Year-End Deduction Planning

Most Americans have only a cursory understanding of the personal income tax portion of the U.S. Tax Code, and are content to pass along their required annual Tax Return preparation to a paid professional, or even to a computer program. While we encourage the use of tax professionals (Note: we are not tax preparers), the truth is that very few professional preparers have time during Tax Preparation Season to delve into individual situations to see where improvements could be made for the future.

Beginning in 2018, the Tax Cuts and Jobs Act of 2017 (TCJA) positioned many taxpayers to discontinue itemizing deductions in favor of a new, much higher, Standard Deduction. It worked. However, changing from one method to the other is an annual decision, left to each taxpayer’s option. When choice is involved, a planning opportunity often exists. This is no exception.

Deductible Expenses. Taxpayers have the annual ability to plan deductions and compare them to simply taking the Standard Deduction (SD). Manipulating the timing of some deductible expenses may allow the taxpayer to switch between itemizing and taking the SD by doubling up on some expenses one year, then skipping the year in between in favor of the large SD.

SALT Deductions. Property taxes are included in the $10,000 annual State and Local Taxes (SALT) deduction limit. Homeowners whose Property Taxes are sufficiently under $10,000 annually can effectively double up payments every other year, as property taxes can generally be paid over the course of a few months, usually spanning a year-end. Doing so will help to maximize itemized deductions in the years of itemizing, leaving zero for the SD years.

Charitable Donations. But wait, we’re not done yet. Charitable Donations are not capped by SALT limits.  For taxpayers who participate in charitable giving annually, double payments can be applied every other year, enhancing overall Itemized Deductions in the itemizing years.

Medical Expenses. Payments for direct medical expenses and insurance premiums are deductible only in excess of 7.5% of a taxpayer’s Adjusted Gross Income, or AGI. Timing the payment of medical expenses can also contribute to a taxpayer’s ability to exceed the deductible expense target, and add to Itemized Deductions in a selected year.

Income Planning. For taxpayers with variable incomes, timing deductions with an eye toward planning income may pay off in taxes saved. Accelerating or delaying income, usually by deciding when to send invoices for small businesses, is not available to everyone, but those who qualify can often influence a specific tax situation, even if only once in a while.

Van Wie Financial is fee-only. For a reason.

Americans everywhere are being bombarded with welcome news regarding falling inflation. We are of course pleased with the news, but at the same time, we are appalled at the misreporting of the true meaning of that news. As usual, much of the erroneous slant on the news is intentional, attempting to convince Americans that prices they pay are falling.

Every increase in the Consumer Price Index (CPI) reflects rising prices. Some items have recently fallen in price, including gasoline and other commodities, but the overall price level of items we all need day to day is higher than ever. Only negative changes in the Index reflect lower aggregate price levels. In fact, we recently saw a negative change in the Producer Price Index (PPI), which reflects a generally lower price level at the wholesale level. This has little effect on the CPI unless negative readings persist.

Loyal readers may remember my discussions of the Chapwood Index, which is similar to the CPI, only accurate. Developed by Ed Butowsky, a financial advisor, the aim of the Chapwood Index is to measure changes in prices of a consistent basket of goods, in 50 consistent geographic areas. Findings are published every six months, and the results are eye-opening. In Jacksonville, FL, one of the locations tracked by the Index, the average annual rate of inflation over several years is 10.4%. For the record, this is about average for population centers tracked. Several areas clock in at over 13%.

In my lifelong study of economics, I was taught that a little inflation was required for a healthy economy. The argument was that purveyors of goods and services were incentivized by inflation to do things now, rather than later. Similarly, consumers were reluctant to wait, as prices would be higher later. The key, we thought, was to keep inflation “under control,” say 3% annually. Today, the Federal Reserve (FED) has a target of 2% annually.

Both numbers are completely useless. Not because of the numbers themselves, but because they are fictitious. With actual price increases closer to double digits, the reported numbers are bogus, but we’re forced to accept them as gospel. As a result, our standard of living is constantly eroding. In fact, during the 110 years of the FED, our dollar today is worth less than a nickel was in 1913. How bad can it get? We’ve seen it before, and it’s not pretty.

Reacting to ever-rising prices is an individual challenge. “Settling” for less quality and/or quantity is, unfortunately, among the rational responses to price pressures. Don’t be fooled by optimism in media and government. Excessive government spending is the underlying cause of inflation. It hurts everyone, and we all must demand lower spending from elected officials.

