2023 Year-End Tax Planning Strategies to Consider

When Should You Start Tax Planning?

You probably want to keep your tax liability as low as possible. But in order to do that effectively, you must plan ahead and make changes in this calendar year that will impact how much you owe when you file your tax return next year.

That's why the end of the calendar year is the time to take actions that can help manage your tax liability.

No specific tax planning strategy works for everyone, so you should speak with your tax advisor to determine a plan that will work best to help achieve your particular goals and objectives.

Here are a few deductions and strategies that might help lower your liability when you file your 2023 tax return next year:


Deductions to Take Before the New Year

If you haven't maximized allowable tax deductions during 2023, now is the time to review the range of deductions for which you might qualify.

Here are 10 common year-end tax considerations :

1. Consolidate Your Charitable Contributions

The amount of charitable gifts you may claim as a deduction for a given tax year is based on the type of asset gifted, your adjusted gross income (AGI) and the type of charity receiving your gift. Any unused portion of the charitable deduction can be carried forward for up to five years.

In 2023, if you donate cash to a public charity, including a donor advised fund or community foundation, you are entitled to take a charitable deduction against it up to 60% of your AGI.

For example, let's say a donor whose AGI is $200,000 provides a cash gift of $20,000 to a donor advised fund and makes no other gifts. In this case, the donor would receive in 2023 the lesser of $20,000 or $120,000 (60% of $200,000 AGI) as a charitable deduction.

For a non-cash gift, the charitable deduction is up to 30% of AGI. Using the example above, if this donor makes a gift of $65,000 of appreciated securities to a public charity, the donor would be entitled to a 30% deduction against their AGI, or $60,000.

By donating stocks rather than cash, some taxpayers get a double tax benefit because they don't just get the charitable gift deduction, but they also avoid paying capital gains tax on the stock's appreciation.

2. Consider a Roth Conversion

You'll need to understand the differences between a Roth IRA and Traditional IRA before deciding what tax benefits you might gain from changes to your retirement accounts.

One of the benefits of a Traditional IRA is that contributions to it can be deducted from taxable income in the year they were made, if your income is under a certain threshold. However, if you made tax-deductible contributions to your Traditional IRA, all distributions you take during retirement will be taxed as ordinary income. Theoretically, your income will be lower after you stop working, and so will your tax bracket.

In contrast, Roth IRAs do not provide an upfront tax benefit, but distributions taken during retirement from qualified Roth accounts are received tax-free. In addition, Roth IRAs do not require you to take minimum distributions by a certain age, as Traditional IRAs do. Therefore, a Roth IRA may be especially beneficial if you wish to manage your taxable income during retirement.

Utilizing a Roth Conversion

If all or part of your retirement savings are currently held within Traditional IRAs, it is possible to move your Traditional IRA assets to a Roth IRA using what's called a Roth conversion. While you'll have to pay taxes in the year of conversion on the entire converted amount, withdrawals in the future are not mandatory, and will be completely tax-free.

To make withdrawals, you must be at least age 59 ½ and you must wait five years after the initial contribution or conversion to your Roth account.

If you are currently in a higher tax bracket, you may want to consider the impact of paying taxes on the converted assets versus the benefit of any market appreciation that may accrue in your Roth IRA in the future.

A qualified financial or tax professional can help you understand whether the conversion process makes sense for you based on your circumstances. A tax professional can also help you calculate the ultimate cost of the conversion and ensure that you are not inadvertently moved into a higher tax bracket as a result if that is not your intent.

With the volatility of the stock market in 2023, the value of many IRAs decreased significantly this year. If you anticipate that the market will rebound over the next few years, taking advantage of the lower value of your IRAs is another reason to consider converting a portion of your Traditional IRA to a Roth IRA this year. The income tax payable upon conversion would be based on the lower valuation, triggering less tax liability. In addition, any future appreciation may be received tax free when you take distributions from the Roth IRA.

3. Harvest Capital Losses to Offset Capital Gains

If you are an investor with large capital gains, consider talking with your advisor to determine whether harvesting capital losses may help you offset gains this year.

If you own stocks with a built-in loss, you may sell them before the end of 2023 and deduct losses up to $3,000 (or $1,500 if married and filing separately) against ordinary income on your federal tax return. If you held the stock for more than one year, then you may instead deduct your 2023 capital losses dollar for dollar against your 2023 capital gains.

As the end of the year draws closer, it's an excellent time to review your investments with your financial advisor and determine if you should sell stocks or other assets that are not performing well and reinvest the proceeds in new investments that may perform better.

Beware of the Wash-Sale Rule

If you do this, however, make sure you're not violating the “wash-sale rule." This rule disallows you from taking a loss if you purchase the same or a very similar stock within 30 days before or after the sale of that stock was completed. If you decide to sell a stock at a loss, consider adding a note on your calendar for when the 30-day period ends. That will remind you not to repurchase the stock too soon after it appreciates so you ensure that you're not inadvertently violating the wash-sale rule.

