By Lee Sherbakoff, CPA/PFS™, CFP®, RICP®
With 2022 behind you, it might be a good time to think about tax strategies (yes, now, so you can implement them throughout the year). Whether you’re looking to ramp up your retirement savings or want to diversify your charitable donations, there are many ways to find savings within a tax-planning strategy. To get you started, here are 10 tax-planning strategies for 2023.
Maximize Your Retirement Contributions
Maximizing your retirement contributions is one of the best ways to minimize your tax liability. This is because retirement plans offer useful tax advantages that are not available if you were to simply put your money in a savings account. There are several accounts to consider, depending on your unique circumstances:
- 401(k), 403(b), and 457 Plans: In 2022, these accounts allowed you to contribute up to $20,500 annually for 2022 ($27,000 if over age 50). In 2023, these amounts have increased to $22,500 and $30,000 if over the age of 50. Not only that, but contributions are pre-tax so they won’t show up as part of your annual income. This is a great way to defer taxes until your retirement years when you could potentially be in a lower tax bracket. Or, if your workplace plan allows it, you may be able to contribute to a Roth 401(k) account. However, you will not get the current year tax break, but distributions in the future will be tax free.
- Traditional IRA: Contributing to a traditional IRA is another way to reduce your tax liability if your income is within certain limits. You can contribute up to $6,500 in 2023. Both years have the same $1,000 catch-up contribution limit for those over age 50. Unlike the qualified retirement plans listed above, contributions to a traditional IRA can be made until the April 15th tax filing deadline.
- Roth IRA: This is an attractive savings vehicle for many reasons, including no required minimum distributions (RMDs), tax-free withdrawals after age 59½, and the ability to pass wealth tax-free to your heirs. The contribution limits are the same as traditional IRAs. However, Roth IRAs have income restrictions and you may not be able to open an account outright if you are above certain limits.
Consider Roth Conversions
If you are outside of the income eligibility threshold for Roth IRAs but still want to take advantage of the Roth tax benefits, a Roth conversion could be the right strategy for you. It works by paying the income tax on your pre-tax traditional IRA and converting the funds to a Roth IRA.
You could also consider the mega backdoor Roth and backdoor Roth IRA strategies:
- Mega Backdoor Roth: With this strategy, you would convert a portion of your 401(k) plan to a Roth. This involves first maximizing the after-tax, non-Roth contributions ($40,500 for 2022 and $44,500 in 2023) in your plan, then rolling it over to either a Roth 401(k) or your Roth IRA. With the mega backdoor Roth, you convert a portion of your 401(k) plan to Roth dollars.
- Backdoor Roth IRA: In this case, you would make an after-tax (non-deductible) contribution to a traditional IRA. You then immediately convert the funds to a Roth IRA to prevent any earnings from accumulating. This strategy makes sense if you don’t already have an IRA set up yet.
All three Roth conversion strategies will allow the contributions to grow completely tax-free and allow you to avoid future RMDs, which is helpful if you expect to be in a higher tax bracket in the future.
Contribute to a Health Savings Account
One of the most underutilized but most efficient ways to maximize your savings and minimize your taxes is to contribute to a health savings account (HSA). HSAs offer triple tax savings: contributions are tax-deductible, earnings grow tax-free, and you can withdraw the funds tax-free to pay for medical expenses. Unused funds roll over each year and will essentially become an IRA at age 65, at which point you can withdraw funds penalty-free for non-medical expenses. You must be enrolled in a high-deductible health plan in order to qualify for an HSA.
HSAs can be a great tax-management tool if you are able to pay medical expenses out of pocket and leave the HSA funds to grow. The 2022 contribution limits for HSAs are $3,650 for individuals and $7,300 for families. In 2023, the contribution limits jumped to $3,850 for individuals and $7,750 for families. If you are 55 or older, you may also be able to make catch-up contributions of $1,000 per year. You have until April 15th for your contributions to count for the previous year’s tax return.
Contribute to a Donor-Advised Fund
If you itemize your tax deductions because of charitable contributions, you may want to consider investing in a donor-advised fund (DAF). You can contribute a lump sum all at once and then distribute those funds to various charities over several years. With this strategy, you can itemize deductions when you make the initial contribution and then take the standard deduction in the following years, allowing you to make the most out of your donation tax-wise.
You can also donate appreciated stock, which can further maximize your tax savings. By donating the appreciated position, you avoid paying the capital gain tax that would have been due upon sale of the stock and you are effectively donating more to your charities of choice than if you had sold the stock and donated the proceeds.
Make a Qualified Charitable Distribution
If you own a qualified retirement account and are at least 70½, you can use a qualified charitable distribution (QCD) to receive a tax benefit for your charitable giving, and since this is an above-the-line deduction, it can be used in conjunction with other charitable tax strategies. A QCD is a distribution made from your retirement account directly to your charity of choice. It can also count toward your RMD, but unlike RMDs, it won’t count toward your taxable income. Individuals can donate up to $100,000 in QCDs per year, which means a married couple can contribute a combined amount of $200,000!
Utilize Tax-Loss Harvesting
Tax-loss harvesting involves selling investments at a loss in order to offset the gains in your portfolio. By realizing a capital loss, you are able to counterbalance the taxes owed on capital gains. The investments that are sold are usually replaced with similar securities in order to maintain the desired asset allocation and expected return.