Van Wie Financial is fee-only. For a reason.

Our Government has long been inconsistent in applying Cost of Living Adjustments (COLAs) for taxpayers. We have been disappointed when inflation adjustments are applied unequally among aspects of our individual financial lives. In practice, every year brings more inconsistencies, and American Taxpayers seem always to wind up on the losing side of the battle to maintain our lifestyles.

According to the Bureau of Labor Standards (BLS), the annual rate of inflation for the U.S. Government’s Fiscal Year 2023 (ended 9/30/2023) was 3.7%. Most Americans believe inflation was much higher than that, but individuals have no say in the process.

Summarizing various inconsistent applications of COLAs for 2024, we were amazed to surmise that Americans are actually receiving a reasonable package of changes, starting January 1, 2024. We cannot remember the last time this happened, and we are not reluctant to share good news.

Even in a good deal, not all aspects are beneficial to every affected American. Social Security Benefit increases and maximum contributions to company-sponsored Retirement Accounts did not keep pace with inflation. Individual savers, however, will receive an above-inflation boost in allowable Contribution Limits to Individual Retirement Accounts, or IRAs.

Other good news can be found in the indexing of Individual Income Tax Brackets, which were expanded (in size, not tax rate), by about 5.4%. Due to the progressive nature of our tax system, taxpayers at every level will preserve more of their income in the two lowest brackets, 12% and 22%. Families with taxable income below $94,300 will also collect any Long-Term Capital Gains tax-free. (Note that taxable income includes Capital Gains.)

The Standard Deduction will also be indexed by 5.4%, and will provide additional relief in excess of the stated change in CPI.

The U.S. Tax Code is getting slightly more user-friendly in 2024; but unless something is changed in Washington, D.C., our current tax brackets will soon return to the pre-2018 level. The Trump tax cuts are set to expire at the end of 2025, costing every taxpayer significantly more tax dollars, beginning on January 1, 2026. Preventing this should be a top priority for every elected representative, but we seldom hear the topic discussed.

Also being largely ignored are looming insolvencies in Social Security and Medicare, as well as the unsustainable National Debt. These problems need to be addressed, and will likely involve tax increases down the road. For now, we’ll take the relatively good news and plan accordingly.

Van Wie Financial is fee-only. For a reason.

Support for American generosity is embedded in the U.S. Tax Code. Why, then, does the IRS make gifting rules so complex and difficult to follow? The rhetorical nature of that question does nothing to lessen the value of carefully following ever-changing terms and conditions for improving a taxpayer’s cash flow through gift-giving.

In general, tax breaks are available for donations to qualified charities. IRS maintains a database of Qualified Charities on the irs.gov website. Search for Tax Exempt Organizations to verify the deductibility of an intended gift.

Gifts can be lumped into a few categories, with differing tax consequences for each type.

 

• No Tax Consequences. Gifts to family or friends do not produce monetary benefits to the donor. Every real person, not an entity such as a trust or corporation, can give any other real person $17,000 in 2023. The transaction is non-taxable, and doesn’t even have to be reported on either tax return. Most estimates are that the amount will be inflation-adjusted to $18,000 for 2024. Keep good records, just to be certain.
• Later Tax Consequences. Wealthy Americans may have their estates subjected to Estate Tax after death, and during life may take steps to minimize or eliminate that possibility. Lifetime gifting to relatives can keep the estate value under the taxation limit, but rules must be followed. Above the current $17,000 annual limit for non-taxable gifts, the donor must file a Gift Tax Return when the limits are exceeded. There is a lifetime upper limit, and IRS will keep track.
• Immediate Tax Consequences. As mentioned earlier, gifts to Qualified Charities receive an immediate income tax deduction for the donor, but even these are limited to a percentage of the donor’s Taxable Income. Qualified donations in excess of the allowable deduction may be carried over to subsequent years.

 

Based on taxation rules as illustrated above, it is apparent that our Federal Government strongly encourages individual generosity. Based on the track record of Americans, it seems that we are only too pleased to respond positively.

In coming Blogs, we will cover many more topics of interest for investors.

Van Wie Financial is fee-only. For a reason.

