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As the year draws to a close, it’s crucial to take stock of your financial situation and make strategic moves to minimize your tax liability. With a little planning and foresight, you can take advantage of various tax-saving opportunities. Here are some last-minute strategies to consider before the year ends.

Itemizing Deductions and Medical Expenses – If you itemize deductions, you can potentially lower your taxable income by paying outstanding medical bills, if the total of all medical expenses paid for the year will exceed 7.5% of your adjusted gross income (AGI). Even if you don’t have the cash on hand, you can pay these bills with a credit card before year-end and still deduct them for the current tax year. This strategy can be particularly beneficial if you’ve had significant medical expenses throughout the year.

Prepaying Property Taxes – Consider prepaying the second installment of your property taxes. This can increase your itemized deductions for the current year. However, be mindful of the $10,000 cap on state and local tax (SALT) deductions, which includes property taxes. If you’re already close to this limit, prepaying may not provide additional tax benefits.

Charitable Contributions and Bunching Deductions – Making charitable contributions is a great way to reduce your taxable income while supporting causes you care about. If you marginally itemize each year, consider “bunching” your deductions. This involves concentrating your charitable contributions and other deductible expenses in one year to exceed the standard deduction threshold, allowing you to itemize. In the alternate year, you can take the standard deduction.

Required Minimum Distributions (RMDs) – For 2024, if you’re 73 years or older, you must take required minimum distributions (RMDs) from your retirement accounts by December 31, 2024, to avoid hefty penalties. Failing to take the RMD can result in a penalty of 25% of the amount that should have been withdrawn. Ensure you meet this requirement to avoid unnecessary costs.

If 2024 is the year you turned 73, you can delay the first RMD until April 1, 2025. This can be beneficial if you have substantial income in 2024, and expect less income the following year. By delaying the distribution, you might be able to reduce your tax liability by taking the distribution in a year when you are in a lower tax bracket.

However, if you choose to delay the first RMD, you must take two distributions in the second year: the delayed first RMD by April 1 and the second year’s RMD by December 31.

Did You Know You Can Make Charitable Deductions from Your IRA Account? – Those who are age 70½ or older are allowed to transfer funds to qualified charities  from their traditional IRA without the transferred funds being taxable, provided the transfer is made directly by the IRA trustee to a qualified charitable organization. The annual limit for these transfers has been $100,000 per IRA owner, but the law was changed so that the annual maximum is inflation adjusted. This means for 2024, an IRA owner can make qualified charitable distributions of up to $105,000. If you are required to make an IRA distribution (i.e., you are age 73 or older), you may have the distribution sent directly to a qualified charity, and this amount will count toward your RMD for the year.

Although you won’t get a tax deduction for the transferred amount, this qualified charitable distribution (QCD) will be excluded from your income, with the result that you may get the added benefit of cutting the amount of your Social Security benefits that are taxed. Also, since your adjusted gross income will be lower, tax credits and certain deductions that you claim with phase-outs or limitations based on AGI could also be favorably impacted.

If you plan to make a QCD, be sure to let your IRA trustee or custodian know well in advance of December 31 so that they have time to complete the transfer to the charity. Your QCD need not be made to just one charity – you can spread the distributions to any number of charities you choose, so long as the total doesn’t exceed the annual limit. And don’t forget to have the charity you’ve donated to provide you with a receipt or letter of acknowledgment for the donation.

If you have contributed to your traditional IRA since turning 70½, the amount of the QCD that isn’t taxable may be limited, so it is a good idea to check with this office to see how your tax would be impacted.

Maximizing Retirement Account Contributions – Maximize your contributions to retirement accounts like IRAs and 401(k)s. Contributions to these accounts can reduce your taxable income, and the funds grow tax-deferred. For 2024, the contribution limit for a 401(k) is $23,000, with an additional $7,500 catch-up contribution for those aged 50 and over. For IRAs, the limit is $7,000 plus an age-50 or older $1,000 catch-up contribution.

Tax Loss Harvesting – If you have underperforming stocks, consider selling them to realize a loss. This strategy, known as tax loss harvesting, can offset capital gains and reduce your taxable income. Be mindful of the “wash sale” rule, which disallows a deduction if you repurchase the same or a substantially identical security within 30 days.

Reviewing Paycheck Withholdings and Estimated Taxes – Review your paycheck withholdings and estimated tax payments to ensure you’re not underpaying taxes. If you find that you’ve under-withheld, consider increasing your withholdings for the remaining pay periods or making an estimated tax payment to avoid or minimize underpayment penalties. The advantage of withholdings is they are treated as paid ratably throughout the year and can make up for underpayments earlier in the year. Other withholding strategies are available, contact this office for details.

Managing Health Flexible Spending Accounts (FSAs) – if you contributed too little to cover expenses this year, you may wish to increase the amount you set aside for next year.  The maximum contribution for 2025 is $3,300.

