"Happiness is not by chance but by choice"
- Jim Rohn
A new tax year is a great time to make smart tax moves and avoid dumb ones.
This difference matters a lot because taxes are often the largest factor affecting investment returns in a portfolio. They also matter to your retirement savings, your home and your donations, among other things.
So let’s kick off 2024 with New Year’s resolutions that lower your tax bill and boost what you keep.
I WILL keep an eye on my AGI
AGI stands for adjusted gross income, found on Line 11 of the 2023 Form 1040. AGI measures a filer’s income before Schedule A itemized deductions and tax credits, so it’s typically larger than taxable income on Line 15.
AGI is a key number. For example, the income limits for making direct contributions to traditional IRAs and Roth IRAs are pegged to AGI. So most married couples who have more than $228,000 of AGI for 2023 can’t make Roth IRA contributions. The income threshold for allowable medical-expense deductions is also 7.5% of AGI.
AGI is tied to what you owe Uncle Sam as well. The 3.8% surtax on net investment income such as interest, dividends and capital gains kicks in at AGI of $200,000 for most single filers and $250,000 for married joint filers, and these thresholds aren’t indexed for inflation. Income-based Medicare premiums known as Irmaa also use AGI.
Savvy taxpayers watch their AGI. With the rise in interest rates, it’s important to check whether income from bank accounts, CDs, or bonds is pushing you into the 3.8% surtax, or deeper into it. To help with this task, financial firms like Vanguard, Fidelity and Charles Schwab provide estimates of annual taxable income from investments.
What reduces AGI? Among other things, making pretax contributions to retirement plans like 401(k)s and traditional IRAs. Timing investment gains, say by pushing part of a year-end stock sale into a new year, could also help. Having low- or no-tax income, such as from municipal bonds, can lower AGI as well.
I WON’T let a low-income year go to waste
Maybe you’re a new retiree. Or a 20-something entering or leaving the workforce due to school. Or a worker of any age caught by layoffs.
Whatever the cause of a low-income year, use it to make smart moves at low tax cost if possible. That could include converting all or part of a traditional IRA to a Roth IRA, or else contributing after-tax dollars to a Roth IRA if you have enough earned income from wages or self-employment.
Do you hold appreciated assets such as stock shares in a taxable account? When you sell, the tax could be $0 if your income is low enough. This is a great tax freebie.
I WILL be aware of state-tax traps in money-market funds
In 2023, investors loaded up on money-market funds holding government debt to grab the benefits of higher interest rates with minimal credit risk.
But this boon has a catch for investors expecting the income to be free of state tax. While it’s true the states can’t tax income from federal obligations, this exemption is for Treasurys, savings bonds, and bonds from some agencies but not others.
It doesn’t include income from Treasury repurchase agreements, known as repos—and many money-market funds now hold lots of repos. If 80% of a money-market fund’s assets are in repos and 20% are in Treasurys, only 20% of the income will be free of state taxes.
Investors in high-tax California, New York and Connecticut fare worse, because no portion of a fund’s income is exempt from state taxes unless more than 50% of its assets were in state-tax-free holdings at each quarter end.
The bottom line: Investors who want to skip state taxes on government-bond funds should consider Treasury-only funds.
I WILL act quickly on tax planning if my spouse—or the spouse of someone close to me—dies
The death of a spouse is a major loss, so taxes are often the last thing survivors are considering. But it’s important not to overlook them for many reasons.
In particular, note that the year of death is the last for which the survivor can file a joint return. Joint filing often results in lower taxes, so the year of death can be a prime time to accelerate income, such as from a Roth IRA conversion. Survivors need to act quickly if a spousal death occurs late in the year.
In selling assets—including a home—be sure to consider the “step-up” in cost basis. Under this provision, investment assets held at death aren’t subject to capital-gains tax. Tax-wise decisions about asset sales after death often turn on the step-up.
I WILL keep records of my home improvements
If you sell your home, capital-gains taxes are due on the difference between the purchase price and sale price. However, an exemption of up to $250,000 of gains for single filers or $500,000 for married couples wipes out this tax for many home sellers.
This exemption isn’t indexed for inflation and is losing value, so be sure to keep records of capital improvements to your home like some new appliances or an addition. Such costs can be added to the purchase price to reduce the amount of taxable gain when the home is sold—but you need proof.
For more on which renovations are eligible, see IRS Publication 523.
I WON’T miss out on my tax break for Qualified Charitable Distributions
For charitably minded donors at least age 70 1/2, QCDs are often an outstanding tax break. They allow owners of traditional IRAs to make nontaxable withdrawals and transfer them directly to charities while still qualifying for the standard deduction. As QCDs don’t raise adjusted gross income, they don’t contribute to raising other taxes or certain Medicare premiums.
But it’s easy to miss claiming QCDs on the tax return. The 1099-R report provided by an IRA sponsor to the IRS doesn’t break them out, and there’s no separate line where filers can put them on the tax return. So they get overlooked, and too many donors wind up overpaying what they owe.
I WON’T get caught by higher interest rates on tax underpayments
The U.S. income tax is pay-as-you-go, and most Americans must pay at least 90% of their taxes long before April 15 or face interest-based penalties.
These charges didn’t matter much when interest rates were superlow. But following the Federal Reserve’s rate increases, the rate on underpayments—which resets quarterly—has climbed to 8% annually. Ouch!
This Week’s Author, Mark Bradstreet
Credit given to Laura Saunders, published December 30, 2023 in the Wall Street Journal
-until next week
