Year-End Tax Planning Strategies
Now that we’re coming to the end of 2024, it’s time to start thinking about implementing any year-end strategies to optimize your tax situation. Year-end tax planning is a critical component of minimizing your tax liability and ensuring that you’re taking advantage of all available deductions, credits, and other tax-saving opportunities. Here are some effective strategies to consider before the end of the year.
Employer Sponsored Retirement Plan Contributions
There are many different types of retirement plans that companies can offer to their employees, but 401(k), 403(b), and 457 plans are some of the most common. Consider increasing the contributions as much as possible to these tax-advantaged accounts.
Chances are, unless you’re already maxing out contributions there is plenty of room to contribute more. For 2024, the contribution limit for 401(k) plans is $23,000 (for individuals under 50) and $30,500 for those 50 and older.
This will lower your taxable income for the year, therefore reducing your tax bill. For example, if your salary is $100,000 and you contribute $23,000 to your 401(k), you will only pay tax on $77,000.
IRA Contributions
Contributing to a Traditional or Roth IRA can be an effective strategy for reducing your taxable income or securing tax-free growth, depending on which type of IRA you choose. The deadline for funding either or both a traditional IRA and a Roth IRA is April 15th of the following year, so it’s not something that you need to do prior to December 31st.
Traditional IRA: You can contribute up to $6,500 ($7,500 if 50 or older). Contributions to a traditional IRA may be tax-deductible depending on your income and whether you're covered by a workplace retirement plan. You can still make the full contribution even if it’s not tax-deductible, but it won’t save you any taxes.
Roth IRA: Contributions to Roth IRAs are not tax-deductible, but qualified withdrawals are tax-free. That means it won’t lower your taxes today, but will lower your taxes when withdrawn in the future. For 2024, the contribution limit is the same as for traditional IRAs, but there are income limits to consider for Roth IRA eligibility.
Backdoor Roth IRA: A Backdoor Roth IRA is a strategy that allows you to still make a Roth IRA contribution even if your income exceeds the Roth IRA eligibility limits. The income limits for 2024 are $153,000 for single filers and $228,000 for married couples filing jointly, meaning that you can’t make a direct contribution to a Roth IRA if your income (MAGI) exceeds that threshold. It works by first making a non-deductible contribution to a Traditional IRA, then converting it into a Roth IRA — thus bypassing the income limits typically imposed on direct Roth IRA contributions.
Key Consideration: Traditional IRA contributions can reduce your current-year taxable income, while Roth IRAs can offer long-term tax-free growth. Which one to choose depends on your current tax situation and future expectations.
Consider a Roth Conversion
If your income is lower this year or if you expect your tax rate to be higher in the future, converting a portion of your traditional IRA or 401(k) to a Roth IRA might be a good strategy. You'll pay taxes on the amount converted, but future withdrawals from the Roth IRA are tax-free, which could be advantageous if you expect your tax bracket to rise.
Conversions must be done before January 1st of 2025 in order to count towards 2024. In practice, however, you should be executing this strategy well before the end of December because:
You need to determine if doing a Roth conversion actually makes sense in your situation
If it does make sense, you need to determine the proper amount to convert, and
You need to give the financial institution enough time to process the conversion. Year-end is a very busy time of year, so transactions can often be delayed.
Remember, since this is a taxable transaction, you will need to ensure that you have cash to pay the additional tax bill. Typically, it’s not recommended to have income taxes withheld from the conversion itself. Any taxes that are withheld is considered a distribution and may be subject to early withdrawal penalties if you’re under age 59 ½.
Health Savings Account (HSA) Funding
A Health Savings Account (HSA) is a tax-advantaged savings account used to pay for qualified medical expenses, designed for individuals who are covered under a high-deductible health plan (HDHP).
Funding your HSA can provide valuable tax savings and prepare you for future healthcare expenses. Contributing the maximum allowed amount reduces your taxable income, offers tax-free growth, and gives you a flexible way to pay for qualified medical costs. Be sure to check that your health plan qualifies as an HDHP.
The deadline to fund an HSA for 2024 is April 15th, 2025. If your HSA is funded directly from your paycheck through payroll deduction, you can also save on payroll taxes, but you’ll need to make your contributions by December 31st if you want to maximize tax benefits for this year.
