It’s the time of year when we are thinking about back to school, the start of cooler weather, leaves turning into fall colors, the upcoming holiday season — and, dare we say, year-end tax planning? Now may be the best time to coordinate with your tax and legal advisor to review plans and implement strategies to optimize tax efficiencies. Here we focus on some strategies that may help you reduce this year’s tax liability and enhance your overall wealth plan.
Selected Tax Credits
As we approach the end of the year, we recommend that you consult with your personal tax advisors to discuss whether you may be eligible for these relatively new tax credits:
- Most of the increased tax credits provided by the American Rescue Plan Act of 2021[1] (ARPA) have expired, with the notable exception of the increased credits for health care benefits, which were extended through 2025 by the Inflation Reduction Act of 2022[2] (Inflation Reduction Act).
- The Inflation Reduction Act modified the credit for nonbusiness energy property, which is now known as the energy efficient home improvement credit.[3] Subject to many requirements, this credit applies to the installation of energy efficient windows, doors, certain heating and cooling systems and certain heat pumps. In general, the modified credit applies to items placed in service in 2023. More information about the Energy Efficient Home Improvement Credit can be found on the IRS website at the URL in the endnotes.[4]
- The Inflation Reduction Act modified the energy efficient property credit, which is now known as the residential clean energy credit.[5] Subject to many qualifications, the credit is available in 2023 for the installation of qualified solar electric property, qualified solar water heating property, qualified fuel cell property, qualified small wind energy property, geothermal heat pump property and qualified battery storage technology. More information about the residential clean energy credit can be found on the IRS website at the URL in the endnotes.[6]
- The Inflation Reduction Act replaced the “new qualified plug-in electric drive motor vehicles” credit with the clean vehicle credit.[7] Subject to many limitations (including income limitations), the new credit applies to certain electric and fuel cell vehicles. For two- and three-wheeled vehicles placed in service after December 31, 2023, the credit will cease to be available.[8] Also, certain provisions of the clean vehicle credit took effect on April 18, 2023, following the publication of proposed regulations.[9] The IRS has also published guidance to assist taxpayers with respect to the requirements to obtain this credit.[10]
- The Inflation Reduction Act added a new credit that applies to the purchase of used clean vehicles.[11] The credit applies to purchases made after December 31, 2022. For more information, see the IRS website at the URL in the endnote.[12]
Philanthropy
People give to charitable organizations for many reasons. As this article pertains to 2023 year-end planning, in this section we focus on tax benefits for gifts to charity in 2023.
If You Itemize — Consider Giving Cash
If you itemize deductions and make charitable contributions, you may be able to deduct on your federal income tax return the amount of such contributions, limited by the application of certain percentages of your contribution base. Your contribution base is your adjusted gross income (AGI) computed without regard to any net operating loss carryback to the taxable year. If you are thinking about giving appreciated securities to a charitable organization, due to the 60% limitation for certain cash contributions[13] it remains worthwhile to analyze whether giving appreciated securities or selling the securities and giving cash will produce a greater tax benefit. A PNC Private Bank® Wealth Strategist can work with you and your tax advisors to provide this analysis.
If You Are Close to Being Able to Itemize — Consider Bunching
Making larger contributions less often could allow you to accumulate deductions and itemize. For example, if a married couple filing jointly contributes $15,000 per year to charity, assuming no other itemized deductions, they would not exceed the $27,700 standard deduction for 2023 and would not receive a tax benefit for their contributions. However, if they contribute $30,000 every other year, they would be able to itemize in the year they make the charitable contribution and benefit from an additional $2,300 deduction if that year was 2023. A donor-advised fund (DAF) can be an effective tool for bunching charitable contributions. You could be eligible to take an income tax deduction in the year the contribution is made, but no distribution must be made from the DAF in any given year. If this is an option for you, be sure to factor the cost of a DAF into your decision.
If You Don’t Itemize
The Tax Cuts and Jobs Act (TCJA)[14] substantially increased the amount of the standard deduction. After enactment of the TCJA, many taxpayers who had previously itemized deductions found that the standard deduction was larger than their previously itemized amounts and that taking the standard deduction provided a greater tax benefit.[15] Individuals age 70½ and older may make qualified charitable distributions (QCDs) from their individual retirement accounts (IRAs) directly to qualified charities up to $100,000 annually.[16] If you make a QCD, you will not receive a charitable deduction for federal income tax purposes. On the other hand, some or all of the amount distributed will be excluded from your gross income.
