, future qualified distributions (which may be taken when rates are higher) are generally tax- and penalty-free to you and to your heirs. Additionally, Roth IRAs do not have RMDs, which makes them attractive if you don’t need future income or are looking to minimize taxable income in retirement.
What’s more, if you believe your income is going to be higher during retirement, converting to a Roth IRA this year can help manage your overall tax burden. However, Roth conversions cannot be undone, so you need to be fully committed to paying any taxes associated with the conversion this season.
Strategy 4: Gift and estate planning
Rising interest rates this year brought opportunity for many estate planners. If your planning includes loaning funds to your children or your grantor trusts, higher interest rates can erode the effectiveness of these techniques, but it makes charitable remainder trust planning more attractive.
Here are five estate planning ideas to consider before year-end:
Annual gift tax exclusion — The federal gift tax exclusion is $17,000 per donor, per donee (person receiving the gift from you) for 2023. The gift can include a check, a transfer of securities or a transfer of life insurance. Additionally, annual exclusion gifts do not count toward your lifetime estate and gift tax exemption, so it is effectively a use-it-or-lose-it option. Married couples can gift a total of $34,000 to each child, grandchild or anyone else via the annual exclusion.
Education planning — College savings 529 accounts offer gift, estate and income tax benefits. The growth on a 529 account is income tax-deferred, and funds used for “qualified higher education expenses” are income tax- and penalty-free. Depending on where you live, your state may offer tax deductions or credits for 529 contributions, so be sure to check with your tax professional.
Over time the definition of a qualified higher education expense has expanded to include more than just college tuition, room and board, and supplies. The definition now includes up to $10,000 for elementary or secondary schools each year, expenses for apprenticeship programs, and up to $10,000 in student loan payments over the course of the account holder’s lifetime. Lastly, 529 accounts can be rolled over into a 529 ABLE account.
If you are a parent or grandparent, a planning tactic you should consider is the use of the “super-annual exclusion gift” whereby you can elect to treat the gift as if it is spread over the next five years of annual exclusion gifts at one time. This allows you to make a gift of $85,000 ($170,000 if you are married) into a 529 account.
Lifetime gifts — The gift, estate and generation-skipping transfer tax exemption is $12.92 million for 2023. In 2018, the TCJA doubled the amount of the exemption from $5 million to $10 million (indexed for inflation). This higher exemption amount is set to sunset at the end of 2025, and in 2026, the exemptions are expected to revert to the prior $5 million limit indexed for inflation.
The IRS has provided guidance under the “anti-clawback” regulations for taxpayers to take advantage of the current rules. For example, if you made a $12.92 million gift in 2023 and died in 2026, when the estate tax exemption is expected to be reduced to approximately $7 million, the additional $5.92 million gift in excess of the $7 million 2026 exemption will remain outside of your estate. This equates to a tax savings of more than $2.3 million using the current 40 percent gift and estate tax rate.
If you are married, one strategy is using one spouse’s $12.92 million before the law changes (to lock in the current exemption amount) and saving the other spouse’s exemption for a future year. This can help minimize taxes while keeping enough money in the estate for your lifetime.
If you are concerned about a future estate tax liability when the sunset occurs, now is the time to talk with your financial advisor and/or estate planning attorney to implement strategies today that will help minimize your estate tax at death.
Consider moving life insurance to an ILIT — With the gift and estate tax reversion in 2026, you might consider moving your existing policies into an irrevocable life insurance trust (ILIT) in 2023. When a life insurance policy is gifted to an ILIT, there is a three-year lookback rule in which the death benefit is brought back into your gross estate. If you survive three years and a day, it is then outside the estate. When the estate tax reverts to its 2017 amount adjusted for inflation, the amount in excess will be lost if not used. Therefore, those with large estates should consider taking advantage of this additional exemption amount before it is lost.
Charitable remainder trusts — While not a new planning technique, charitable remainder trusts (CRTs) came back into vogue recently, thanks to the rising interest rate environment. A CRT provides for distributions to a beneficiary during the trust term with the remainder payable to charity. The trust term can be several years or based on the life of an individual. A CRT allows you to make a gift to charity while preserving an income stream personally or for any other non-charitable beneficiary. Additionally, when appreciated assets are transferred to the trust, the CRT can sell the appreciated asset without paying tax on the gains. Lastly, you can receive an immediate charitable income tax deduction. A CRT works well in a high interest rate environment (compared to a lower interest rate one) because it creates a larger upfront charitable tax deduction.
Changes to Watch for as Year-End Approaches
With the passage of the SECURE Act and the SECURE Act 2.0, substantial changes have been made to retirement plans, including qualified plans and IRAs. The changes made are scheduled to be rolled out over the next few years.
In general, from a tax-planning perspective you’ll want to keep an eye on the following changes that will become effective in 2024:
- Potential changes to RMD rules for inherited IRAs
- Changes that allow unneeded 529 funds to be converted to a Roth IRA
- Increases in catch-up contributions for IRAs
- Allows employers to include Roth accounts in SIMPLE and SEP IRA plans
Your Financial Advisor Can Help You Maximize Tax Savings
Year-end is a great time to consider how you can reduce your tax bill and revisit your overall circumstances compared to your current financial plan and objectives. Effective planning takes time and requires paying attention to the details. Connect with your financial advisor today to get a jump-start on your 2023 year-end planning to help maximize your tax savings.
This article is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.
As an attorney in Sophisticated Planning Strategies, I work with Northwestern Mutual financial advisors as they help clients achieve financial security.
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