No, I’m not talking about the return due in today. I’m talking about your 2023 tax return. Let’s face it, when the clock strikes midnight on 31 Dec, your tax return is completed (with a couple of notable exceptions). You’re just filling in the blanks when you file it. So now is the time to start and complete your 2023 return. What should you do?
Get a Handle on Your AGI
Your Adjusted Gross Income (AGI) is the single most important number on your tax return. It is calculated by adding up all your income that is subject to tax and subtracting adjustments. This number controls your ability to qualify for some credits and deductions. Here are some examples:
- The ability to deduct losses for actively managed real estate phases out from $100,000 - $150,000 of AGI
- The American Opportunity Credit and Lifetime Learning Credit phase out from $160,000 - $180,000 for Married taxpayers. For single filers the amount phases out at ½ of the above numbers
- Married taxpayers become subject to the Net Investment Income Tax (NIIT) at $250,000 of AGI and Single taxpayers get hit with the NIIT at $200,000 of AGI
- The Medical Expense deduction only kicks in if your expenses exceed 7.5% of your AGI
If increasing AGI reduces your eligibility for credits and deductions it would stand to reason that reducing your AGI would be a good idea. Here are some ways to do that.
- Max out your pre-tax contributions to an employer sponsored retirement plans
- If self-employed, make sure you account for health insurance premiums as an adjustment to income
- If you don’t have access to an employer sponsored retirement plan max out your Traditional IRA
- If you’re 70 ½ or older and want to support charity, do so via Qualified Charitable Distributions (QCD) from your Traditional IRA
- If you have a lot of actively managed mutual funds or mutual funds in general, look to tax efficiently move to ETFs which don’t have those capital gains distributions in December
Check your Itemized Deductions
If your State and Local Taxes (SALT), mortgage interest and charitable contributions add up to a number close to the standard deduction ($27,700 for Married in 2023, Single is $13,850), consider timing your spending.
The idea is to alternate between taking the standard deduction one year and itemizing the next. For the two-year period your total deductions will be higher than if you itemize both years. Ways to do this include alternating the years you make charitable contributions (make two years’ worth of contributions in the years you make contributions). Or you might look at paying your January mortgage payment in December (again every other year) to get 13 months’ worth of interest in a single year. If you control when you pay your property tax lumping two years of payments into one year (remember the $10,000 SALT limit) could help. Do all of these in the same year, if you can.
Don’t Forget the Long Game
While you want to minimize the taxes you pay this year, don’t forget about your future. I was in some continuing education the other day and the instructor said, “If you’re paying $0 in taxes, you probably goofed up.” I thought about it for a bit, and I think he is right. The idea is that if you’re paying $0 taxes you probably paid or will pay taxes at a higher rate than necessary (probably doesn’t apply to combat deployments). The idea is to fill up lower tax brackets each and every year so that you don’t end up in a higher tax bracket at some point in the future. Here’s an example.
The insurance industry talks about the miracle of a 0% tax rate on distributions (which are really loans) from life insurance policy. Imagine you went all in on this technique, and you literally have a 0% tax rate in retirement (we’ll ignore military retirement pensions which make it virtually impossible to have a 0% tax rate in retirement). You won the game, right? No. Not really. When you paid the premiums for that life insurance policy you paid with money that was probably taxed at a rate higher than 0%. If you’re working, you probably paid 22% of more on the taxes. If you instead took some of the money you put towards insurance and diverted those funds to your pre-tax employer sponsored plan, you might be able to take it out at a rate of less than 22% in retirement.
While you’re thinking about the long game, don’t ignore state income taxes. If you’re currently in a state that has an income tax and you know you’re moving to a state without an income tax when you retire, it is really hard to imagine that your Federal tax rate will be higher in retirement than your combined Federal and State tax rate. That means pre-tax investing (employer plans or IRAs) is probably the best long game play.
Control What You Can Control
We can’t control the market and we can’t control the economy or government. But we can to an extent control how much and when we pay taxes. It can be worth your time to look at it.
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