The excludable amount of qualified charitable distributions for a taxable year is reduced [but not below zero] by the aggregate amount of IRA contributions deducted for the taxable year and any earlier taxable years in which the individual was age 70 ½ or older by the last day of the year (post-age 70 ½ contributions) … other than the amount of post-age 70½ contributions that caused a reduction in the excludable amount of qualified charitable distributions for earlier taxable years.[17]
Your AGI is the starting point for calculating a number of tax-related items. For example, AGI is used in determining how much of your Social Security benefits are taxed, Roth IRA contribution eligibility, applicability of the net investment income tax, your Medicare premium, your state income taxes (depending on state law) and whether your itemized deductions are phased out. Accordingly, taking steps to reduce AGI can produce many benefits.
Further, if you have attained age 72, a QCD will count toward some or all of your IRA required minimum distribution. If you no longer itemize deductions, a QCD may be a tax-efficient way to fulfill your charitable giving goals.
Deferred Compensation and Retirement Planning
Revisit Deferred Compensation Arrangements
Revisit Deferred Compensation Arrangements Before making 2024 elections regarding non-qualified deferred compensation arrangements, we believe it’s important to determine if deferring income is right for you and to decide on the deferral timing.
Deferred compensation plans allow highly compensated employees to defer a portion of their income to a future year. The idea is to lower income levels during high-earning years. The income is paid out at a future date of your choice that is typically when overall income is less, as is your corresponding tax bracket. Additionally, during the deferral period, the income may be invested in a selection of investments set by the plan provider and may grow on a tax-deferred basis. If you leave your job, the plan typically would return your vested balance at that time.[18]
Following enactment of the TCJA, most taxpayers found themselves in lower tax brackets, but the lower tax rates are scheduled to expire at the end of 2025. This means any income deferred to 2026 and beyond may be subject to higher tax rates.
The decision whether to defer income, the length of the deferral, and whether election dates should be changed, if allowed, is complex. It is impossible to know what future tax rates may be, but it is possible to project what your income may be at the time the compensation is taken and how deferred compensation fits in with other available planning strategies. Deferred compensation elections for 2024, must be made by December 31, 2023. However, employers may require elections to be finalized earlier in the year.
Converting Some or All of a Traditional IRA to a Roth IRA
Converting your traditional IRA to a Roth IRA[19] could save income tax over the long term. Although converting your traditional IRA will cause an income tax today on the amount converted that would not have been subject to income tax had you not converted to a Roth IRA,[20] future growth in the converted assets (now in a Roth IRA) will be tax-free. This could be important if tax rates rise in the future. Qualified distributions from a Roth IRA are tax-free to the owner and/or beneficiary and the lifetime required minimum distribution rules do not apply to Roth IRAs.
Converting to a Roth works best when the tax incurred on the conversion can be paid from assets not held in a traditional IRA or qualified retirement plan, as withdrawing assets therefrom to pay the income tax attributable to the Roth conversion will incur additional income tax. Roth conversions require careful analysis to determine whether incurring an income tax today will save income tax in the future. As each person’s financial circumstance is unique, before undertaking a Roth conversion you should seek the advice of your tax and financial advisors.
Repayment of COVID-19-Related Distributions
The Coronavirus Aid, Relief and Economic Security Act[21] (CARES Act) allowed qualified taxpayers impacted by COVID-19 to withdraw up to $100,000 from certain qualified plans and IRAs as a "coronavirus-related distribution.” The CARES Act allows coronavirus-related distributions to be repaid within three years. The U.S. Treasury Department has provided detailed guidance regarding this repayment.[22] If you repaid some or all of a coronavirus-related distribution this year, you should take this into consideration when determining your withholding or estimated tax payments for 2023.
Explore Tax Loss Harvesting
Losses in Your Portfolio
If you have unrealized losses in your portfolio, you may be able to use those losses to decrease your 2023 tax bill through tax-loss harvesting.
Tax-loss harvesting generates capital losses by selling assets that are currently worth less than what you paid for them. These losses are then used to offset capital gains recognized during the year. Your plan may be to repurchase the asset at some point, but if you recognize a loss you must wait at least 31 days to repurchase the same asset or the tax loss will be disallowed.[23]
If your capital losses exceed your capital gains, you can use up to $3,000 of the excess loss to offset other income. Any remaining capital losses can be carried forward. For example, if you sell an asset and recognize a $15,000 capital loss and have $10,000 of capital gains, you can claim zero gains for the year. You can then use $3,000 of your remaining $5,000 in capital losses to offset other income in 2023. The remaining $2,000 may be used to reduce taxable income in 2024.
