2023 Year-End Tax Planning Strategies

strategies for businesses, individuals, trusts and estates

2023 has been relatively quiet year from a tax standpoint. The ability to pass any meaningful tax legislation through the end of 2023 is limited at best. Tax planning can never be done in a vacuum. Good planning requires a longer-term horizon approach. Couple the upcoming expiration of the Tax Cuts and Jobs Act (TCJA) provisions and a Presidential election year in 2024, focusing on the “knowns” with an eye to the “unknowns” is key.

The TCJA legislation, passed in 2017, is scheduled to expire on Dec. 31, 2025. This legislation was one of the largest overhauls of the tax code in several decades. It provided for some of the largest tax rate decreases in recent years and included a number of taxpayer and business friendly provisions. These included lower individual income tax rates and increases to the standard deduction, child tax credit and AMT exemption. The estate tax was reduced, and a 20% deduction for qualified business income of business activity from sole proprietorships and pass-through entities was enacted. It also included revenue raising provisions such as removal of the personal exemption and the $10,000 cap on the state and local tax deduction.

If the TCJA is allowed to expire at the end of 2025 as scheduled, tax rates will increase to pre-2018 rates which are significantly higher. It is estimated that extending the TCJA for another 10 years would cost up to $3 trillion.

With all this as a background, the tried-and-true methods below of controlling the timing of income and deductions are still relevant, but multi-year planning and timely action is important.

Tax Planning for Individuals

There are some basic information and numbers you need to know each year as you start your planning.

• Adjusted Gross Income (AGI) – Many of your tax benefits will be connected or even limited by your AGI.
• Tax Rate – This is the rate at which the last dollar of your income is taxed. Tax brackets are indexed each year for inflation.
• Alternative Minimum Tax (AMT) – This tax can be triggered by certain things. The goal is to avoid this tax. Watching where your income is in relation to the exemption amounts is a key.
• Standard Deduction – The standard deduction amount for 2023 is $27,700 for married returns and $13,850 for single filers. Your itemized deductions must be greater than the standard deduction to be beneficial. This number is important when considering the timing of itemized deductions.

• Income Tax Bracket Planning

The IRS recently released its inflation adjusted rates for 2024. These brackets increased or “widened” by 5.4% for 2024. Deferring income to 2024 may be a winner for you as more income would fall into a lower tax bracket.

• Maximizing Deductions

For 2023, the standard deduction amount is $27,700 for joint filers and $13,850 for individual filers. This high standard deduction coupled with the $10,000 limit on deducting state and local taxes, makes itemizing deductions more difficult. A good strategy is to bunch itemized deductions from two or more years into one year. This strategy takes good planning and review of outflows such as medical expenses, charitable contributions and mortgage interest.

• Green Energy Credits

The Inflation Reduction Act (IRA), provided some expanded tax credits for individual taxpayers. These credits start in tax year 2023 and are limited once your income reaches certain AGI limits, so it is important to review.

• • The New Energy Efficiency Home Improvement Credit is generally equal to 30% of your qualified expenses. These expenses can include doors, windows, qualifying energy property and even a home energy audit.
  • The Residential Clean Energy Credit is also equal to 30% of qualifying costs and applies to the installation of solar cells, small wind turbines or battery storage.
  • Electric vehicles credits include $7,500 for the purchase of new clean vehicles and $4,000 for a used clean vehicle. There are stringent requirements so check out the vehicle you are purchasing to make sure it qualifies. The ability to take these credits phases out once income exceeds $300,000 (married filing joint) and is completely lost after $400,000 of income.

• Retirement Savings & Investment Planning
  • The SECURE Act 2.0 made many changes in the retirement arena, but many do not take effect until 2024. For tax year 2023, one change takes place for Required Minimum Distributions (RMDs) from IRAs. The age required for taking RMDs increases from 72 to 73.
  • IRA Donations to Charity – If you are charitably inclined, one way to minimize the tax impact of taking income from an IRA is to make contributions from your IRA directly to the charity of your choice using a Qualified Charitable Distribution (QCD). The income does not get reported on your tax return. This strategy is available for RMDs received over age 70 ½ and a total amount of up to $100,000 can be contributed.
  • Retirement Plan Contributions – Review opportunities to increase 401(k) contributions or IRA contributions if you need to reduce your AGI. Maximum contribution amounts to defined contribution plans for 2023 is $66,000. For each type of plan see below:

• • Tax Loss Harvesting – Review the income streams from your taxable investments. Large gains in investments can be offset with tax loss harvesting. This is the strategic sale of investments at a loss, most generally that may no longer be a fit in your investment portfolio. This allows you to offset the loss against other gains and use the cash to rebalance your positions.