With the extreme market volatility of 2022, chances are you have some capital losses that can be utilized. For example, if you are expecting a large capital gain this year, sell an underperforming stock and harvest the losses to offset your gain.
Tax-loss harvesting can also be used to reduce your ordinary income tax liability if capital losses exceed capital gains. In this case, up to $3,000 can be deducted from your income, and capital losses in excess of this amount can be carried forward to later tax years.
Understand Long-Term vs. Short-Term Capital Gains
Understanding the tax implications of long-term versus short-term capital gains can go a long way in reducing your tax liability. For instance, in 2022 a married taxpayer will pay 0% capital gains tax on their long-term capital gains if their taxable income falls below $83,350. That rate jumps to 15% and 20% for taxable incomes that exceed $83,350 and $517,200, respectively. The thresholds increase slightly in 2023, but understanding where you fall on the tax table is an important part of minimizing your liability.
Gains that are short term in nature (held less than one year) will be taxed at your marginal tax bracket, which could be up to 37%! Knowing both the nature of your gain, as well as your tax bracket, is crucial information if you want to minimize your tax liability.
Take a Qualified Business Income Deduction
Business owners involved in partnerships, S corporations, or sole proprietorships can take a qualified business income deduction (QBID) to help reduce taxable income and maximize tax savings. This allows for a maximum deduction of 20% of qualified business income, but limits apply if your taxable income exceeds a certain threshold. To qualify for this deduction, consider reducing or deferring income so that you can remain below the phase out threshold. A great way to do this is to maximize your retirement contributions to tax-advantaged accounts (as discussed in point #1).
Consider Estate Tax-Planning Techniques
Estate tax-planning techniques can also be an effective way to reduce current-year tax liability. For 2022, the lifetime exemption is $12.06 million for individuals and $24.12 for married couples; these amounts increase to $12.92 million and $25.84 million in 2023.
The annual gift tax exclusion has also been increased to $17,000 per recipient in 2023, up from $16,000 in 2022. This means that taxpayers can give this amount tax-free without using any of the previously mentioned lifetime exemptions. Not only that, but the annual exclusion applies on a per person basis, so each taxpayer can give $16,000 ($17,000 in 2023) per person to any number of people per year.
Though gifting and other estate tax-planning strategies are not tax-deductible, they can help to significantly reduce your taxable estate over time.
Make Sure Your Advisory Team Is Working Together
Beyond consulting with a tax professional, you’ll want to be sure your entire financial team is working together to provide cohesive oversight and guidance. This should include professionals like CPAs, financial advisors, investment advisors, and estate attorneys. Your finances don’t exist in a bubble and so neither will your tax-minimization strategies. When your advisory team works together, strategies are easier to identify and execute, and proactive tax solutions become much easier to implement, reducing stress and your tax bill.
Start Saving Today
Our team is skilled in constructing financial strategies tailored to your specific needs, investment objectives, and risk tolerance. We develop a strategy that enables our firm to give you continuous and focused advice. If you have questions about tax-planning strategies and how to incorporate them into your overall plan, reach out to set up a complimentary appointment. Call us at (865) 691-0898 or contact us online. Let’s find out if our services are the right fit for you on your financial journey.
Lee Sherbakoff is principal and financial advisor with The Nalls Sherbakoff Group, LLC, an independent, fee-only financial planning and investment management firm. He specializes in serving pre-retirees and retirees, helping them create and execute financial plans and retirement income plans that lead to sustainable long-term, real-life returns that meet their deepest and most important financial goals and objectives. Lee has a Bachelor of Science in Finance from The University of Tennessee and a Master of Strategic Studies from the U.S. Army War College as well as the Certified Public Accountant (CPA), Personal Financial Specialist (PFS™), CERTIFIED FINANCIAL PLANNER™ professional, and Retirement Income Certified Professional® (RICP®) certifications. Lee spent over 31 years in the U.S. Army Reserves, including serving at the Army’s highest levels on the Department of Army staff at the Pentagon and being deployed in support of Operation Desert Storm (1991) and Operation Iraqi Freedom (2008-2009). Lee lives by the motto, “As I served my country, I now serve you.” When he’s not giving his best to his clients, Lee enjoys giving back to the community and to his profession. He served as a council member of the Tennessee Society of CPAs and is a member of the American Institute of CPAs. In addition, he is past President of the Knoxville Chapter of Tennessee Society of CPAs and past President of the East Tennessee chapter of the Financial Planning Association. To learn more about Lee, connect with him on LinkedIn.
DISCLOSURES: The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy, or investment product, and should not be construed as investment, legal, or tax advice. The Nalls Sherbakoff Group, LLC makes no warranties regarding the information or results obtained by third parties and its use and disclaims any liability arising out of, or reliance on the information. Please contact us if there have been any changes in your financial situation or investment objectives, or if you wish to impose any restrictions on the management of your account or modify existing restrictions. You may contact us by phone at 865-691-0898 or email at email@example.com. Any indexes reflect investments for a limited period and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of The Nalls Sherbakoff Group, LLC. Past performance does not guarantee future results.