Americans are truly the most generous people on the planet. During COVID-19, we slid to 19^th place in world rankings but quickly recovered to a tie for first place with Myanmar (we learned it as Burma). Even American millennials have begun to establish patterns of generosity. For the record, we applaud their efforts.

For many Americans, generosity is not rooted in tax benefits but is instead just part of their DNA. Studies have shown that the number one reason for charitable gifting is to support causes and concepts near and dear to them. Nonetheless, saving on taxes, or otherwise improving current or future cash flow, is a plus.

Uncle Sam encourages gifting, using the tax system to exclude donations to qualified charities from taxable income. This deduction is currently applicable only to taxpayers who itemize deductions, which has become a far smaller percentage of the population in recent years. The loss of itemized deductions has surprisingly not put a damper on our collective generosity.

Taxpayers aged 70-1/2 and above may avoid taxation on their charitable gifts using Qualified Charitable Distributions (QCDs) from IRAs. We discussed QCDs in recent blogs. Maximizing the cash flow impact of donations for people under 70-1/2 will be a subject for upcoming Blogs.

Wealthier Americans use gifting to spread their assets around while they are alive, possibly shielding those funds from a high Estate Tax rate upon their death. While the value of assets excludable from taxation at death is currently quite high, there is a strong likelihood that those limits will drop in the future. Depending on the possible reduction in exclusion limits, many more Americans may find themselves over the tax-free limit. Escalating housing values, retirement assets, and higher incomes, all add up over time, and planning is critical to minimize the impact of future Estate Taxes.

This time of year, many charities solicit donations using a matching gift process, whereby a wealthy Samaritan matches (sometimes even multiplies) donations from average Americans. While this does not improve the donors’ cash flows, it adds to the satisfaction received from their generosity.

Based on taxation rules, it is apparent that our Federal Government strongly encourages individual generosity. Based on the track record of Americans, it seems that we are only too pleased to respond positively.

In the coming Blogs, we will cover many more topics of interest to charitably-minded citizens.

Van Wie Financial is fee-only. For a reason.

According to my calendar (which I thoroughly believe must be lying to me, because we can’t really be this close), there are only a couple of months left until Christmas, 2023. By then, most Americans are pretty much done making financial decisions for the year, not really thinking about business until sometime in January 2024. We have been stressing the need to complete a few financial items prior to singing along to Auld Lang Syne.

Deferring certain items past year-end may not cause actual harm to an investor, but too often it results in another year going by without reviewing, updating, correcting, or even initializing important details. Among our favorite pursuits, this time of year is encouraging clients and radio listeners to revisit their Beneficiary Designations before year-end. Failure to stay current can be disastrous, resulting in assets being distributed to unintended recipients.

Over half of adult Americans, including attorneys, do not have a Will and/or a Living Trust. If you have one or both, review the Beneficiary Designations at least annually. They need to reflect the life-altering changes we all periodically incur. If you don’t have at least a simple Will, make an appointment with an attorney to get it done. This should also include your medical directives and Powers-of-Attorney. Costs are reasonable and can be shopped around to find a good fit at a reasonable price.

Retirement Accounts, whether Pensions, IRAs, or Qualified Retirement Plans, pass at the owner’s death to Named Beneficiaries, which means those whose names appear in the Plan documents as being successor owners. Keep them current, starting right now, to avoid unintended consequences.

Account custodian changes, such as TD Ameritrade recently becoming Charles Schwab, often require new paperwork, and keeping Beneficiary Designations up to date will eliminate potential confusion later. This can also happen when you change financial advisors or begin working with an advisor.

Here’s one most people will never consider. Nearly 20% of assets in 401(k) (and similar) Plans belongs to ex-employees. Aside from being a poor investing strategy, how many of these old accounts are forgotten, and have never been reviewed for possible changes to Beneficiary Designations?

Life insurance and annuity contracts also need accurate Beneficiary Designations. Most people cannot even quickly produce their actual contracts, and may not realize that their Designated Beneficiaries may need updating.

Performing a complete review of Beneficiary Designations is an easy method of assuring an orderly transition of assets when the inevitable happens, either with warning or without. We can help.

Van Wie Financial is fee-only. For a reason.

Earlier this year, we posted a Blog expressing our disgust at the way Cost-of-Living Adjustments (COLAs) are applied to certain government functions that affect most Americans. The Department of Labor is charged with the annual task of determining the net increase in overall prices we all pay. Their results are published as the Consumer Price Index or CPI.

