Closing the Fiscal Year: Tax Strategies You Can't Miss
Essential Steps to Optimize Your Tax Liability Before Year-End
As an entrepreneur aiming to reduce taxes and achieve financial freedom legally, it's imperative to recognize that many tax-saving strategies must be executed before December 31st. Waiting until the tax filing deadline in April may forfeit valuable opportunities. This checklist provides advanced strategies with examples to help you optimize your tax position as the fiscal year closes.
1. Recognize the True Tax Deadline: December 31st
While tax returns are due in April, most tax planning strategies must be implemented by December 31st to affect your current year's tax liability. Proactive planning is essential to take full advantage of available deductions and credits.
2. Defer Income and Accelerate Deductions
Strategy: Shift income into the next tax year and bring deductible expenses into the current year to lower taxable income.
Deferring Income Examples:
Delay Invoicing: Postpone sending out invoices until late December or early January, so payments are received in the next tax year.
Year-End Bonuses: If you are both the owner and an employee, consider deferring bonuses to yourself until the following year.
Accelerating Deductions Examples:
Prepay Expenses: Pay upcoming expenses such as rent, utilities, or insurance premiums before year-end.
Purchase Supplies and Equipment: Buy office supplies or equipment now to claim deductions, ensuring they are placed in service by December 31st.
Charitable Contributions: Make planned charitable donations before year-end and consider donating appreciated stock to maximize tax benefits.
Advanced Considerations:
Cash vs. Accrual Accounting: Ensure that your accounting method aligns with these strategies; deferral and acceleration techniques may vary based on your accounting method.
Alternative Minimum Tax (AMT): Be cautious of the AMT, which may limit the benefits of accelerated deductions for higher-income taxpayers.
3. Implement Tax-Loss Harvesting
Strategy: Realize investment losses to offset capital gains and reduce taxable income.
Example:
Portfolio Review: Suppose you have a stock that has decreased in value by $15,000 and another that has increased by $12,000.
Action: Sell the losing stock to realize a $15,000 loss and sell the appreciated stock to realize a $12,000 gain.
Result: The $15,000 loss offsets the $12,000 gain, eliminating tax on the gain, and the remaining $3,000 loss can offset ordinary income (up to $3,000 per year).
Carry Forward Excess Losses: Any losses beyond $3,000 can be carried forward to future tax years indefinitely.
Advanced Considerations:
Wash-Sale Rule: Avoid repurchasing the same or "substantially identical" security within 30 days before or after the sale to maintain the deductibility of the loss.
Asset Allocation: Reinvest in a different security or fund to maintain your investment strategy without violating the wash-sale rule.
4. Monitor and Avoid Unwanted Capital Gains Distributions
Strategy: Prevent unexpected taxable income from mutual fund and ETF capital gains distributions.
Example:
Fund Distribution Announcement: A mutual fund announces an expected capital gains distribution of 12% of its net asset value (NAV).
Action: If you own shares in a taxable account, consider selling the fund before the ex-dividend date to avoid the taxable distribution.
Alternative: Reinvest in a similar fund or ETF to maintain market exposure.
Advanced Considerations:
Tax Efficiency of Funds: Evaluate funds for their tax efficiency; index funds and ETFs generally have lower turnover and fewer distributions.
Long-Term Strategy: Incorporate tax efficiency into your investment selection to minimize future distributions.
5. Evaluate Roth IRA Conversions
Strategy: Convert traditional IRA assets to a Roth IRA to benefit from tax-free growth and withdrawals in the future.
Example:
Low-Income Year: Suppose your business had a down year, resulting in lower taxable income.
Action: Convert $60,000 from your traditional IRA to a Roth IRA, paying tax at your current lower rate.
Future Benefit: All future growth on the converted amount is tax-free, and qualified withdrawals in retirement are tax-free.
Advanced Considerations:
Tax Bracket Management: Convert an amount that keeps you within your current tax bracket to avoid pushing yourself into a higher bracket.
Medicare IRMAA Thresholds: Be aware that higher income from conversions may increase Medicare premiums (Income-Related Monthly Adjustment Amount).
State Taxes: Consider state income taxes on the conversion amount, especially if you plan to retire in a no-income-tax state.
6. Leverage the 0% Capital Gains Tax Rate
Strategy: Realize long-term capital gains at a 0% federal tax rate if your taxable income falls within certain thresholds.
2024 Tax Year Thresholds: (As per IRS updates.)
Single Filers: Taxable income up to $45,000.
Married Filing Jointly: Taxable income up to $90,000.
(Note: These figures are estimates based on inflation adjustments. Verify with the latest IRS data.)
Example:
Retired Couple: A married couple with $75,000 in taxable income, including $20,000 in long-term capital gains.
Action: Sell additional appreciated assets to realize up to $15,000 in gains, staying within the $90,000 threshold.
Result: The additional gains are taxed at 0% federal capital gains tax.
Advanced Considerations:
Interaction with Other Income: Be mindful of how additional income affects Social Security taxation and potential phase-outs of deductions or credits.
