Year-end tax planning for 2023
Vol. 79, No. 6 / Nov. - Dec. 2023
As year-end approaches for 2023, it is important to consider tax planning. Individual taxpayers will want to review applicable tax rates, the standard deduction, limits on itemized deductions, and multiple other issues. Businesses should review corporate tax rates, limits on business deductions, increased expensing, and first-year depreciation for some assets. The deduction for qualified business income also continues to impact individuals and their businesses. This article outlines several individual and business planning issues to consider before year-end. These items will not apply in every situation, and taxpayers should adjust their planning for their circumstances, as well as monitoring legislation that impacts planning matters.
Year-end planning for individuals
- Consider the expanded standard deduction, eliminated personal exemptions, and limits on itemized deductions. For 2023, the basic standard deduction is $27,700 for joint filers, $20,800 for heads of household, and $13,850 for singles and married taxpayers filing separately. For taxpayers either 65 or older or blind, there are additional standard deductions. Many itemized deductions remain either reduced or eliminated. So, unless allowable medical deductions (as limited by 7.5% of adjusted gross income, or AGI), allowable state and local taxes (as limited), allowable charitable deductions, interest deductions on qualifying residence debt, and other allowable itemized deductions exceed the standard deduction, taxpayers may find that the increased standard deduction provides more tax benefit. For taxpayers with timing flexibility, there may also be an incentive for “bunching” allowable itemized deductions into one year and using the standard deduction in other years.
- Have an employer increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end for deduction of those taxes this year. This can be beneficial if a taxpayer expects to itemize deductions this year and doing so will not cause state and local tax deductions to exceed the applicable limitation.
- Plan for the 3.8% tax on unearned income. This surtax is 3.8% of net investment income (NII) that exceeds modified adjusted gross income (MAGI) thresholds. Year-end planning for the 3.8% surtax depends on estimated MAGI and NII. Some taxpayers may want to defer additional NII until next year, some may want to reduce MAGI other than NII, and some may be able to minimize both NII and other MAGI.
- Consider the additional 0.9% Medicare tax. This tax applies to individuals receiving a combination of wages with respect to employment and self-employment income exceeding applicable thresholds. Employers must withhold the additional Medicare tax from wages in certain circumstances. Self-employed persons must include it in estimated tax payments, and some employees may need more withholding to cover the tax.
- Accelerate income into this year in cases where a taxpayer’s marginal tax rate is expected to be lower this year than it will be next year due to economic conditions or expected changes in filing status or applicable rates. Postponing income can produce savings for taxpayers who expect to be in a lower tax bracket next year.
- Consider lower long-term capital gain rates on sales of assets held for more than one year. Depending on taxable income levels, taxpayers may want to utilize these lower rates for capital gain sales and avoid selling capital assets with offsetting losses that reduce the benefits of the lower rates. The reduced rates apply to adjusted net capital gain to the extent that this amount, when added to regular taxable income, does not exceed certain thresholds based on filing status. So, analysis of taxable income, potential capital gains, and other applicable taxes is required to determine the best combination.
- Consider retirement plan contributions, including catch-up contributions of additional amounts for taxpayers 50 and older.
- Remember that retirement plan distributions may be subject to a 10% early withdrawal tax penalty for taxpayers that are not at least 59 ½. There are certain exceptions to this penalty, including a limited qualified birth or adoption distribution.
- Review required minimum distributions (RMDs) from retirement accounts. RMDs are the minimum amounts that must be withdrawn from qualified retirement plan accounts beginning at age 72 for prior years and then beginning date at age 73 for taxpayers reaching age 72 after Dec. 31, 2022. Participants who are still working and making contributions to an employer-sponsored retirement account also may be able to further delay RMDs on that account. Taxpayers who fail to take RMDs can be subject to a substantial excise tax on the required amounts that are not withdrawn.
- Consider making charitable donations from traditional IRAs. Qualified charitable distributions are made directly to charities, and the amount is not included in gross income or itemized deduction calculations and limits. In addition, the qualified charitable distribution may reduce RMDs when applicable. Taxpayers can plan for this benefit by maximizing contributions to traditional IRAs with amounts that may later be used for qualified charitable distributions.
- Consider a Roth IRA conversion. A taxpayer that would prefer a Roth IRA can convert traditional IRA investments into a Roth IRA if eligible. A conversion will increase AGI for this year, so taxpayers should consider the impact on other AGI tax calculations.
- For taxpayers eligible to make health savings account (HSA) contributions, consider HSA contributions before the end of the year. HSA contributions may be deductible from AGI, so the benefits could be available even if a taxpayer does not itemize deductions.
- Increase the amount set aside for next year in a flexible spending account (FSA) if the taxpayer did not set aside enough for this year. Earnings set aside in an FSA allow payment of medical and dental bills with pre-tax earnings.