• • Gain Harvesting – Timing of sales of your investments and coordination with capital loss carryovers can reduce your taxes. Investments or property held over one year are taxed at favorable capital gains tax rates. Review your current rate of tax on the gain vs. the anticipated future rate.
  • Net Investment Income Tax – An additional 3.8% tax is added onto certain investment income if your income is over $250,000 for married join returns and $125,000 for individual taxpayers. Investment income includes interest, dividends, capital gains and royalties as well as income from other passive investments like rental property or business investments that you do not materially participate in.
  • “Backdoor” Roth IRA – If your income is too high to contribute to a Roth IRA, you can make a non-deductible IRA contribution and then convert that to a Roth IRA. You will have to pay income tax on a percentage of the amount converted.
  • Roth IRA Conversions – Use Roth conversions to spread taxable income over many years and lower tax brackets. Anticipated increases in future tax rates, makes the next two years prime opportunities to review the conversion of your traditional IRAs, SEPs and Simple IRAs, 403(b) plans or 457 plans to Roth IRAs. This conversion will be taxable in nature, but locks in tax rates at today’s rates. The Roth IRA continues to grow tax free and future distributions are not taxable from a Roth IRA. Make sure to consider state tax implications. For example, if you are going to be moving to a state with no state tax income tax, review if waiting to convert makes sense.

• Passive Loss Carryovers & Excess Business Losses

If you have passive loss carryovers from prior years, review opportunities to recognize passive income in 2023. Consider the limitation on deducting current year business losses. The ability to deduct business losses from companies you actively participate in are limited. The threshold is $289,000 ($578,000 for joint return filers). This limit applies at the principal or shareholder level. The remaining losses (the excess business loss) are not “lost” but will carryover to the next year as a net operating loss. The excess business loss limitation has been extended by the Inflation Reduction Act through the end of 2028.

• Estimate Tax Payments & Withholdings
  • The IRS requires taxes to be paid quarterly that equal the lessor of 100% of the tax on your 2022 return or 90% of the tax on your 2023 return when filed. (For those earning over $150,000 jointly, the number increases to 110% of prior year income).
  • After determining your estimated taxable income, review your pay in amounts to determine if you need to adjust your W-2 withholdings or make an extra payment to reduce your underpayment penalty.
  • The IRS interest rate on underpayments is now at 8%, so the “penalty” for underpayment is much more substantial than in the past.
  • Consider the impact of the Net Investment Income tax or additional income you may have not received in the prior year such as unemployment benefits, IRA distributions or property sales.

• Education Credits & Deductions
  • 529 Plans – This plan allows savings for future education expenses in a tax-advantaged savings plan. While there is no federal deduction for contributions, many states allow an income tax deduction for contributions to the plan. Tax-free distributions can now be made for elementary and secondary education expenses. Beginning in 2024, the SECURE Act 2.0 allows 529 plans that have been in existence for at least 15 years and not spent on education to be rolled to a Roth IRA, free from tax and penalty. This is a huge win for continued tax deferred growth and tax-free withdrawals with the added benefit of losing the “education strings” attached. The lifetime limit is $35,000 and the per year amount will follow the normal Roth IRA annual contribution limits.
  • American Opportunity Tax Credit/Lifetime Learning Credit – These credits are available as both partially refundable and non-refundable credits to offset tax liability. Watch your AGI limitations as they phase out quickly. If you are close to a phase out range, tax planning can help with ways to reduce AGI within the range. These credits are phased out between $160,000 – $180,000 for joint filers.
  • Student Loan Interest Deduction – 2023 brought back student loan interest payments for many taxpayers. The deduction for student loan interest is capped at $2,500 and phases out completely when your AGI exceeds $90,000 ($185,000 for joint filers).

