There’s still time to trim your personal income tax bill

Factors such as turbulent markets, high interest rates, and changes to retirement planning rules have made 2023 a confounding year for tax planning.

While uncertainty lingers, the good news is that there is still time to implement year-end tax planning strategies that might reduce your income tax bill for the year. Here are a few steps to consider.

Manage your itemized deductions

The standard deduction for 2023 is $13,850 for single filers, $27,700 for married couples filing jointly, and $20,800 for heads of households. Those levels are higher than they were before the Tax Cuts and Jobs Act (TCJA), which has reduced the number of taxpayers who itemize their deductions. But “bunching” certain outlays may help you qualify for a higher number of itemized deductions.

Related: Standard deduction, other limits going up for 2024

Bunching involves timing deductible expenditures so they accumulate in a specific tax year and total more than the standard deduction. Likely candidates include:

• Medical and dental expenses that exceed 7.5% of your adjusted gross income (AGI)
• Mortgage interest
• Investment interest
• State and local taxes
• Casualty and theft losses from a federally declared disaster
• Charitable contributions

There’s been talk on the federal level of capping the value of itemized deductions (for example, at 28%). This proposal could come up again if the expiration of several TCJA provisions at the end of 2025 prompts new tax legislation, so it could be beneficial to maximize deductions while you can.

Leverage your charitable giving options

Several strategies could increase the charitable contribution component of your itemized deductions. For example, you can donate appreciated assets that you’ve held for at least one year. In addition to avoiding capital gains tax — and, if applicable, the net investment income tax — on the appreciation, you can deduct the fair market value of donated investments and the cost basis for nonstock donations. (Remember that AGI-based limits apply to charitable contribution deductions.)

Although it won’t affect your charitable contribution deduction, you also might want to make a qualified charitable distribution (QCD) from a retirement account with required minimum distributions (RMDs). You can distribute up to $100,000 per year (indexed annually for inflation) directly to a qualified charity after age 70½. The distribution doesn’t count toward your charitable deduction, but it’s removed from your taxable income and is treated as an RMD.

Pay yourself, not the IRS

If possible, you generally should maximize the annual savings contributions that can reduce your taxable income, including those to 401(k) plans, traditional IRAs, Health Savings Accounts (HSAs), and 529 plans. The 2023 limits are:

• 401(k) plans: $22,500 ($30,000 if age 50 or older)
• Traditional IRAs: $6,500 ($7,500 if age 50 or older)
• HSAs: $3,850 for self-only coverage and $7,750 for family coverage (those 55 and older can contribute an additional $1,000)
• 529 plans: $17,000 per person (or $34,000 for a married couple) per recipient without implicating gift tax (individual states set contribution limits)

Contributing to 529 plans has become more appealing now that, beginning in 2024, you can transfer unused amounts to the beneficiary’s Roth IRA (subject to certain limits and requirements).

Harvest your losses

The up-and-down financial markets this year may provide the opportunity to harvest your “loser” investments that are valued below their cost basis and use those losses to offset your gains. If the losses exceed your capital gains for the year, you can use the excess to offset up to $3,000 of ordinary income and carry forward any remaining losses.

It’s vital, however, that you comply with the wash-sale rule, which bans the deduction of a loss when you acquire substantially identical investments within 30 days before or after the sale date.

Execute a Roth conversion

Recent market declines also may make this a smart time to think about converting some or all your traditional IRA to a Roth IRA — because you can convert more shares without increasing your income tax liability. Yes, you must pay income tax in 2023 on the amount converted, but you might be able to minimize the impact by, for example, converting only to the top of your current tax bracket.

Additionally, the long-term benefits can outweigh the immediate tax effect. After conversion, the funds will grow tax-free. You generally can withdraw qualified distributions tax-free if you have held the account for at least five years; and Roth IRAs don’t come with RMD obligations. Plus, you can withdraw from a Roth IRA tax-free and penalty-free for a first-time home purchase (up to $10,000), qualified birth or adoption expenses (up to $5,000), and qualified higher education expenses (with no limit).

Bear in mind, though, that a Roth conversion may leave you with a higher AGI. That could limit how much you benefit from tax breaks that phase out based on AGI or modified adjusted gross income.

Review your estate plan

Your estate plan probably won’t affect your 2023 income taxes, but it makes sense to review it now considering the expiration of certain TCJA provisions at the end of 2025 — particularly the TCJA’s generous gift and estate tax exemption. For example, the TCJA nearly doubled the exemption back in 2018, which is currently $12.92 million ($25.84 million for married couples). A return to a pre-TCJA level of $5 million (adjusted for inflation) could have dramatic implications to your estate plan.

The lingering high interest rate environment also might make certain estate planning strategies more attractive. For example, the value of gifts to qualified personal residence trusts and charitable remainder trusts generally is lower when rates are high.

Cover your bases

Some of the tried-and-true methods for reducing your taxes — such as deferring income and accelerating expenses — are also still worth considering. Keep in mind that these methods might not be as helpful if you expect to be in a higher tax bracket in 2024.

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