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We’re quickly approaching the end of the year and time’s running out on a number of highly valuable tax-saving moves you can make.
One particularly savvy move for savers is to contribute to a traditional IRA. Using this type of retirement account, you can claim a deduction from your taxable income, subject to income restrictions, earning an easy tax break in the process.
When it comes to IRAs, you still have plenty of time to get your plan together. The deadline for making IRA contributions for the current tax year is Tax Day (typically April 15) of the next calendar year. So for claiming a deduction in the 2023 tax year, you have until April 15, 2024 to get the funds into your IRA.
But take heed, taxpayers. You have many other important tax-saving actions that must be taken before the calendar year ends or they’ll be lost forever. These last-minute moves can slim down your taxes and claw back some of your cash.
7 tax-saving moves to make before the end of the year
1. Don’t buy that mutual fund – yet!
At the end of each year, mutual funds distribute their capital gains – a gain that they’ve realized from selling a security – to the fund’s owners. Typically funds will distribute them in December, creating an immediate taxable gain, if you own the fund in a taxable account.
“Basically, the investor is receiving a taxable return of their own principal,” says Jeff Warnkin, certified financial planner and certified public accountant with the JL Smith Group. “They must report the distribution as taxable income on their tax return, but do not receive any economic benefit from it.”
“In other words, they did not actually own the shares and participate in the appreciation that led to the distribution itself, so they are paying tax on other shareholders’ gains,” says Warnkin.
Warnkin also suggests that you could contact the fund company and see when its distribution will occur, so that you can time your purchase to avoid it. But you may find that the distribution is small or non-existent, in which case you can purchase the fund with no or minimal tax effect.
2. Max out those retirement contributions
While the deadline to contribute to an IRA is not until Tax Day, if you’re using a 401(k) or 403(b) or other employer retirement plan, you’ll want to get your contributions squared away before the year ends. Taking advantage of a workplace retirement plan, such as a traditional 401(k), allows you to contribute pre-tax money.
“Though it may seem obvious, many people neglect to utilize this as a year-end tax planning strategy,” says Elizabeth Lindsay-Ochoa, a private wealth strategist at Raymond James.
Workers can save up to $22,500 (for 2023) in their 401(k) plans if they’re under 50, and up to $30,000 if they’re 50 or older, says Lindsay-Ochoa. And the self-employed can take advantage, too.
“If you’re self-employed, you should consider setting up a self-employed retirement plan and contributing the maximum amount to minimize your tax bill,” she says.
3. Dodge the net investment income tax (NIIT)
If you have income from investments such as stocks and bonds, the IRS may levy an extra tax on your income called the net investment income tax (NIIT), if your income exceeds certain thresholds: $250,000 modified adjusted gross income if married filing jointly, $125,000 if married filing separately, or $200,000 in all other cases.
If you’re an individual, you’ll pay the lesser of 3.8 percent on (1) your net investment income or (2) the amount in excess above your threshold. If you’re under the dollar thresholds, you won’t pay any NIIT, but if you go over and you have investment income, then you’re going to get hit.
One solution is to make sure you’re selling unrealized losses on your investments to offset any gains, says Lindsay-Ochoa. This process is called tax-loss harvesting, and it can help keep your income below the threshold to pay NIIT or at least minimize it.
4. Avoid capital gains taxes and step up your basis
If you’re in a lower tax bracket, you may be able to ditch capital gains taxes entirely and set up your portfolio so that you pay lower taxes in the future, too.
“If your total income leaves you in the 12 percent tax bracket or lower, you are able to recognize capital gains in your non-retirement accounts at a zero percent federal capital gains tax rate,” according to Matthew Schwartz, a certified financial planner at Great Waters Financial in the Minneapolis area.
“By selling, and realizing the gains, then repurchasing the investment, you would be able to step up your cost basis without paying additional federal tax,” says Schwartz.
This step-up in basis means you’d pay fewer taxes later on, if you sold for a gain.
5. Bunch your deductions in order to itemize
The Tax Cuts and Jobs Act of 2017 increased the standard deduction on tax returns, making it harder for filers to itemize and achieve a tax break greater than the standard deduction. For example, many taxpayers used to be able to itemize a deduction for all of their state and local taxes (SALT). But with this amount now being capped at $10,000, it often makes more financial sense to accept the standard deduction.
One way around this difficulty is to strategically bunch your deductions, so you can clear the threshold for the standard deduction and receive credit for your expenses. Other expenses that can be itemized include charitable donations and healthcare costs above a certain level.
If you frequently give charitable donations, Schwartz suggests another alternative – a donor-advised fund – for achieving the effect of bunching while allowing you to give what you want.
“Utilizing a donor-advised fund would allow you to receive a deduction for several years of giving (in this year), while maintaining control over where the money is directed in the future,” Schwartz says.
And donating a winning investment to charity could be another way to help bunch deductions.
“Especially after a year of strong market returns, investors should consider donating appreciated stock to a charity to avoid paying capital gains and potentially get a charitable deduction,” says Lindsay-Ochoa.
6. Get a two-for-one with a losing investment
Turn your capital loss into a charitable deduction and get two deductions.
“If you do have losses, what many don’t realize is that you can sell the stock for cash, donate the cash proceeds to charity (and possibly receive a charitable deduction) and also take advantage of a capital loss on the sale of the stock,” says Lindsay-Ochoa.
7. Donate straight from your IRA
It’s possible for you to skip the middleman – you – in the donation process and still get the money to the charity you want to fund.
“If you are 70 1/2 years old or older, are charitable, and have money in your IRA, consider utilizing a qualified charitable distribution,” says Schwartz. With a direct donation, you can avoid the taxes that come with an IRA withdrawal.
“Additionally, a QCD [qualified charitable distribution] can offset the taxes resulting from required minimum distributions and potentially lower your Social Security taxation,” says Schwartz.
Of course, even if you’re not using your IRA to donate, you can still give stock directly to charity.
If you’re scrambling to get your financial house in order before the year ends, you’re certainly not alone. But be sure to know which steps you must take before the year ends and which you can push until later. And for other tax-saving strategies such as using a traditional 401(k), use the start of the year to set up an investment plan that works throughout the year to save you money.