Tax Planning for Businesses

• Depreciation Options
  • Bonus Depreciation – Review timing of major purchases. This provision begins phasing out in 2023 from the prior year 100% expensing allowed on equipment purchases. It is scheduled to phase out in 20% increments and completely gone in 2027.

• • Section 179 Depreciation – This provision still allows taxpayers to tax a deduction for capital asset purchases in 2023. For larger businesses it will not be as advantageous, but the deduction limit is $1,160,000 with a placed in-service limit cost of $2,890,000.
  • Vehicles Weighing over 6,000 Pounds – Buying a vehicle for business purposes is popular. If the passenger vehicle you purchase exceeds the depreciation limit set by law (6,000 pounds) the purchase is not subject to the dollar limit for depreciation ($12,200 in 2023, $20,200 if bonus depreciation is taken).
• Qualified Business Income (QBI) Tax Deduction
  • Individual taxpayers with qualified business income from a pass-through entity (S Corporation, LLC or single-member LLC) or a sole proprietorship can qualify for  deduction generally equal to 20% of your qualified business income.  For 2023, if taxable income does not exceed a threshold of $364,200 (joint filers) or $182,100, the deduction is not limited.
  • The benefit of this deduction starts to phase out when income reaches $182,100 – $233,100 ($364,200 – $464,200 married filing joint). Strategies to increase the QBI deduction include review of wage base limit and controlling taxable income. The calculation is very fact intensive but worth planning to maximize this deduction if you will hit the phase out threshold.

• Deferring Income
  • While C Corporations enjoy a flat 21% statutory rate, and pass-through entities are taxed at lower rates, income deferral is a consideration if you expect taxable income to be higher in 2023 than 2024 or if you anticipate income tax rates to be higher in the future.
  • Review your method of accounting. Changing from the accrual method of accounting to the cash method of accounting can generally put you in a better position to accelerate deductions and defer income. This requires approval by the IRS, but it is obtained automatically by filing Form 3115, Application for Change in Accounting Method. The change can be made by the due date of the return including extensions. Certain C Corporations and associated with a C Corporation principal can make this automatic method changes if their average annual gross receipts for the prior three tax years are $29 million or less. Sole proprietorships, LLCs, relationships and S Corporations can change to the cash method of accounting regardless of income as long as inventories are not a material income-producing factor.
  • There are a number of automatic accounting method changes that may put you in a better tax favored position. Working with a knowledgeable tax advisor can help you identify what makes sense for your business.

• Accelerating Deductions
  • Bad Debts – If you use the accrual method of accounting, analyze your receivable balances, and write off those balances that are totally or partially worthless. For non-business bad debts (such as uncollectible loans) the debts must be wholly worthless to be deductible and may be deductible only as a capital loss. A bad debt deduction is not available if you use the cash basis of accounting.
  • Bonuses accrued at year-end to your employees and paid within two and half months after the company’s year-end are typically deductible in the year of accrual.
  • Inventories of Obsolete Goods – Check inventory at least annually to determine if your business has inventory that is “subnormal.” This is inventory not able to be sold at normal prices due to things like damage, imperfections, shop wear, style changes or other reasons. You can take a deduction for any write-downs associated with this inventory. The inventory must be offered for sale within 30 days of being identified. The inventory does not have to sold within 30 days.
  • Business Interest Expense – Your ability to deduct 100% of your interest payments may be reduced. The ability to deduct interest is limited to the sum of your business interest income plus 30% of your business adjusted taxable income plus floor plan financing interest. While the deduction is not “lost”(it gets carried forward), being aware if this applies to your business is important. If your business had average annual gross receipts of $29 million or less, this does not apply to your business. The limit also does not apply to certain businesses that opt out including real estate, farming businesses and certain regulated utilities.

• Tax Credits

Tax credits directly reduce a taxpayer’s liability on a one-to-one basis. In 2023, it’s important to be aware of numerous existing credits, as well as several new ones.