If you have a balance remaining in your employer’s health flexible spending account (FSA), make sure to use it before the year ends. FSAs typically have a “use-it-or-lose-it” policy, meaning any unused funds may be forfeited. The amount you haven’t used in 2024 that may be carried to 2025 is $640 and must be used in the first 2½ months of 2025. Any unused portion is lost.

Did You Become Eligible to Make Health Savings Account (HSA) Contributions This Year? – If you become eligible to make health savings account (HSA) contributions late this year, you can make a full year’s worth of deductible HSA contributions even if you were not eligible to make HSA contributions for the entire year. This opportunity applies even if you first become eligible in December. In short, if you qualify for an HSA, contributions to the account are deductible (within IRS-prescribed limits), earnings on the account are
tax-deferred, and distributions are tax-free if made for qualifying medical expenses.

Prepaying College Tuition – If you qualify for either the American Opportunity or Lifetime Learning education credits, check to see how much you will have paid in qualified tuition and related expenses in 2024. If it is not the maximum allowed for computing the credits, you can prepay 2025 tuition if it is for an academic period beginning in the first three months of 2025. That will allow you to increase the credit for 2024. This is especially effective for students just starting college who only have tuition expenses for part of the year.

Is Your Income Unusually Low This Year? – If your income is unusually low this year, you may wish to consider the following:

• Converting your traditional IRA into a Roth IRA – The lower income likely results in a lower tax rate, which provides you an opportunity to convert to a Roth IRA at a lower tax amount. Also, if you have stocks in your retirement account that have had a significant decline in value, it may be a good time to convert to a Roth.
• Planning for Zero Tax on Long-Term Capital Gains – Lower-income taxpayers and those whose income is abnormally low for the year can enjoy a long-term capital gain tax rate of zero, which provides an interesting strategy for these individuals. Even if the taxpayer wishes to hold on to a stock because it is performing well, they can sell it and immediately buy it back, allowing them to include the current accumulated gain in the sale-year’s return with no tax while also reducing the amount of taxable gain in the future. Since the sales results in a gain, the wash sale rule doesn’t apply.

To determine if you can take advantage of this tax-saving opportunity, you must determine if your taxable income will be below the point where the 15% capital gains tax rate begins. For 2024, the 15% tax rates begin at $94,051 for married taxpayers filing jointly, $63,001 for those filing as head of household and $47,026 for others.

Example: Suppose a married couple is filing jointly and has projected taxable income for 2024 of $50,000. The 15% capital gains tax bracket threshold for married joint filers is $94,051.  That means they could add $44,050 ($94,050- $50,000) of long-term capital gains to their income and pay zero tax on the capital gains. 

Additionally, if the taxpayer has any loser stocks, he or she can sell them for a loss, and thereby allow additional long-term capital gains to take advantage of the zero-tax rate.

Contact this office for assistance in developing a plan to take advantage of the zero capital gains rate.

Don’t Forget the Annual Gift Tax Exemption – Though gifts to individuals are not tax deductible, each year, you are allowed to make gifts to individuals up to an annual maximum amount without incurring any gift tax or gift tax return filing requirement. For the tax year 2024, you can give $18,000 ($19,000 in 2025) each to as many people as you want without having to pay a gift tax. If this is something that you want to do, make sure that you do so by the end of the year, as you are not able to carry the $18,000, or any unused part of it, over into 2025. Such gifts need not be in cash, and the recipient need not be a relative. If you are married, you and your spouse can each give the same person up to $18,000 (for a total of $36,000) and still avoid having to file a gift tax return or pay any gift tax.

By implementing these strategies, you can optimize your financial outcome and minimize your tax liability. Remember, tax planning is a year-round activity, and these last-minute moves are just one part of a comprehensive tax strategy.

Tax planning is a crucial aspect of financial management, yet it often remains underestimated by many taxpayers. One area that frequently causes confusion and potential financial strain is the management of estimated tax payments and the associated penalties for underpayment. Understanding the intricacies of estimated tax safe harbors, the requirement for payments to be made ratably, and the strategies to mitigate penalties can significantly impact a taxpayer’s financial health. This article delves into these topics, offering insights into how taxpayers can navigate these challenges effectively.

Understanding Underestimated Penalties – Underpayment penalties can catch taxpayers off guard, especially when they fail to meet the required estimated tax payments. The IRS imposes these penalties to encourage timely tax payments throughout the year, rather than a lump sum at the end. The penalty is essentially an interest charge on the amount of tax that should have been paid during the year but wasn’t. This penalty can be substantial, especially for those with fluctuating incomes or those who experience a significant increase in income without adjusting their estimated payments accordingly. While most wage-earning taxpayers have enough tax withheld from their paychecks to avoid the underpayment penalty problem, those who also have investment income or side gigs may find their withholding isn’t enough to meet the prepayment requirements to avoid a penalty.