The contribution limits for 2024 are $3,850 for individual coverage, and $7,750 for family coverage. If you're over 55, don't forget to take advantage of the additional $1,000 catch-up contribution.
Tax Gain & Loss Harvesting
Tax gain and loss harvesting can be an effective strategy to rebalance your investment portfolio in a tax efficient manner.
Tax Gain Harvesting
If you find yourself in an unusually low tax bracket this year, you may want to sell some assets that have appreciated. You’ll pay tax on the gain, but your tax basis will be increased, therefore reducing taxes in future years. If you’re in the 12% or lower federal marginal income tax bracket, the capital gains tax rate is 0%, meaning you can realize gains without paying any tax. Gains may still be taxable at the state level though.
Example: You’re married filing jointly, and you expect your taxable income for the year to be $50,000. You could realize $44,050 of capital gains without paying any additional federal income tax. That will bring your taxable income up to $94,050, which is the top of the 12% marginal tax bracket.
Tax Loss Harvesting
Selling investments that have decreased in value (capital losses) can help offset any capital gains you've realized during the year. If you sell a security at a loss, you can use that loss to offset capital gains and potentially reduce your taxable income. If you have more losses than gains, you can use up to $3,000 of net capital losses per year to offset ordinary income. Losses above that can be carried forward to future years.
Be sure to avoid the wash sale rule though. You can’t sell a security at a loss and repurchase the same or "substantially identical" security within 30 days, or the IRS will disallow the loss. It’s important to avoid triggering this rule if you want to claim the loss for tax purposes.
Example: You expect your taxable income for the year to be $100,000. $70,000 is wages from your job, and $30,000 is capital gains from stocks that you sold earlier in the year. If you realize $40,000 in capital losses, you’ll offset the $30,000 of capital gains, $3,000 can be used to offset the wages from your job, and the remaining $7,000 will be carried forward to future years. Your taxable income will be reduced to $67,000.
Bunching Itemized Deductions
Bunching itemized deductions is a tax strategy that involves consolidating or "bunching" certain deductible expenses into a single tax year in order to exceed the standard deduction threshold and maximize your itemized deductions. This is worth considering if your itemized deductions are already close to the standard deduction and you can afford to spend a little more to get above that threshold.
The standard deduction amounts for 2024 are:
· $14,600 (single filers)
· $29,200 (married filing jointly)
· $21,900 (head of household)
You must choose whether to take the standard deduction or use itemized deductions when filing your tax return. If your itemized deductions are below the standard deduction, you won’t get any additional tax benefits.
Common itemized deductions include:
· Medical Expenses
· State & Local Taxes (SALT), including property and income taxes
· Mortgage Interest
· Charitable Contributions
Typically, charitable contributions and medical expenses are the easiest way to increase your itemized deductions. Consider making next year’s charitable contributions early or paying for some additional medical expenses that you know will be incurred in the future.
Charitable Contributions
Charitable contributions offer several tax benefits that can reduce your taxable income and potentially lower the amount of taxes you owe. These benefits apply to both cash donations and donations of property (like stocks or real estate).
Here are a few strategies to consider:
Qualified Charitable Distributions (QCDs): If you are over the age of 70½ and have an IRA, you can make Qualified Charitable Distributions (QCDs) directly to a charity. These distributions (up to $100,000 per year) count toward your required minimum distribution (RMD) but aren't included in your taxable income. In most cases, this is better than regular charitable donations because you don’t need to itemize your deductions to get the tax benefit.
Donating Appreciated Property: Donating appreciated property (such as stocks, mutual funds, or real estate) is typically better than just giving cash. When you donate property that has appreciated in value, you can receive a double tax benefit.
No Capital Gains Tax: Normally, if you sold appreciated property, you would have to pay capital gains taxes on the profit. However, when you donate appreciated property to a qualified charity, you don’t have to pay capital gains taxes.
Fair Market Value Deduction: You can generally deduct the fair market value (FMV) of the property at the time of donation, rather than just the amount you originally paid for it. For example, if you bought stock for $5,000 and it is worth $10,000 when donated, you can deduct the full $10,000 value (as long as it’s a qualified charity).