4. Max Out Tax-Deductible or Tax-Deferred Accounts

Contributing to a qualified 401(k) or health savings account (HSA) plan can reduce your taxable income for 2023.

Individuals and married couples can make 2023 contributions to traditional IRAs, SEP-IRAs, SIMPLE IRAs and HSAs all the way up to and including April 15, 2024. Note that the extended timeframe does not apply to contributions to 401(k)/profit-sharing plans, which require contributions to be made during the calendar year, no later than Dec. 31, 2023.

Pre-tax contributions to a 401(k) are limited to $22,500 for 2023. However, workers 50 and older can make an additional $7,500 in catchup contributions to their plans, increasing the maximum contribution to $30,000 total.

If you own a business or are an independent contractor, you may consider establishing a Simplified Employee Pension Plan or SEP-IRA. You can contribute the lesser of 25% of your compensation (including bonuses) or $66,000 to your SEP every year. You have until the date you file your taxes (April 15 or Oct. 15, if extended) to make the SEP contribution. These rules also apply to participants in profit-sharing defined contribution plans.

If you participate in a qualified high-deductible family health insurance plan, you can deduct up to $7,750 in contributions to an HSA in 2023. Individuals with self-only coverage can deduct up to $3,850. In addition, those aged 55 or older are eligible for an additional $1,000 catch-up contribution.

5. Wait to Purchase Mutual Funds

It's a good idea to avoid purchasing mutual funds at the end of the year if the funds will be held in a taxable account. This is because buying a mutual fund immediately before its year-end distribution may result in an unexpected tax bill.

If you buy shares before Dec. 31, you could receive a Form 1099 for year-end dividends even if you did not own the fund when the dividends were earned. Part of the dividends would be treated as ordinary income, and part would be treated as capital gains.

Essentially, this means you could pay taxes on a profit from which you never received a benefit. To avoid paying additional taxes, speak with a tax or investment advisor before making a purchase to figure out when fund distributions will be made.

6. Defer Income to Next Year

If you believe you will be subject to a higher income tax bracket for this tax year, then you may wish to consider deferring some income to a later time, or even to retirement.

You can do this through various nonqualified deferred compensation plans, such as a supplemental executive retirement plan (SERP), a defined benefit plan (such as a cash balance plan) or certain life insurance strategies that allow employees to defer income to a later year. The goal with any deferred compensation plan is to postpone income to lower your taxes in years where your compensation is high and push it into the future, to a time when your taxable income will likely be lower (typically in retirement).

On the other hand, if your 2023 investment income is low because of market conditions, you may wish to accelerate income to this year so it can be recognized when you're in a lower tax bracket.

Income may be accelerated in various ways, including doing partial or total Roth conversions of Traditional IRAs (as discussed above) or exercising vested nonqualified stock options, which are treated as ordinary income.

If you're a small business owner or contractor and want to defer income, consider delaying client billing until late December. That way, you can ensure that clients pay you in 2024 rather than 2023, reducing your 2023 tax liability.

7. Review Retirement Distribution Requirements

After you reach a certain age, the IRS requires you to take annual distributions from any traditional IRAs or 401(k) plans. In late 2022, Congress passed new legislation that raised the age you have to start taking required minimum distributions (RMD) from 72 to 73 years old starting in 2023. It is set to increase again to age 75 beginning in 2033.

If you turned 73 in 2023, you'll have to take your first RMD by April 1, 2024, and you'll need to take another one by the end of 2024.

Each year, the amount of your RMD changes based on your age and the balance in your account. To calculate your RMD for the current year, you divide your account balance at the end of last year by your life expectancy. The IRS provides tables that show you which life expectancy numbers to use based on your age and whether you are sharing your RMD with a spouse.

8. Consider a Qualified Charitable Distribution

A qualified charitable distribution (QCD) is often an overlooked planning tool, but it can be a great option for those who are charitably inclined, have a large IRA and do not need the minimum required distributions.

Even though the new age for RMD has shifted to 73, taxpayers can still make a QCD out of their Traditional IRA upon reaching age 70 ½.

Taxpayers who are 70 ½ or older may make a direct contribution of up to $100,000 per tax year (adjusted for inflation starting in 2024) from their IRAs to a qualified charitable organization.

This type of distribution from your IRA counts toward your minimum required distribution and is not included in your taxable income. However, a charitable income tax deduction cannot be claimed for a QCD.

In addition, QCDs can be made from an inherited IRA — you must be 70 ½ or older to make a QCD even if it's from an IRA you inherited.

9. Consider Life Insurance Tax Implications

Now is a great time to revisit your life insurance policies.

