Follow these tax planning tips for 2024 and bring your A game at tax time. Most of us don’t even think about our taxes until after the New Year. After all, most personal tax filings aren’t due until April 15th. But if you don’t do it now, you might miss out.
Shortly after each calendar year ends, most taxpayers are focused on how large their IRS refund will be. However, using the IRS as a savings vehicle will rarely leave one better off financially. Here are some areas to consider when planning the annual dance with the IRS.
Tax planning tips for 2024
Independent contractors:
Whenever a person takes on “1099” work versus W-2, the tax consequences can be dramatic. 1099s are subject to an additional tax of about 15% (a.k.a. self-employment tax). This is the same tax that gets paid when you are an employee except the big difference is that the employer pays half and your half comes out of your paycheck. Because of this, many folks who received 1099 income are surprised by how much tax is owed.
If you haven’t already, start setting cash aside now. I know it’s easier said than done but independent contractors need to be ready to cover the self-employment tax. There are plenty of tax advantages to being self-employed, but this isn’t one of them. Remember, you must pay the taxes that are owed even if you’re planning to extend filing your tax return.
Long and short-term gains:
Understanding the holding period of capital assets (like stocks and bonds or mutual funds) is critical. The tax rates can be dramatically different between the two categories.
Long-term capital gains (LTCG) have special tax treatment. LTCGs are gains realized by selling securities held for at least one year. If you meet this holding period you can potentially pay 0% on your LTCGs if your taxable income is under a certain amount. See the chart below:
Short-term capital gains (STCG) are gains realized by selling securities held for less than one year. STCGs are taxed at your ordinary income rates which are likely much higher.
It may be only a matter of holding an asset a few days longer to reap a large tax savings.
Tax Loss Harvesting:
If you have securities that have appreciated in value and you’d like to sell them for a gain, consider tax loss harvesting. This process allows you to offset your capital gains to the extent you have realized losses. The result is avoiding taxes on the realized gain.
Consider the following example. Let’s say you bought 100 shares of ABC stock at $10 per share. Your basis in the stock is $1,000 ($10 price X 100 shares). ABC stock increased in value to $15 per share. Your total value is now $1,500. Your unrealized gain is $500 ($1,500 value – $1,000 basis). Assuming you held the stock for more than 12 months and sold the 100 shares of ABC, you would realize a long-term capital gain (LTCG) of $500. This gain is subject to the special LTCG tax rates.
Now, let’s assume DEF stock, which you purchased a year ago, hasn’t performed well. You have an unrealized long-term capital loss of $500. You determine that the prospects of this investment are dim and would like to part ways.
If you sell DEF, you can offset the realized gains of ABC and pay zero long-term capital gains rates. Please note that this is a basic example and the rules become complicated when considering other factors.
Mutual Fund Distributions:
If you own mutual funds in a taxable account, you might be surprised by the end of year distributions. When the portfolio manager buys and sell securities within your mutual fund, they generate gains and losses. Mutual funds are required to pass on 90% of the net realized gains to you, the shareholder. This usually occurs in December.
Let’s consider the following example. You are considering buying mutual fund XYZ in a taxable brokerage account (non-retirement) in November. XYZ mutual fund had a good year and realized significant gains this year. In fact, some of the gains were from investments the mutual fund owned for many years and finally decided to sell. To determine which shareholders of the fund receive this distribution, the fund will look at all shareholders owning XYZ as of the day before the record date.
This means that you buy into the fund in November and the fund pays out a dividend in December. At first, you might be glad that you received this distribution. However, it’s not what it seems. You are now getting the privilege of paying tax on the distribution while receiving no economic benefit.
One way to avoid this is to monitor the proposed distribution rates that are published by the mutual fund companies. You can wait just one day past the record date to buy the fund and avoid the distribution.
Another way to minimize this issue is investing in more tax efficient securities like index Exchange Traded Funds or ETFs.
Divorce:
Going through a divorce is a rough process to say the least. There are complex considerations to be evaluated all while dealing with the emotional toll of a relationship at its end. Future tax filing may not be at the top of the list.
Finalizing your divorce without understanding the tax implication of who claims the children as exemptions can be costly. Depending on the income each party earns, there are tax credits that may go unused if the exemption is taken on the higher earner’s tax return.
Another consideration involves your tax filing status and making sure you follow the IRS rules. These issues can be complicated and will involve the help of an attorney. However, you need to realize that tax tax rates and standard deductions vary depending on your filing status. These include married filing jointly, married filing separately, single, and head of household to name a few.
Withholding too much from your paycheck:
If you’re getting a large refund at the end of the year from the IRS or state, you’re probably withholding too much from your paycheck. The IRS doesn’t pay interest to those that overpay them, in most instances. Don’t count on receiving a toaster or even getting a thank you note.
