Tax Planning Strategies For 2024 Tax Year With Mistakes To Avoid

If you track your spending; you will notice that often taxes are the biggest expenses. Because most taxes are usually deducted at source; we do not notice the huge bite taken by the government. While one cannot avoid paying taxes; you should take all the necessary legal steps in order to minimize paying taxes via year end tax planning strategies.

Most of the tax strategies need to be implemented before the end of the year. By the time you file taxes in April, it is too late to reduce your tax liability

I have created a quick checklist of various year end tax tips. But please bear in mind that there is no guarantee as to accuracy or completeness. This is for informational purposes only and in no event should be construed as legal, tax or financial advice. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned. Refer the IRS website for the latest information

The US tax code is complicated and runs over 75,000 pages. No wonder, I found out that even CPAs make mistakes on your tax returns.  With the new bill for additional tax changes being debated in Congress; one can expect more complications after 2022. For now let us focus on our circle of influence with the 2022 year end tax moves to make.

Tax Planning for Individuals

Reduce Taxable Income

Pre-tax Retirement Contributions

Max out your Pre-tax retirement contributions since this is the easiest way to reduce your taxable income. Contributions made to pre-tax accounts such as employer-sponsored 401(k) plans, 403(b) plans are made with income that has not been subject to payroll or income taxes. The advantages of pre-tax accounts is that the contributions grow tax-deferred. Note that these accounts are subject to ordinary income tax upon distribution in retirement when your tax bracket should be lower. For 2024,  the pre-tax contribution limit is $23,000 for 401(k)s and 403(b)s. If you are older than 50, the catch-up contribution limit will remain at $7,500.

Besides the pre-tax contributions which reduces your taxable income; check if you have an after-tax provision in your 401(k). If yes, then you can contribute after tax money to your 401(k) and roll over the contributions immediately into a Roth IRA. The Roth IRA money grows tax free and is a better option than a regular taxable account. Check your 401(k) plan for this option specifically. The 2024 total contribution limit from all sources is $69,000. And for participants ages 50 or older it is $76,500

If you are eligible for an IRA, you have until April 15th of next year to make a contribution to your IRA and have it still count towards the current tax year. But it is always better to contribute immediately, so your money has more time to grow tax free. IRA contribution limits are $7,000 for tax year 2024. An additional $1,000 is available to savers over 50.

Health Savings Account (HSA)

HSAs (health savings accounts) are triple tax advantaged. The contributions are exempt from tax, the account grows tax deferred and you receive tax-free distributions when used for medical purposes.  To be eligible for HSAs, you must participate in a high-deductible health plan (HDHP). The maximum allowed contributions to $4,150 for an individual or $8,300 for a family in 2024. Since money in an HSA account remains yours and contributions reduce taxable income, maximizing contributions is a smart tax planning move. Fund HSA via payroll by Dec 31st. Non payroll deadline is April 15th

Flexible Spending Account (FSA)

The advantage of FSA is that the payroll deductions avoid both income and Social Security taxes If you participate in the healthcare Flexible Spending Account (FSA), make sure you spend all the funds in your account by December 31.

Amazon has a FSA/HSA section with a list of FSA eligible products. So make sure you order before Dec 31st.

Commuter account

You can set aside the monthly cost of your commute before taxes in a Commuter benefit account. Besides transit, Commuter benefits can be used for parking and UberPool. In 2022, the IRS mandated limit for pre-tax contributions to commuter benefits accounts is $315 per month in transit expenses. Per IRS regulations, your employer can’t refund your unused commuter benefits funds back to you. However, you can submit claims for eligible expenses incurred during employment for up to 90 days.

Deferred Compensation Plan

Depending on your level in the organization you might have the option to enroll in Deferred Compensation Plan. This is great for Financial Freedom Countdown readers because you can set aside a portion of your compensation to be deferred for the future. For individuals with no pension; this is an excellent way to ensure you are covered to answer the question “when can I retire“?

Eg: if your salary is $250K, you can set aside $100K as deferred compensation. For the current year you only pay taxes on $150k. The deferred $100K can be invested (usually with similar investment options as your 401(k) and then you can opt to receive it at a later age; say 50. By this time you have already retired and are in lower tax bracket resulting in negligible tax burden.

Deferred Bonus

You can ask for your year end bonus to be deferred and paid next year. This could reduce as well as defer your tax. It only makes sense if you will be in a lower bracket next year compared to the current year.

Tax Loss Harvesting

While the goal of investing should not be to lose money; sometimes we make bets which do not seem to pay off. In such cases; it might be advisable to sell the securities and book the loss. You can deploy the capital immediately to buy other securities which are not substantially identical or wait at least 31 days before buying back the same security. Just ensure you do not run afoul of the Wash Sale rule. Also you can’t sell a security in taxable account and buy an identical one in tax deferred and vice versa. The Wash Sale rule applies across ALL accounts.

The advantage of the Tax Loss Harvesting is that you are allowed to deduct $3,000 a year in capital loss deductions. The unused losses are carried over into the following years till exhausted.

The “substantially identical” text is vague and not been clarified. So technically you could sell the Vanguard Total World fund and buy the Schwab US index fund and still claim losses.

Since crypto currencies such as Bitcoin are technically not securities; certain CPAs mention that the Wash Sale rule does not apply and one can claim the loss and buy it back immediately. I am sure this will be soon tested in the IRS courts.

Opportunity Zones

If you have substantial Capital gains look at investment options in the Opportunity Zones.

Standard or Itemized Deduction

The Tax Cut Jobs Act (TCJA) made a number of significant changes which means you now need to decide if you file for Standard or Itemized deduction at the Federal level. Also remember you can chose Standard at the Federal level and Itemized at the State level. 