On a yearly basis, you should perform the following life insurance checkup:

  • Request an in-force ledger from your insurance company which shows how your policy will perform based on current and guaranteed interest rate assumptions.
  • Check or confirm your beneficiary designations on each of your policies.
  • Determine if you need more or less life insurance based on any major life changes (such as marriage, divorce, a liquidity event, etc.).
  • If the life insurance is owned by an Irrevocable Life Insurance Trust (ILIT), make sure you follow all the steps necessary to ensure that the policy will not be included in your taxable estate, such as sending out what are known as "Crummey notices."

A Crummey notice is a letter letting a beneficiary know that assets (in most cases cash) have been added to a trust and informing the beneficiary of their right to withdraw those assets within a period of time, if applicable.


Other End-of-Year Tax Considerations

Make Gifts to Family Members Before Year's End

For 2023, the IRS allows taxpayers to make gifts of up to $17,000 to any person without the money being subject to federal gift tax. For married couples, this annual exclusion from gift tax grows to $34,000 ($17,000 per spouse). If you plan to make gifts to family members, you will need to complete the gift before Dec. 31, 2023, in order to take advantage of the annual gift tax exclusion.

Pay State and Local Taxes Early

If you will owe state income taxes or local property taxes in 2024, you could consider paying those tax bills before the end of the year. That way, you can deduct the state or local tax payments from your federal taxable income for 2023.

Bunch Itemized Deductions

To itemize deductions such as medical and dental expenses, deductible taxes, charitable contributions and mortgage interest, your expenses in each category must be higher than a certain percentage of your AGI.

In 2023, for example, medical expenses must equal at least 7.5% of your AGI in order for you to take the itemized deduction. 

If you have unpaid medical or dental expenses or planned charitable contributions that won't get you to the minimum threshold for deducting in 2023, consider holding those until 2024. This practice of delaying some expenses to a future tax year in order to qualify for itemized deductions is known as “bunching" deductions.

Consider Repaying Early Distributions Taken from Qualified Plans or IRAs

Typically, withdrawals from a tax-deferred retirement account made before age 59 1/2 incur a 10% early withdrawal penalty. However, the CARES Act eliminated that penalty for people who needed to make early withdrawals due to the coronavirus pandemic. Eligible individuals included those who were diagnosed with COVID-19, had a spouse or dependent diagnosed with COVID-19, or who were financially impacted by the pandemic due to unemployment, reduced hours or similar circumstances.

Participants were allowed to withdraw up to $100,000 per person without being subject to the early withdrawal penalty. Any withdrawals were considered ordinary income subject to income tax, but distributions were included in income over a three-year period, starting with the year the distribution was received. For example, if you received a $30,000 COVID-related distribution in 2021, you could report $10,000 in income on your federal income tax return for 2021, 2022 and 2023, spreading the tax burden on the withdrawal amount over a three-year period. Alternatively, you could have included the entire distribution in your income for 2021, the year of the distribution.

However, if you choose to pay your plan back for the amount of withdrawn funds within three years, then you may be eligible for a full refund of the taxes paid on the withdrawal. While the repayment would not change your current-year taxable income, you could be reimbursed for any taxes paid previously for the withdrawal amount.

Spend Any Remaining FSA Funds

If you contributed to a flexible spending account (FSA), remember to spend the funds in your account prior to Dec. 31, unless your employer allows you until March 2024 to finish using the money. While an FSA saves you money on your taxes, the money in the account is typically “use it or lose it," so it should be used before it expires.


Meet With Your Tax Advisor to Discuss Specific Tax Strategies

Congress did not pass new tax legislation in 2023 that dramatically changed tax rules. But you will still benefit by developing an income tax plan for the end of 2023 and beyond.

The provisions of the Tax Cuts and Jobs Act of 2017 are scheduled to sunset on Dec. 31, 2025 unless Congress passes new legislation that is signed into law by the president to extend it.

If the 2017 Act provisions expire, the following will occur:

Estate, gift and generation-skipping transfer (GST) exemptions will return to the prior exemption levels, indexed for inflation. This will be calculated as the prior exemption of $5 million indexed for inflation, or an estimated $6.8 million. This is nearly half of the 2023 exemption amount of $12.92 million.

The top income tax rate would increase from 37% to 39.6%.

You should consider these factors, along with your unique financial situation, when determining ongoing tax-savings strategies that might work for you. Consider meeting with your tax advisor now to help you understand how to best accomplish your specific goals for this year's tax season and beyond.

This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.

City National, its managed affiliates and subsidiaries, as a matter of policy, do not give tax, accounting, regulatory, or legal advice, and any information provided should not be construed as such. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. Any strategies discussed in this document were not intended to be used, and cannot be used for the purpose of avoiding any tax penalties that may be imposed. You should consult with your other advisors on the tax, accounting and legal implications of actions you may take based on any strategies or information presented taking into account your own particular circumstances. Trust services are offered through City National Bank.