Failure to realize an increase in overall income results in erosion of buying power. In any given year, far too few Americans realize a sufficient increase in income. This pattern has been endemic in our society for longer than the entire life of the Social Security System.

In 2023, Social Security monthly benefits were raised by 8.75%, despite inflation well in excess of that figure. In November of 2022, the government-reported annual rate of inflation hit a multi-year high of 11.1%. Social Security benefits covered only 78% of our price level increases, resulting in a reduction of purchasing power.

As bad as that sounds, it gets worse, as recently released numbers plainly depict. Despite a 4.1% increase in our daily living costs (reported CPI change for 12 months), Social Security has announced a 2024 COLA of only 3.2%, leaving recipients a (pre-tax) shortfall of 0.9%. As usual, that is only the tip of the iceberg. Misapplication of COLA adjustments in other aspects of our financial lives exacerbates the problem.

A large percentage of Social Security recipients are covered by Medicare. Whenever a Medicare participant is also receiving Social Security monthly benefits, Medicare premiums are deducted from benefits payments. Wouldn’t it be logical to assume that one inflation rate would apply to all government functions equally? In that case, Medicare premiums would also be increased by 3.2% for 2024, just like the reported CPI. But no, Medicare premiums are going up by 5.9%, leaving individuals to cover the extra 2.7%. One more decrease in our standard of living, compliments of “Uncle Sam.”

Adding proverbial insult to injury, higher-income Americans have long been subjected to surcharges for monthly Medicare premiums. Dubbed IRMAA, for Income-Related Monthly Adjustment Amounts, affected Americans will also find IRMAA costs rising faster than inflation.

But wait, there’s more! Medicare-covered payments (usually 80% of your actual costs) kick in only after an increased annual deductible amount has been met. In the coming weeks, the IRS will release many more “inflation adjustments,” and we will explain them to you.

Van Wie Financial is fee-only. For a reason.

The U.S. Tax Code is a behemoth, and little understood. It is enforced by a [service-oriented] Department of the Federal Government. The Internal Revenue Service, or more commonly IRS, has the ability to ruin lives, and the American people rightly fear and loathe the “Service.” It is little wonder to me, as I share most Americans’ feelings about the way IRS operates. IRS is the only department of the U.S. Government that places the burden of proof on the accused. In other words, once a charge is levied against a taxpayer, it is incumbent on that taxpayer to prove innocence.

Reducing fear (if not loathing) involves gaining an understanding of the Tax Code as it applies to your personal financial situation, yet most people tune out at the very mention of IRS, the most hated of all Washington acronyms.

We must point out that Van Wie Financial is not a tax preparer. We offer education and planning for those interested in learning how they are taxed, and we can work with your Tax Preparation professionals.

Understanding how to utilize the Tax Code for your personal best result requires an understanding of Tax Brackets. Brackets are presented in an IRS-published chart, which is updated annually to reflect inflation and Congressional modifications. Brackets are misunderstood by many Americans, so today we hope to clarify application of Tax Brackets.

Any individual’s Marginal Tax Bracket is the one his or her next dollar earned falls on the chart. But not every dollar of Taxable Income is taxed at the same rate. Everyone receives full benefit from each of the lower tax brackets up to the Bracket limits.

Due to the effects the Trump-era Tax Cuts and Jobs Act of 2017(TCJA), Brackets currently carry historically low Tax Rates (10%, 12%, 22%, 24%, 32%, 35%, and 37%), as well as being applicable to a large share of Taxable Income. TCJA changes have encouraged taxpayers and financial planners to set targets for Taxable Income, attempting to minimize total tax each and every year.

Within reason, taxpayers get to influence their own tax rates, whether by earning more or less money, or by creating more deductions and exemptions. One favored Taxable Income reduction strategy is to make deductible contributions to Retirement Accounts. Conversely, taxable Roth IRA Conversions can increase Taxable Income within your current Tax Bracket.

For today, remember that creeping into a higher Tax Bracket does not punish your Total Taxable Income. We can help you plan.

Van Wie Financial is fee-only.  For a reason.