Estimated Tax Penalty Amount – The IRS sets the interest rates for underpayment penalties each quarter.  It is equal to the federal short-term interest rate plus 3 percent. With the recent rapid rise in interest rates the underpayment interest rate for each quarter of 2024 is a whopping 8%, the highest it has been in almost two decades. Something you should be concerned about if you expect your withholding and estimated tax payments to be substantially underpaid.

Estimated Tax Due Dates – For individuals, this involves using Form 1040-ES to make the payments, generally on a “quarterly” basis.

The estimated tax payment schedule for individuals and certain other taxpayers is structured in a way that does not align with the even quarters of the calendar year. This is primarily due to the specific due dates set by the IRS for these payments. For 2024, the due dates for estimated tax payments are as follows:

1. First Quarter: Payment is due on April 15, 2024. This payment covers income earned from January 1 to March 31.
2. Second Quarter: Payment is due on June 17, 2024. This payment covers income earned from April 1 to May 31. Note that this period is only two months long, which contributes to the uneven nature of the quarters.
3. Third Quarter: Payment is due on September 16, 2024. This payment covers income earned from June 1 to August 31.
4. Fourth Quarter: Payment is due on January 15, 2025. This payment covers income earned in the four months of the period September 1 to December 31.

Note, these payment due dates normally fall on the 15^th of the month. However, whenever the 15^th falls on a weekend or holiday, the due date is extended to the next business day.

Estimated Tax Safe Harbors – To avoid underpayment penalties and having to make a projection of the expected tax for each payment period, taxpayers can rely on safe harbor rules. These rules provide a guideline for the minimum amount that must be paid to avoid penalties. Generally, taxpayers can avoid penalties if their total tax payments equal or exceed:

• 90% of the current year’s tax liability or
• 100% of the prior year’s tax liability.

However, for higher-income taxpayers with an adjusted gross income (AGI) over $150,000, the safe harbor threshold of 100% increases to 110% of the prior year’s tax liability.

Ratable Payments Requirement – One critical aspect of estimated tax payments is the requirement for these payments to be made ratably throughout the year. This means that taxpayers should aim to make equal payments each “quarter” to avoid penalties. However, income is not always received evenly throughout the year, which can complicate this requirement. For instance, if a taxpayer receives a significant portion of their income in the latter part of the year, they may find themselves underpaid for earlier quarters, leading to penalties.

Uneven Quarters and Computing Penalties – The challenge of uneven income can be addressed by understanding how penalties are computed. The IRS calculates penalties on a quarterly basis, meaning that underpayments in one quarter cannot be offset by overpayments in a later quarter. This can be particularly problematic for those with seasonal or sporadic income. To mitigate this, taxpayers can use IRS Form 2210, which allows them to annualize their income and potentially reduce or eliminate penalties by showing that their income was not received evenly throughout the year.

Workarounds: Increasing Withholding and Retirement Plan Distributions

• Increase Withholding – One effective workaround for managing underpayment penalties is to increase withholding for the balance of the year. Unlike estimated payments, withholding is considered paid ratably throughout the year, regardless of when the tax is actually withheld. This means that increasing withholding later in the year can help cover any shortfalls from earlier quarters.
• Retirement Plan Distribution – Another strategy involves taking a substantial distribution from a retirement plan such as a 401(k) or 403(b) plan, which is subject to a mandatory 20% withholding requirement. The taxpayer can then roll the distribution back into the plan within 60 days, using other funds to make up the portion of the distribution which went to withholding. Tax withholding can also be made from a traditional IRA distribution, but this approach requires careful planning to ensure compliance with the one IRA rollover per 12-month period rule.
• Annualized Exception – For taxpayers with uneven income, the annualized exception using IRS Form 2210 can be a valuable tool. This form allows taxpayers to calculate their required estimated payments based on the actual income received during each quarter, rather than assuming equal income throughout the year. By doing so, taxpayers can potentially reduce or eliminate underpayment penalties by demonstrating that their income was not received evenly.

Managing estimated tax payments and avoiding underpayment penalties requires careful planning and a thorough understanding of IRS rules and regulations. By leveraging safe harbor provisions, understanding the requirement for ratable payments, and utilizing strategies such as increased withholding and retirement plan distributions, taxpayers can effectively navigate these challenges.

If you are expecting your pre-payment of tax to be substantially underpaid and wish to develop a strategy to avoid or mitigate underpayment penalties, please contact this office.  But if you wait too late in the year, it might not provide enough time before the end of the year to make any effective changes.

There are special rules for qualifying farmers and fishermen, who may have different requirements and potential waivers for underpayment penalties; contact this office for details.