• • Research & Development (R&D) Credit – If your business is involved in projects involving development and betterment of new processes, products or techniques, you may be eligible for this credit. Small businesses ($50 million or less in gross receipts) may also claim the credit against alternative minimum tax.
  • Work Opportunity Tax Credit – This credit is available to employers for hiring and employing individuals from certain targeted groups. The credit is 40% of the first $6,000 wages paid.
  • Small Employer Retirement Plan Credit – If you did not have a pension plan in the prior three years, your business may be able to claim a nonrefundable credit for expenses incurred to set up and administer the plan. The credit applies to 50% of the costs for each of the first three years of the plan (or 100% is you employ less than 50 employees) and is capped at $5,000. The expense must be paid by the business and not by the retirement plan itself.
  • Energy Credits – The energy investment credit if available for investments in alternative or renewable energy property and is either 10% or 30% of the cost. The Inflation Reduction Act also introduced many new tax credits beginning in 2023 to encourage clean energy and conservation.

• State Considerations
  • Many states have implemented pass-through entity tax provisions which allow the business to take a tax deduction for state income tax payments made on behalf of its owners. Make these payments prior to the end of the year if you use the cash method of accounting to create current year deductions. If you use the accrual method of accounting, it is generally advised to make all payments during 2023 since state taxes are deductible when paid. Kansas and Arkansas adopted provisions starting in 2022.

• Planning for the Future
  • Review your entity structure. Is your business organized in the best possible way for tax and asset liability protection considerations? Complexity of structure can outweigh the tax savings, so a one-size fits all approach is not the best way. Should you form an LLC for liability protection? Elect S-Corporation Status? Does the flat 21% statutory rate of a C-Corporation fit best? Year-end is a good time to review your current entity structure to consider if it is a proper fit as your business continues to grow.
  • If you own a qualifying small business in the form of a corporation, an exclusion of gain on the sale of stock exists. The stock must have been acquired after Sept. 27, 2010 and held more than five years. Current rules allow for a 100% gain exclusion on sale of this kind of stock. This provision is extremely popular for start-up entities.
  • Evaluate global value chain and cross border transactions to optimize transfer pricing and minimize global tax liabilities.
  • Perform a cost segregation study with respect to investments in buildings or renovation of real property to accelerate taxable deductions, claim qualifying bonus depreciation and identify other incentives to reduce or defer various taxes.
  • Evaluate possible co-sourcing or outsourcing arrangements to assist with priority projects as part of your overall business strategy.

Tax Planning for Gifts & Estates

There are many “known” unknowns in the world of estate planning. What we do know is the per person current estate tax exemption ($12.9 million in 2023) is set to expire at the end of 2025. The exemption amount will revert back to pre-TCJA amounts, estimated to be $6.4 million. The rush to plan for this decrease in exemption amount will be overwhelming if you wait until the 11th hour of Dec. 2025.

A good strategy is to work with your CPA and attorney to get a plan in place to review the “what-ifs.” If a trust would be beneficial, now is the time to form your trust, with funding to come later if needed. If you anticipate you will have a taxable estate, time is of the essence to get an asset transfer and gifting plan in place. If the increased amount of the estate exemption (roughly $6.4 million) is not “used” prior to expiration in 2025, it is lost.

• Gifting Strategies

If you own a business, you may want to consider gifting an interest in the business in 2023. You can take advantage of valuation discounts including marketability and minority discounts. The gift tax exclusion is $17,000 per recipient ($34,000 when jointly gifting) in 2023. This exclusion amount will increase to $18,000 in 2024.

Making payments for tuition directly to the educational institution for children or grandchildren can be taken advantage of. These types of payments are not subject to the annual gift tax exclusion amount. Please note, these types of gifts do not include books, supplies, dorm fees or similar expenses.

• Portability elections

Estate tax returns are not required to be filed if the value of the decedent’s estate is under the exemption amount. However, if a spouse dies and has an unused exemption amount, it can be transferred or “ported” to the surviving spouse. Even if the estate exemption is reduced after the expiration of TCJA in 2025, the amount of this unused exemption will still be available. This can be a significant advantage for you if your estate exceeds the expected $6.4 million exemption. An Estate Tax Return, Form 706, must be filed within five years after the date of death or your spouse.

Questions?

While the future looks somewhat uncertain, your decisions today can significantly impact your success. All the above areas can be part of a productive discussion with your tax professional. Contact an Adams Brown advisor with specific questions about your situation.