Recently enacted at the end of December 2022, SECURE 2.0 incorporated numerous changes for employer and employee retirement options. As part of these changes and effective for the 2023 tax year, domestic employers are now allowed to set up and fund a SEP-IRA for their nannies, housekeepers and other domestic employees that they employ, pay wages to and report on a Form W-2. The maximum allowed SEP-IRA funding is 25% of the employee’s reported W-2 wages annually. Establishing and funding a SEP-IRA for a nanny or other household employee is a great option for paying a year-end bonus to show appreciation for the employee’s commitment throughout the year. Funding the SEP-IRA is tax deferred compensation to the employee without creating a tax current liability for the employee and provides them with a long-term retirement planning opportunity.
Prior to 2023, a SEP-IRA retirement option was only allowed for employers and employees in an active trade or business, and not permitted for household employers.
If you or your parents have significant medical tax deductions this year, consider this year-end tax saving idea.
It is not unusual for elderly taxpayers to incur significant qualified tax-deductible medical expenses in a year related hospital stays, home healthcare and/or specialized medical care facilities. Often, these expenses are so large that the taxable income (frequently just required minimum distributions (RMDs) from IRAs and social security income) on their tax returns is reduced to $0 after accounting for their medical deduction. If this may be a situation you find yourself or your elderly parents in, consider converting a portion or all traditional IRAs owned to a Roth IRA. By taking advantage of a significant medical deduction, converting your traditional IRA to a Roth IRA could result in minimal or no taxes on the Roth conersion.
The two main benefits to the Roth IRA: first, there are no annual RMDs and second, earnings on the appreciation of the investments held in the Roth IRA are tax-free. Plus, depending on when the taxpayer’s Roth IRA was established, there may be no taxes related to RMDs made by the beneficiary of an inherited Roth IRA once received upon the death of the taxpayer.
As overall interest rates have crept up over the past few years, so has the interest rate assessed by the IRS on taxpayers that owe significant taxes with the filing of their personal income tax return. Going back to the first quarter of 2022 that underpayment interest rate was 3%. Gradually increasing over the past 2 years, the assessed IRS rate on underpayments of taxes is now at 8% for the fourth quarter of 2023. For taxpayers who generally saw their Underpayment of Estimated Tax Penalty assessed in the amount of $500 on their tax return when a large tax balance was owed resulting from not paying estimated taxes in prior years, that penalty quite possibly may jump to more than $1,200 under a similar tax shortfall scenario in 2023, an increase of more than 250%.
Paying a fourth quarter estimated tax will help reduce an assessed penalty, but not by very much if nothing was paid in quarters 1, 2 and 3. Assuming you currently have the funds for the taxes to be owed set aside for the current year, one alternative to avoid the possible assessment of this tax shortfall penalty is to take advantage of the 60-day rollover rule. A taxpayer is allowed to take a distribution from an IRA or employer plan and roll over the funds within a 60-day period of time. For a taxpayer facing a tax shortfall and looking to avoid an Underpayment of Estimated Tax Penalty assessment, they can take the IRA or retirement plan distribution in the amount of the projected tax shortfall and withhold the entire amount of the distribution for federal and state taxes – thus, getting the tax shortfall paid into the IRS and state by December 31, 2023. Although the taxpayer has 60 days to roll over the full amount of the gross distribution (distribution amount before withheld taxes), we recommend rolling over the funds within a week or two to be sure the rollover isn’t forgotten. One last caveat to note, the IRS limits taxpayers to making an IRA-to-IRA rollover only once per any 12-month period of time.
For taxpayers and borrowers making student loan payments, they should check out the Saving on a Valuable Education (SAVE) Plan that partially went into effect this past summer. The SAVE Plan replaces the Revised Pay As You Earn (REPAYE) Plan. Additional SAVE Plan benefits are scheduled to be implemented beginning July 2024.
The SAVE Plan is an income-driven repayment (IDR) plan for student loans. Under this IDR plan, monthly payments are determined based upon the borrower’s income and family size. There are two major changes that were implemented as a result of the SAVE Plan this past summer that may impact the amount of the monthly student loan payment and are based upon the borrower’s “discretionary income” calculation noted below:
- A borrower’s discretionary income is the difference between their Adjusted Gross Income (AGI) and 225% of the poverty line (exemption amount). Because the SAVE Plan increased the exemption amount from 150% to 225% of the poverty line, a borrower’s discretionary income will be lower, and they may qualify to make a lower monthly student loan payment.
- If a taxpayer files his or her income taxes separately from their spouse, that borrower can exclude their spouse’s income in determining their AGI, resulting in a lower AGI amount and therefore potentially qualifying for a lower monthly loan repayment amount.
One major consideration with regard to item #2 above, taxpayers will need to determine if the total dollars being saved as a result of making smaller loan payments when excluding a spouse’s income in calculating IDR will result in a larger cash benefit when compared to the potential increase in income taxes from filing taxes separately from their spouse. Generally, taxpayers will see a tax benefit when their tax filing status is married filing jointly compared to married filing separately. Married filing separately is generally not a tax favorable filing method for most married taxpayers. Taxpayers considering filing taxes separately from their spouse to take advantage of excluding their spouse’s income in the IDR calculation, should consult with their tax preparer as well to determine whether or not there is a significant tax cost as a result from filing taxes separately.
Shoppers need to remain on the alert for internet predators and scam artists while working on their holiday shopping list this time of year. As a helpful guide, the IRS has posted the following tips on their website to help protect shoppers doing their on-line shopping this holiday season.
- Shop at sites where the web address begins with “https” – the “s” is for secure communications and look for the padlock icon in the browser window.