Donor-Advised Funds (DAFs): A Donor-Advised Fund (DAF) is an account set up with a charity that allows you to contribute cash or securities, receive an immediate tax deduction, and then recommend grants from the fund to qualified charities over time. If you plan to donate large sums to charity over time, consider utilizing a Donor-Advised Fund. You get an immediate charitable deduction, but still maintain flexibility since you can control when the funds are distributed and which charities it goes to.
Required Minimum Distributions (RMDs)
Depending on your age, you may need to withdraw a minimum amount from your retirement accounts before year-end. Generally, you must start taking RMDs when you reach age 72 (73 if you reach age 72 after Dec. 31, 2022).
If you have a workplace retirement plan (e.g., a 401(k) or 403(b)) you can delay taking their RMDs until the year you retire, unless they're a >5% owner of the company.
Failing to make the withdrawal can result in penalties. It used to be 50% of the amount you failed to withdraw, but the SECURE Act 2.0 dropped it to 25%; possibly 10% if the RMD is timely corrected within two years.
These rules can be complex and confusing, so it’s recommended to consult with a professional if your situation isn’t straightforward.
Note: Roth IRAs don’t have required minimum distributions for the original account owner, so they don’t apply in all circumstances.
Annual Exclusion Gifting
The annual gift tax exclusion is a set dollar amount that you can give to someone without reporting it to the IRS. The limit per recipient is $18,000 in 2024, meaning you can gift anyone up to that amount without needing to report it. For married couples, the limit is $18,000 each, for a total of $36,000.
You can gift to as many people as you want. For example, if you have 2 siblings, you can give them both $18,000 (or $36,000 if you’re married). The transfer needs to happen before year-end though to count for 2024.
Review Your Withholding
If you've experienced a significant life event (e.g., marriage, divorce, birth of a child) or if your income has changed, you may want to adjust your withholding to avoid surprises come tax season.
You can use the IRS Tax Withholding Estimator or consult with a tax professional to determine if you’re having enough withheld from your paycheck. This will help ensure that you’re keeping as much money as possible throughout the year without underpaying the IRS.
Review Estimated Tax Payments
Making estimated tax payments is an important part of tax planning, especially for individuals who do not have taxes automatically withheld from their income. This includes self-employed individuals, freelancers, small business owners, real estate investors, and others who have income that is not subject to regular withholding.
Failing to make accurate estimated payments can result in an unwanted surprise at tax time, and possibly additional interest and penalties.
Close to year-end is a good time to evaluate where your income is at for the year and determine whether additional payments are necessary.
You can either pay based on safe harbor (see below) or have your tax professional run a projection based on actual YTD numbers.
Safe Harbor Rules: You will avoid incurring any underpayment penalties if:
You owe less than $1,000 in tax after subtracting all withholdings and credits.
You pay at least 90% of your actual tax liability for the year in estimated taxes or withholding.
You pay 100% of your previous year's tax liability in estimated taxes or withholding (if your income is $150,000 or less).
You pay 110% of your previous year's tax liability in estimated taxes or withholding (if your income is more than $150,000).
Accelerate Expenses or Defer Income
Deferring business income and accelerating expenses can be a useful year-end strategy to reduce your taxes. Most small businesses use the cash method of accounting, meaning they recognize income when it is received and expenses when they are paid. If you can defer income to the following year and accelerate expenses to the current year, it can result in substantial tax savings. It will decrease your total profit for the year, therefore resulting in a lower tax bill.
Income Deferment:
If possible, simply delay billing to your clients until the next tax year. This will defer the recognition of income to the following year.
For example, say you did $5,000 worth of work for your client in December. Instead of requesting payment immediately, wait until January of the following year.
This strategy can also work for employees if you have some control over when you receive income.
For example, if your employer is going to pay you a bonus before year-end, see if it’s possible to delay payment until the following year.
This is especially useful if you expect to be in a lower tax bracket next year.
Expense Acceleration:
Pay for expenses before year-end to get the deduction in the current year. This will increase your total expenses, therefore lowering your profit for the year.