A better option is to make the necessary tax withholding adjustments so you keep more of your money throughout the year. Those funds could go toward other retirement accounts, college savings plans, or to pay off debt.
Required Minimum Distributions (RMDs)
If you’re over 73 years of age, the IRS requires you to take distributions from an IRA. The distributions are included in your taxable income.
Utilizing a Qualified Charitable Distribution (QCD) strategy could reduce the tax impact of the RMD if structured properly.
Another consideration is the timing of the RMD. These distributions must occur no later than December 31st unless it’s the first RMD the account holder has taken. Setting that exception aside, let’s consider the following example.
Your RMD is $2,500 for 2024 and you already satisfied the requirement earlier in the year. Stated another way, you are not required to take any more from your IRA in 2024. Then in December of the same year, you realize that you want an extra $1,000 to cover some expenses or to splurge on Christmas presents for the grandkids.
If you wait until January 2nd (January 1st is always a holiday) you could take that $1,000 from the IRA and apply it toward your 2025 RMD. By waiting just a couple of weeks to pull the $1,000 from one tax year and into another.
Early IRA distributions:
This area of the law can be confusing to most. Simply plugging in numbers, after the fact, into tax preparation software might help a taxpayer report what happened in a given year, but it leaves no opportunity to plan distributions in a tax efficient manner.
Early distributions often occur in a year when the taxpayer has had a financial setback. Waiting until the last minute may result in lost opportunities to help offset some of the additional taxes and penalties incurred from the early distribution.
Setting up retirement plans:
Many people don’t realize how early you need to establish certain retirement plans to take advantage of the tax benefits. The reason is that most of us are used to the rules that apply to Traditional IRAs, Roth IRAs, and SEP IRAs. These accounts can be set up and funded during tax season so that the reduction in tax is applied to the prior year.
For example, in March of 2025 you start preparing your tax return for the 2024 tax year. You determine that making a retirement account contribution will help reduce your taxes. In this case, you could establish and fund a Traditional IRA or SEP IRA in 2025 and receive the deduction for the 2024 tax year.
However, what if you would have been better off setting up an Individual 401k plan (a.k.a Solo 401k or I401k)? In this case, it would be too late. These plans need to be established in the year for which the contribution is intended. These can be powerful retirement planning tools but you need to plan ahead to take advantage of them.
Maximizing retirement plans:
If you participate in a 401k, 403b, or SIMPLE IRA retirement plan at work, you are in the home stretch for 2024. If you have been considering making an increase in your contributions, now is the time. The minimum you should be contributing to the 401k is the amount that qualifies for 100% of the matching from your employer. If you’re ready to increase even further, every dollar you put in will either reduce your taxes now, or minimize them in the future if you’re making Roth 401k contributions.
Unlike Traditional IRAs, Roth IRAs, and SEP IRAs, company retirement plan contributions must be made within the calendar year. Whatever you’ve socked away in a 401k, 403b, or SIMPLE IRA by December 31 is all that is counted toward your 2024 tax bill.
More on early withdrawals:
I was recently asked “Can I take money out of my Individual Retirement Account (IRA) while working?” The short answer to this question is “yes.” You can take withdrawals from your IRA at any time. But there is catch. Assuming all of the contributions you made were tax deductible, the withdrawals would be taxable as ordinary income. If you are under age 59 ½ you would likely be subject to an early withdrawal penalty from the IRS. When added together, the taxes and penalties can take a huge bite out of your IRA.
Just because you can take money out of an IRA, doesn’t mean you should. For many people, it is an easy place to look when funds are needed. It’s almost too easy to withdraw from an IRA and it can lead to less than optimal financial decisions.
If you’re getting to the point where you have no other choice but to make an early withdrawal, consider the timing. Let’s say you decide to make a withdrawal and it’s mid-November or early December. If you could hold out a few more weeks and wait until after the New Year, you now have a taxable event in 2025 versus 2024.
This is due to the fact that IRA withdrawals are based upon the calendar year they were taken. So, if you make an early IRA withdrawal on December 31 of 2024, you’ll be paying the tax and penalties at tax time in April 2025.
Tax planning tips for 2024 disclaimer:
Please remember this should not be considered tax advice. Make sure to consult a tax professional for guidance on your personal situation. Take the time to start tax planning now. These tax planning tips for 2024 can go a long way toward minimizing taxes and avoiding some costly pitfalls.
Do you have questions about these tax planning?
Schedule a call with me via this link!
Image courtesy of FreeDigitalPhotos.net
My mother broke her hip last week and I find your advice on withdrawing from one’s IRA can be taxed to be worrying. I want to help pay her hospital bills and keep her calm for her to recover faster. Reading your article made me consider getting her taxes sorted out by a professional in order to avoid penalties from using her IRA early.
I love what you said about maximizing retirement plans. Tax planning should be done with the help of experienced accountants. If I were to need help filing my taxes, I would make sure to work with the best accountant I could find.