Gains in Your Portfolio
If you have realized capital gains and mutual fund capital gain distributions in excess of your realized capital losses in 2023, you may wish to adjust your income tax withholding or quarterly estimated income tax payment to take capital gains into consideration.
Gift and Trust Planning
In 2018, the TCJA increased the basic exclusion amount for the federal estate and gift tax. For 2023 that amount is $12.92 million and is indexed for inflation in future years. Unless Congress takes further action, the increased exclusion amount will “sunset” on January 1, 2026, causing the exclusion amount to be approximately halved (to 2017 levels, indexed for inflation). We are more than halfway to sunset.
Now may be a good time to talk to your attorney about planning to use the increased exclusion amount. If you intend to use the increased exclusion amount, we suggest not waiting until 2025 to meet with your attorney. Waiting until 2025 could see your plans go unfulfilled. Instead, consider working with your attorney now to prepare any legal documents necessary to to take advantage of the increased exclusion amount. As 2026 approaches, monitor Congress’s actions with respect to the exclusion amount. If it looks like the exclusion amount will be decreased, you can execute your plan without rushing to complete legal documents.
Perennial Items
Review Withholding and Estimated Tax Payments
Be sure that you are withholding enough to satisfy your federal tax liability. Failure to withhold sufficient tax (or pay sufficient quarterly estimated tax) may cause you to owe tax with your return and to be subject to interest and penalties. Similarly, by withholding too much, you are making an interest-free loan to the government.
The IRS has published a simplified withholding estimator that can provide a rough estimate of overall withholding and income. This calculator can be found at: https://apps.irs.gov/app/tax-withholding-estimator (last accessed September 27, 2023). By updating your W-4, your employer can adjust the amount withheld from your salary to cover any shortfall, avoiding potential underpayment penalties.
Fund Employer-Sponsored Retirement Plans
Studies show that many Americans do not have resources adequate to provide for their retirement.[24] If you are able to do so, you should fund your retirement plans to the extent of the amount that can be set aside before taxes. If you cannot fully fund your employerprovided plan and if your employer matches your contributions to a defined contribution plan, at least save enough to get the employer’s match. Failing to do that is “leaving money on the table.”
Review Contributions to 529 Plans
529 plans can be an effective way to save for educational expenses. A unique feature of 529 plans allows donors to front-load accounts with up to five years of annual exclusion gifts.[25] This means that in 2023 (if you haven’t previously front-loaded a 529 plan) you can contribute up to $85,000 ($170,000 for a married couple) to a 529 plan, all of which would qualify for annual exclusion gift treatment (being reported ratably over five years). 529 plans grow tax-free, and distributions for qualified higher education expenses are tax-free. The term “qualified higher education expenses” means: (i) tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution, (ii) expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with such enrollment or attendance, and (iii) expenses for the purchase of computer or peripheral equipment (as defined in IRC § 168(i)(2)(B)), computer software (as defined in IRC § 197(e)(3)(B)), or internet access and related services, if such equipment, software or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution” provided that it shall not include expenses for computer software designed for sports, games or hobbies unless the software is predominantly educational in nature. The term also includes up to $10,000 per beneficiary per year for elementary and secondary school (grades K through 12) tuition, certain expenses for registered apprenticeship programs, and the payment of up to $10,000 (in total from all plans) in student loan debt for the beneficiary and the beneficiary’s siblings (including step-siblings). The state in which you live may offer a state income tax deduction for contributions to a 529 plan. Confer with a tax advisor who understands the laws of your state to determine how contributing to a 529 plan will affect you.
Plan Now
As the daylight wanes in the Northern Hemisphere, we turn our attention to the fall and winter holidays that make the dark days brighter. It seems somehow appropriate that at the “darkest” time of the year, our annual tax liabilities become fixed.
Each family’s tax and financial circumstances are different. Although the ideas presented herein are of a general nature, we hope you can use them to prepare for year’s end. We encourage you to consult with your tax, legal and financial advisors with respect to your particular circumstances.
For more information, please contact your PNC Private Bank advisor.