State Taxes: Some states do not offer a 0% capital gains rate; consider state tax implications.
7. Maximize Retirement Plan Contributions Before Year-End
Strategy: Contribute the maximum allowable amounts to retirement accounts to reduce taxable income.
2024 Contribution Limits:
401(k), 403(b), and 457 Plans:
Under Age 50: $23,000.
Age 50 and Over Catch-Up: Additional $7,500, totaling $30,500.
IRA Contributions:
Under Age 50: $7,000.
Age 50 and Over Catch-Up: Additional $1,000, totaling $8,000.
Example:
Self-Employed Individual: Establish a Solo 401(k) by December 31st.
Action: Make an employee deferral of $23,000 and an employer profit-sharing contribution of up to 25% of net self-employment income, up to the combined limit of $67,500 (for 2024).
Result: Significant reduction in taxable income and increased retirement savings.
Advanced Considerations:
Deadline Awareness: Employee deferral contributions must be made by December 31st; employer contributions can often be made up to the tax filing deadline, including extensions.
Catch-Up Contributions: Ensure catch-up contributions are accounted for if you are age 50 or older.
Plan Type Selection: Evaluate whether a SEP IRA, Solo 401(k), or Defined Benefit Plan offers the most significant tax advantage based on income and retirement goals.
8. Plan for Increased Contribution Limits in 2024
Strategy: Adjust your payroll and contribution plans to accommodate increases in retirement plan limits.
Example:
Automatic Increase: With the 401(k) limit increased to $23,000, adjust your payroll deferrals in January to contribute the full amount over the year.
Monthly Contribution Calculation: Divide the annual limit by 12 months to determine the monthly deferral amount (e.g., $23,000 ÷ 12 ≈ $1,916.67 per month).
Advanced Considerations:
Maximizing Employer Match: Ensure your contribution schedule aligns with your employer's matching program to avoid missing out on matching contributions.
Non-Discrimination Testing: Highly compensated employees should be aware of potential limits due to IRS testing rules.
9. Optimize Business Deductions and Credits
Strategy: Review your business expenses and take advantage of available deductions and tax credits.
Examples:
Section 179 Deduction:
Action: Purchase qualifying equipment or software and place it in service by December 31st.
Limit: Deduct up to $1,180,000 in 2024 (subject to phase-out thresholds).
Research and Development Credit:
Action: Document qualifying R&D expenses to claim the credit.
Qualified Business Income (QBI) Deduction:
Action: Review income levels and consider strategies to maximize the 20% QBI deduction under Section 199A.
Advanced Considerations:
Bonus Depreciation: Evaluate using 60% bonus depreciation for qualifying property placed in service in 2024 (continuing phase-down from prior years).
Energy Efficiency Credits: Consider credits for energy-efficient building improvements or equipment.
10. Conduct a Comprehensive Tax Projection
Strategy: Simulate your tax liability before year-end to identify planning opportunities and avoid surprises.
Example:
Software Tools: Use advanced tax planning software or consult with a CPA to project your tax liability based on current income and deductions.
Adjustments: Identify areas where you can make adjustments, such as increasing retirement contributions, accelerating expenses, or timing income.
Advanced Considerations:
Estimated Tax Payments: Ensure you've made sufficient estimated tax payments to avoid underpayment penalties.
Alternative Minimum Tax (AMT): Analyze whether you're subject to AMT and how it affects your deductions.
11. Be Mindful of Tax Law Changes
Strategy: Stay informed about recent tax legislation that may impact your tax planning strategies.
Examples:
Secure Act 2.0 Provisions:
RMD Age Increase: The Required Minimum Distribution age increased to 74 starting in 2024.
Catch-Up Contributions: Higher catch-up contributions for individuals aged 60-63 starting in 2025.
Tax Cuts and Jobs Act Expirations: Some provisions are set to expire after 2025, which may affect future tax rates and deductions.
Advanced Considerations:
Sunsetting Provisions: Plan for potential changes in tax rates and deductions due to expiring legislation.
State and Local Taxes (SALT): The $10,000 cap on SALT deductions remains in effect; consider strategies like Pass-Through Entity (PTE) tax elections where available.
12. Consult with a Tax Professional
Strategy: Engage with a qualified tax advisor to tailor strategies to your specific situation.
Benefits:
Expert Guidance: A CPA or tax attorney can provide insights into complex tax laws and identify opportunities you may have overlooked.
Compliance Assurance: Ensure all strategies comply with IRS regulations to mitigate audit risks.
Long-Term Planning: Develop a multi-year tax strategy that aligns with your financial and business goals.
Final Thoughts
Year-end tax planning is a critical component of financial success for entrepreneurs. By proactively implementing these advanced strategies before December 31st, you can significantly reduce your tax liability and enhance your path toward financial freedom.
Action Steps:
Schedule Time: Dedicate time before year-end to review your financial situation.
Gather Documentation: Collect relevant financial statements, investment reports, and expense records.
Note: Tax laws and limits mentioned are based on information available as of October 2023.