- Complete annual gift tax exclusion gifts before the end of the year to save gift and estate taxes. For 2023, taxpayers can give $17,000 each to an unlimited number of individuals but cannot carry over unused exclusions from one year to the next. These transfers also may save family income taxes where income-earning property is given to family members in lower-income tax brackets who are not subject to tax at their parents’ rates (kiddie tax).
- Consider education deductions and other credits. Tax-free distributions from § 529 qualified tuition programs of up to $10,000 are allowed for higher education expenses, which has been expanded to include elementary or secondary public, private, and religious schools, as well as expenses for participation in certain apprenticeship programs and limited amounts of qualified education loan repayments. For taxpayers under certain income thresholds, there are also several credits and deductions available and limited student loan interest may be deductible. Student loan forgiveness in 2023 should generally be excludible from income for federal tax purposes but may result in state or local income taxes.
- Consider home-related tax provisions. Working from home continues to be a significant consideration for many taxpayers. Self-employed workers and business owners may be able to deduct related expenses, although these would not be deductible for employees. Mortgage interest is limited to the level of acquisition indebtedness depending on when the home was acquired ($750,000 for homes acquired after Dec. 16, 2017; $1,000,000 for homes acquired before that date), but mortgage interest allocable to the portion of a home used to operate a business is not subject to this limitation. Interest on home equity indebtedness may be deductible to the extent the debt was used to buy, build, or substantially improve the home. Gain of up to $500,000 for married taxpayers ($250,000 for other taxpayers) on the sale of a home is excluded from income, but the portion of the home used for business or rented reduces this exclusion from gain. Discharges of qualified principal residence indebtedness in 2023 are not included in gross income.
- Consider clean energy credits. Clean energy credits available in 2023 include residential energy property credits and vehicle related credits. Eligibility for property credits depends on the improvements made, annual limits, and/or applicable percentages. Vehicle credits vary by date of acquisition, battery size, and manufacturer eligibility, which can be impacted by total qualifying vehicles sold and place of final assembly.
Year-end planning for business owners
- Consider the qualified business income deduction for non-corporate taxpayers of up to 20% of qualified business income from a domestic business operated as a sole proprietorship, partnership, LLC taxed as a partnership, or S corporation. For 2023, the deduction may be limited (with a phase-in for the limitation) if taxable income is over $362,400 for married couples filing jointly or $182,100 for other filers. These deduction limitations may apply depending on whether the taxpayer has a service-type trade or business such as law, accounting, health, or consulting, or whether the trade or business meets W-2 wage and qualified property (like machinery and equipment) requirements. Because there are taxable income thresholds and phaseouts for certain taxpayers, there may also be significant tax savings from deferring income or accelerating deductions into a particular year, depending on the taxpayer’s circumstances. Similarly, a taxpayer may be able to increase the deduction available by increasing W-2 wages or qualified property before year-end.
- Consider making expenditures before year-end that qualify for §179 business property expensing. For tax years beginning in 2023, the expensing limit is $1,160,000 for property placed in service this year, reduced dollar for dollar for property placed in service over $2,890,000. This expensing is available for most depreciable property and qualified improvement property, which generally includes interior building improvements, and roofs, HVAC, fire protection, alarm and security systems. Importantly, property acquired and placed in service before year-end is eligible for full expensing for the year.
- Consider 80% first year bonus depreciation for new and some used machinery and equipment purchased and placed in service. Like expensing, bonus depreciation is available for the full year even if the asset was placed in service late in the year, so year-end purchases may receive a full first year bonus write-off. Notably, bonus depreciation is being phased out, with 80% available in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and elimination in 2027.
- Consider changing to the cash method of accounting, rather than the accrual method. Small businesses with less than $29 million of average annual gross receipts over a three-year period may be eligible for the cash method if they meet other requirements. Depending on the business, the cash method of accounting may allow more flexibility in timing income and deductions.
- Consider timing for a debt-cancellation event, including whether lower effective tax rates are expected this year or next year.
- Consider timing for disposition of a passive activity to allow a deduction for suspended losses to reduce current year taxable income.
- Review partnership and S corporation basis to make sure it is sufficient to deduct losses in current and future years.
- Review S corporation salaries to ensure that shareholders receive reasonable wages. The Internal Revenue Service often audits S corporations that pay all profits as distributions without accounting for reasonable wages to shareholders for their work in the business.
- Consider setting up a retirement plan and health insurance plan. These plans can provide key benefits for retention of employees and for owners of a business.
Taxpayers should carefully consider these matters, taking their specific circumstances into account and watching for continuing tax law changes. As noted, legislation is always possible which could provide additional considerations for year-end planning, including possible change