Traditional IRA vs. Roth IRA – easy choice? Not so much. Add in Roth IRA Conversions (from Traditional IRAs), and year-end 2023 financial planning gets even more complicated. Yet, the long-term consequences of these conversions, positive or negative, are serious. Consequently, Van Wie Financial is already involved in our clients’ year-end planning. Naturally, it gets more intense as the remaining days of 2023 wane.

Among the most complex topics in Retirement (and year-end) Planning is Roth Conversions. Traditional IRA assets get converted to Roth IRA assets in taxable transactions, but will not be taxed when removed later in life. Today, Roth Conversions are more complicated than in the past. A few short years ago, all or part of a Roth Conversion could be reversed (Recharacterized) in the year following, so any undesired overages were easily corrected. That privilege was short-lived, and the only substitute today is better planning.

Today’s U.S. Tax Code is marked by lower tax rates and wider tax brackets than existed only a few years ago. Most taxpayers attempt to stay in one of the lower brackets by managing total annual income. Savvy taxpayers will simultaneously attempt to push income up against the next higher tax bracket, without going over by so much as a dollar. Needless to say, that presents an estimating and planning challenge.

Roth IRAs are not subject to Required Minimum Distributions (RMDs) until the account has been inherited from the original owner. Further, funds withdrawn later in life are not considered taxable income to the owner. Hence the growing popularity of Roth IRAs, which provide ultimate flexibility for income and tax planning. Thousands of taxpayers are entering into Roth Conversion Plans, many of which will span several years.

For people who don’t expect to need their entire future taxable RMDs, Roth Conversions provide one alternative. The downside lies in current tax bills, which will be incurred by the conversion. Managing those amounts is the essence of year-end income planning, and hence tax planning. But it is not the only method of reducing RMDs.

Qualified Longevity Annuity Contracts, or QLACs, are insurance products that can be purchased within taxable Retirement Accounts. With an upper limit of $200,000, the QLAC reduces the IRA account balance, thereby deferring that portion of the associated RMD. QLACs are flexible as to size within the limit and duration, from 1 year to age 85. While there is no annual return on the QLAC funds, deferring that portion of taxable income provides tax savings for the QLAC owner. To the right candidate, a QLAC is valuable.

Van Wie Financial is fee-only.  For a reason.

In advanced mathematics, there is a tenet called Necessary and Sufficient. In financial planning, those terms are applicable to the relationships we maintain with clients, readers, listeners, and within our own business. As fiduciaries, we must always act in the best interests of our clients. As responsible broadcasters, we bring you the best we have every week.

This time every year, we trigger a series of activities falling under the necessary and sufficient umbrella. Necessary for owners of IRAs and other Qualified Retirement Accounts to ensure compliance with Required Minimum Distribution (RMD) rules for people in the affected age group. This includes account holders who reach age 73 in the year 2023. It is necessary to plan and execute their required withdrawals, but that alone is not sufficient. We also need to discuss with these people that they do not actually have to withdraw their first funds in calendar 2023, as their Required Beginning Date (RBD) is March 31, 2024.

For anyone opting to delay their first RMD until next year, it is also necessary to inform them that they will have to take a second RMD, prior to year-end 2024. But that alone still falls short of being sufficient, as we must also verify that their Beneficiary Designations are complete, accurate, up to date, and on file with the custodian of the account. Individual situations change throughout any calendar year, and we must take the initiative to complete our tasks, both necessary and sufficient.

Owners of small businesses have time remaining to adopt most forms of Retirement Plans for 2023, but for those who are best suited to a SIMPLE IRA Plan, it is necessary to have the Plan established by September 30, 2023, to be effective on January 1, 2024. Other successful small business owners (no employees other than the business owner and a spouse, if applicable) can open Individual 401(k) Plans, which offer significantly larger tax-deductible contributions but can be adopted next year, even for 2023.

For participants in existing 401(k) and similar Plans, whose salary deferral contributions are less than optimal so far this year, it is necessary to explain that, unlike IRA contributions, further 2023 salary deferrals must be made from paychecks in 2023. Employers are often slow to react to new requests, so time is of the essence. Opportunity Costs for missed deferrals are steep.  Falling short means more income tax today and fewer tax-deferred contributions.

Next week we will discuss the complex topic of Roth Conversions, which can be used to reduce future taxable RMDs, but must be carefully planned and executed to avoid unintended consequences.

Van Wie Financial is fee-only.  For a reason.