POST-TAX SEASON MONEY MOVES: PROACTIVE STRATEGIES TO REDUCE NEXT YEAR’S TAX BILL
Although tax season is behind us, you may still be feeling the sting of an unexpectedly high tax liability. If you were caught off guard this year, now can be a great time to take steps to proactively reduce next year’s tax bill.
Most people tend to wait until year-end to implement tax savings strategies. However, by making smart money moves now, you can avoid the last-minute rush and ensure you’re financially prepared for next tax season.
Consider the following post-tax season money moves to proactively reduce next year’s tax bill:
#1: Review Your 2022 Tax Return
To proactively reduce next year’s tax bill, it’s helpful to understand your starting point. By analyzing your previous return, you can identify areas where you may have missed deductions, tax credits, or opportunities for tax savings.
In some cases, any missed tax savings opportunities you find may be valuable enough to refile your 2022 tax return. If so, keep in mind the IRS allows taxpayers to file an amended tax return to correct errors.
Reviewing last year’s tax return allows you to pinpoint areas for improvement and better understand how changes in your personal financial situation or tax laws may impact your future tax liability. Armed with this knowledge, you can develop a plan to minimize your tax burden in the future.
#2: Keep Track of Your Deductions
As you review last year’s tax return, it can also be helpful to compare your total itemized deductions to the standard deduction for your filing status. For the 2023 tax year, the standard deduction amount is $13,850 for single taxpayers and $27,700 for those filing jointly.
If your total deductions were close to the standard deduction but not quite enough to itemize, you may want to consider boosting next year’s deductions to put you over the threshold. For example, you can step up your charitable giving or accelerate deductible expenses to the current tax year.
Giving yourself the ability to itemize can be an effective way to proactively reduce next year’s tax bill. By developing a plan now rather than waiting until it’s too late, you’ll be in a better position to influence next year’s outcome.
#3: Step Up Your Contributions to Qualified Retirement Accounts
Another way to potentially reduce next year’s tax bill is by lowering your taxable income.
First, be sure to check the contribution limits on your employer-sponsored retirement plan and/or traditional IRA. In 2023, you can contribute up to $22,500 to a 401(k) ($30,000 if you’re age 50 or above) and up to $6,500 to an IRA ($7,500 for those 50 and above). Since you’re contributing pre-tax dollars to these accounts, maxing out your contributions can help reduce your taxable income.
In addition, if you have a qualifying high-deductible health plan, consider contributing to a health savings account (HSA). These accounts offer triple tax savings, as contributions, capital gains, and withdrawals are all tax-free if you use your funds for eligible healthcare expenses. You can also deduct your contributions from your taxable income in most cases.
Lastly, depending on your compensation plan, you may want to consider deferring part of your income to reduce next year’s tax bill. Be sure to review the distribution schedule in your plan documents to see if it offers any tax planning opportunities.
#4: Use Portfolio Losses to Your Advantage
While no one likes to see their investment account balances decline, a down market often creates opportunities to proactively reduce next year’s tax bill.
Tax-loss harvesting is the process of selling investments that have lost value to offset gains on other investments, thereby lowering your overall tax liability. By strategically realizing losses, you can potentially offset capital gains taxes and even ordinary income taxes up to a certain limit.
In fact, a recent Vanguard study found that in volatile stock market years, tax-loss harvesting adds an average benefit of 0.95% to your investment results. Working with a fiduciary financial planner can be a great way to ensure you’re taking advantage of this valuable tax planning opportunity.
#5: Revisit Your Investment and Asset Location Strategies
In addition to using portfolio losses to reduce next year’s tax bill, be sure to evaluate your overall investment strategy for tax efficiency. You may be able to lower your potential tax burden by diversifying your account types, adjusting your investments, or both.
First, make sure you’re contributing to both qualified (non-taxable) and taxable investment accounts as your budget allows. For example, if you max out your retirement contributions, consider adding funds to a taxable investment account.
At the same time, placing tax-efficient investments in taxable accounts and tax-inefficient investments in qualified accounts can help minimize your tax liability. If you invest in fixed income, for example, you may want to hold taxable bonds in your qualified retirement accounts and municipal bonds in your taxable accounts.
A financial professional can help you develop an investment strategy that’s in line with your financial goals and tax situation.
#6: Establish a Tax-Smart Charitable Giving Strategy
Charitable giving is another strategy that can potentially reduce next year’s tax bill if you’re able to itemize on your tax return. If you need to boost your deductions so you can itemize next year, one option is to bunch your charitable donations.
Bunching is a strategy that involves making two or more years’ worth of donations in one tax year so you can realize the full tax benefit.
For example, suppose you plan to donate $5,000 to charity each year for the next several years. If you have extra cash on hand this year, you may want to consider donating $10,000 or more to your charity of choice so you can itemize your deductible expenses. Then, next year, you can skip your regular donation and take the standard deduction.
Donor-advised funds (DAFs) are also becoming an increasingly popular giving strategy. When you contribute cash or non-cash assets to a DAF, you can take an immediate tax deduction in the tax year you make the donation.
Like bunching, a DAF allows you to front-load several years’ worth of donations and deduct the full amount on the current year’s tax return, up to IRS limits. Yet unlike bunching, contributing to a DAF means you don’t have to decide immediately which organizations receive your donation. Instead, your funds can grow tax-free within the DAF until you direct them to a specific charity.
#7: Work with a Financial Planner to Reduce Next Year's Tax Bill
Taking a proactive planning approach in the aftermath of tax season can set you up for financial success in the coming year. Don’t wait until it’s too late to start thinking about ways to reduce next year’s tax bill. Consider working with a fiduciary financial planner, who can help you determine which tax planning strategies make sense for you within the context of your financial plan.
Our team is here to help you navigate the complexities of tax planning and create a personalized strategy tailored to your unique needs. To find out how we can help you take control of your financial future and maximize your wealth, please schedule a call.