- Don’t shop on unsecured public Wi-Fi in places like a mall or restaurant.
- Keep security software for computers, tablets and mobile phones updated.
- Protect the devices of family members, including young children, older adults as well as less technologically savvy users.
- Make sure anti-virus software for computers has a feature to stop malware, and that there is a firewall enabled that can prevent intrusions.
- Use strong and unique passwords for online accounts.
- Use multi-factor authentication whenever possible. It helps prevent thieves from easily hacking accounts. The IRS also reminds the tax community that the Federal Trade Commission this summer updated their standards and now requires tax professionals to use multi-factor authentication to protect information.
A few other safeguards to consider:
- Ask your credit card company to provide alerts for total purchases in excess of a set threshold in a month.
- Use your credit card for online purchases and avoid using a debit card. Most credit cards have a payment protection plan in place, debit cards do not.
- Avoid providing your social security number.
- Carefully look at email addresses for validity pertaining to email notifications and solicitations you receive in your email inbox.
- Supervise your children’s online purchases and their use of your credit card while making internet purchases.
As the year winds down, now is the time to take steps to cut your 2023 tax bill while being mindful to not defer so much taxable income that you push yourself into the next tax bracket in 2024. Prior to December 31st:
- Increase your 401(k) and 403(b) contributions if you haven’t been contributing at the maximum rate all year. This year you can put up to $22,500 into your 401(k) or 403(b) plan at work. Anyone 50 or older by December 31st can put away an additional $7,500 for a total of $30,000. Contributing to a 401(k) or 403(b) plan at work is one of the best tax shelters available to you during your working years.
- If you’re self-employed, consider setting up a Solo 401(k). A Solo 401(k) plan lets a self-employed person hit the $66k retirement plan max with less income than a SEP IRA, and allows a self-employed person aged 50 or older to put away $73.5K for 2023 versus $66k into a SEP IRA. Solo 401k’s are also Roth Conversion friendly by accepting rollovers of tax-deferred income from your current IRAs.
- Take a look at your withholdings and instruct your employer to withhold additional taxes to avoid getting hit with an underpayment penalty if you haven’t had enough taxes withheld during the year. (Take a look at the IRS’ Withholding Calculator to set your withholdings for 2024.)
- Consider selling your investments held in non-retirement accounts that have decreased in value since your capital losses can offset other capital gains realized during the year (including capital gain distributions from your mutual funds). Excess losses can then be used to offset up to $3,000 of wages and other income while any remaining losses get carried over to next year. Make sure to wait at least 31 days before buying back a security sold at a loss, or the IRS will disallow the loss under the “wash sale” rules. Please note that wash sale rules currently don’t apply to crypto losses.
- Consider selling your investments held more than one year that have increased in value if you are in the two lowest tax brackets since the long-term capital gains rate for you will be 0%. You can then buy back those securities, and the “cost-basis” will be the higher amount. Wash sale rules don’t apply to securities sold at a gain. This strategy will save you taxes down the road when you sell these securities. Just make sure that the capital gains realized don’t push you out of the 22% tax bracket since you’ll be taxed on those long-term capital gains that fall outside that bracket at 22%.
- Send in your January 2023 mortgage payment early enough so it will be processed prior to 12/31/23. By sending in your payment a few weeks early, you can deduct the interest portion of that payment a full year earlier if you will be itemizing your deductions.
- Clean out your closets and donate your clothing and household items to a charitable organization, since “non-cash” contributions are deductible if you itemize. Don’t forget to get a receipt. And you should make a list of each item donated, along with its condition, and snap a few photos as well. Remember, only donations of clothing and household items in “good condition or better” qualify for a deduction.
- For gifts of money, making your donation by credit card before December 31st allows you to deduct the donation on this year’s return, even if you don’t pay your credit card bill until 2024. And you always have the option of donating appreciated investments to charities or a Donor Advised Fund. You get to claim your donation based on the value of the assets donated without paying any capital gains taxes on the appreciation. (Use this IRS tool to confirm a charity as legitimate.) Don’t donate investments that have decreased in value. Instead, sell them first, take the loss on your taxes, and donate the money received from the sale. Learn more about Managing Your Charitable Donations.
- Pre-pay your projected state tax shortfall if you’ll be itemizing your deductions and will have less than $10k in state income taxes and real estate taxes combined. Practice owners operating in Massachusetts and many other states as S-Corps and Partnerships can now get around the $10k max and pay their personal Mass taxes on the flow-through profit as a deductible expense to the practice known as the Entity Level Tax.
- Pre-pay and pay off your medical bills if your total allowable medical expenses exceed 7.5% of your income and you itemize. If you have a qualifying high deductible health insurance plan in place, max out your 2023 Health Saving Account at $3,850 if single or $7,750 for families by 4/15/24. Anyone 55 or older can add $1k to their H.S.A.s.
Practice owners should begin by finalizing their plans to replenish supplies and pay outstanding bills by 12/31, purchase and install equipment and technology by 12/31, and figure out the maximum retirement plan contribution allowable that makes the most long-term financial sense.
Lastly, as a bonus year-end planning tip, don’t forget that you have 180 days from the date you realize a capital gain to invest up to the full amount of the capital gain into an Opportunity Zone fund and defer paying income taxes on your realized gain until that investment is sold.
And, as always, evaluate whether you’ll save any taxes by postponing 2023 income or deductions into 2024 or by accelerating 2024 income or deductions into 2023. Don’t forget that the Massachusetts millionaire’s tax started 1/1/23, so successful practice owners with income greater than $1M per year should incorporate that new tax in their planning.