The  (TCJA) dramatically increased the standard deduction. For 2024 it is $14,600 for individual filers. And 29,200 for married filing jointly. For heads of household, the TCJA increased the deduction is 21,900

In addition, the TCJA eliminated or restricted many itemized deductions available under previous tax laws. Some of the more significant changes for itemizing taxpayers include:

• • • State and local taxes (SALT). State, personal property, and either income or sales taxes are still deductible. However the TCJA capped the total itemized deduction at $10,000. This provision has hit the home owners in California, New Jersey, New York etc. the hardest as these states have high state income taxes and also expensive properties which leads to higher property taxes. Even a fixer upper 1 bedroom in San Francisco costs around $1,000,000. Property taxes alone would exceed $10,000. So in effect you are being taxed at a Federal level on the State Income tax you already paid.

• • • Mortgage loan interest. For mortgages December 14, 2017, or earlier, interest will be deductible on up to $1,000,000 of debt (the old cap), even if refinanced after December 14, 2017. For mortgage loans taken out after December 15, 2017, the TCJA allows itemizing homeowners to deduct mortgage interest paid on up to $750,000 worth of principal.

• • • Home equity loan interest. Home equity interest is no longer deductible unless the debt is used to buy, build, or substantially improve the taxpayer’s home secured to the loan. Before the TCJA, home equity loan interest was deductible for loans up to $100,000.

• • • Medical expenses. Unreimbursed medical costs that exceed 10 percent of adjusted gross income are deductible. Pre-TCJA it was 7.5 percent of AGI.

• • • Miscellaneous itemized deductions Tax preparation fees, moving expenses, unreimbursed employee expenses are all no longer deductible. Prior to the TJCA, you could deduct unreimbursed employee expenses as long as it exceeded 2% of your Adjusted Gross Income (AGI).

• • • Charitable contributions. The TCJA raised the limit for charitable donations from 50% to 60% of AGI. As a result it is no longer beneficial to do charitable contributions. Since the government has effectively raised taxes by making it uneconomical to itemize; one can only hope that these extra taxes are used for charitable endeavors.

Increase Taxable Income

Sometimes, it might make sense to increase income depending on what is your tax bracket. Typically only in early retirement do these strategies make sense for high income earners. If you do not have a lot of income after achieving Financial Freedom; this technique can be used to bump you into a Silver Plan on the Affordable Care Act exchanges instead of Medicaid.

Tax Gain Harvesting

Long-term capital gain from sales of assets held for more than one year is taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. If you hold long-term appreciated capital assets, consider selling enough of them to generate long-term capital gain sheltered by the 0% rate.

Roth Conversions

Consider converting Traditional IRAs to Roth IRAs, especially if you are either 1) in a low tax bracket and can pay the taxes now with other funds available or 2) have a large net operating loss that can offset the income that is triggered on a Roth conversion.

You can also consider doing a Backdoor Roth IRA contribution depending on your income limits. Make sure you do not have any money in a tax-deferred IRA account.

Required Minimum Distributions (RMDs)

Take the mandated RMDs from inherited IRAs by December 31st. The SECURE Act changed the age by which one must begin withdrawing money to 72. Individuals who reached 70 ½ in 2019 or earlier, did not have an RMD due for 2020 as per the CARES Act. From 2021, they will have an RMD due by Dec. 31 as per the IRS

Avoid taking IRA distributions prior to age 59½ or a 10% early withdrawal penalty may apply.

Estate planning

Gift up to $15,000 per individual annually in federal tax-free gifts. This, combined with the doubling of the lifetime gift tax exemption amount makes it easy to consider your estate planning strategy. Taking advantage of the gift tax exemption limit every year is the best way to transfer generational wealth before dying. Many of the other strategies to transfer generational wealth have tax consequences for the estate.

Real Estate Live-in Flip

This is used by a lot of DIY investors. The basic strategy is to buy a fixer-upper; live in it and fix it up. When you sell after 2 years; up to $250,000 ($500,000 for married couples filing jointly) of the gain can be excluded from federal income tax as per Section 121.

Tax Planning for Businesses

Retirement Plans

Business owners, including freelancers and gig economy workers are self-employed and have multiple retirement options such as Keogh, Profit-Sharing or Pension Plan. However you need to make sure that these are set up by year-end.

SEP IRAs offer extreme flexibility and a long contribution window. You can contribute to your SEP IRA plan for your business all the way out to the tax extension deadline of October 15th of the next year and still qualify for the prior year contribution and deduction.

With Solo 401k plans you can contribute up to $23,000 or 100% of compensation, whichever is less . Maximum contribution a self employed individual can contribute to a solo 401(k) for 2024 is $69,000. Extra catch-up contributions of $7,500 are available if one is older than 50.

Business expenses

If you run a business make sure you keep track of all your expenses so you can write it off. Business meals, mileage, trips, etc.

Qualified Business Income

Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income (QBI) under Section 199A. QBI is also applicable to rental properties.

Rental property depreciation

If you have rental property; don’t forget to take the rental property depreciation. This is important because even if you do not take the depreciation when you sell the property; IRS would consider as if you took the depreciation and hit you with depreciation recapture.

Also check with your CPA if certain items in your rental property are eligible for accelerated depreciation. Personally, I have done cost segregation in order to maximize the depreciation and you should seriously look into this with your CPA. The Book on Tax Strategies for the Savvy Real Estate Investor is a good start.

100% bonus first-year depreciation

Businesses are permitted a deduction for machinery and equipment bought new or used (with some exceptions) if such purchases are placed in service this year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in the current year under Section 179 Bonus Depreciation

Summary

Readers, which of the above year end tax planning strategies you are currently not using and would like to do so going forward?