Things to Consider:
Prepay Expenses: Pay for normal operating costs now that you know will occur in the next year. For example, if you know you will pay $10,000 for marketing next year, you can pay for them now and take the deduction this year.
Credit Card Utilization: You can use a credit card to pay for the expenses before year-end, but often delay paying the bill until the following month. This can help if your business is tight on cash.
Purchase Supplies or Equipment: Buy necessary supplies, inventory, or equipment now that will be utilized next year. This could be furniture, tools, office supplies, a new computer, etc.
Employee Bonuses: If you’re planning on giving your employees a bonus, you can pay that out before year-end.
Maximize Business Deductions (If You’re Self-Employed or Have a Side Business)
Maximizing your business deductions before year-end is a smart way to reduce taxable income and lower your overall tax liability for the current year. There are several strategies you can implement to ensure you’re taking full advantage of allowable deductions and credits.
Here’s are some of the key opportunities to consider:
Business Travel: Plan any business travel or before year-end. Travel expenses can include airfare, lodging, transportation services, etc.
Section 179 Deduction: If you’ve purchased equipment for your business, you may be able to deduct the full cost in the year of purchase under Section 179, instead of depreciating them over time. Assets that typically qualify include machinery, equipment, and vehicles.
Bonus Depreciation: This allows businesses to accelerate the depreciation of qualified property in the year it’s purchased and placed in service. This is available for most tangible assets such as equipment, machinery, computers, furniture, and vehicles. In 2024, you can deduct 60% of the cost immediately, with the remaining 40% depreciated over the following years.
Home Office Deduction: If you use a portion of your home exclusively for business, you may be able to deduct related expenses (e.g., utilities, internet, property taxes, mortgage interest, etc.). You can also stock up on office supplies or purchase necessary equipment before December 31st. Supplies like computers, phones, and office furniture can be fully deductible, and capital expenses may be eligible for Section 179 deductions or bonus depreciation.
Retirement Plan Contributions: Self-employed individuals can set up a SEP-IRA or Solo 401(k) and make larger contributions than traditional employees, which can reduce taxable income and also helps you invest for the future.
Review Inventory: If you have excess or obsolete inventory, consider writing it off before year-end. Business owners can deduct the cost of goods sold (COGS) and write off unsellable or outdated inventory that’s no longer valuable to the business. It’s also a good idea to review your inventory to make sure all costs are accounted for, and adjust your books to reflect any changes.
Tax Credits: You’re probably familiar with the child tax credit, but there are also special tax credits for business owners. Review your situation to see if you may qualify for any. Some of the most common include:
Research & Development (R&D) Credits
Work Opportunity Tax Credit (WOTC)
Energy Efficiency Credits
Disabled Access Credit
Retirement Plan Start-Up Credits
Pass-Through Entity (PTE) Tax Credit
Clean Up Your Books
Cleaning up your books before year-end is essential for both tax preparation and financial decision-making. Properly maintaining your financial records ensures that you’re ready for tax season, allows you to identify opportunities for maximizing deductions, and sets your business up for success in the new year. It’s also a great way to identify potential financial issues early, making it easier to take corrective action and keep your business on track.
Moreover, a clean set of books makes it easier for your accountant or tax preparer to finalize your financials. If your books are well-maintained, they can work more efficiently, reducing the time it takes to prepare your tax returns, likely resulting in lower accounting fees.
Close to year-end, it’s a good idea to have a discussion with your accountant to identify adjustments that should be made based on your financial situation.
Take Advantage of State-Specific Deductions & Credits
Some states offer specific tax deductions or credits that you can take advantage of at the end of the year, such as contributions to state-sponsored college savings plans (e.g., 529 plans) or state-specific retirement plans.
These deductions and credits vary significantly from one state to another, so understanding the rules for your specific state is essential to maximizing your tax savings.
Review Your Tax Situation with a Professional
Tax laws change frequently, so it’s probably a good idea to get personalized advice. A tax professional can help ensure you're using the latest strategies and taking full advantage of any new opportunities. They can also help you project your tax liability for the upcoming year and advise on any last-minute moves that might be beneficial.
By considering these strategies before the end of the year, you can potentially reduce your tax bill, optimize your financial situation, and ensure that you’re on track for tax planning in future years.