Stock trades, donations and retirement contributions can have surprising effects on your taxes. Here’s how to use tax software to determine whether it will pay to pull the trigger.
By William Baldwin, Senior Contributor
Three weeks remain for end-of-year tax dodges. This review suggests strategies that might work for you and tells you how to find out if they will work.
Some of these schemes are, or should be, familiar, such as harvesting tax losses in your portfolio. Some are less so, such as choosing Roth for a last-minute contribution to a self-employed retirement plan. All have the potential for creating surprises.
Surprises? Selling a depreciated stock might make your college tax credit go up. Sticking with pretax retirement contributions over the aftertax (Roth) kind might damage the 20% pass-through deduction for the self-employed. A Roth conversion could easily make your dividend taxes go up. Any of these things can produce weird effects on your foreign tax credit.
For such surprises you can thank the convoluted ways in which different tax rules are connected. Instead of a flat tax, Congress has created a system of benefits and phase-outs, credits and surtaxes, goodies and grab-backs, all wrapped around rewards for favored behavior or favored constituencies. Unspoken platform element of both political parties: “Let’s curry votes by making the tax code more complicated.”
Don’t throw up your hands. Do this instead: Buy software. Buy it now, not in February when you were going to start work on your taxes. It won’t cost more to buy early. Updates, which stream in constantly during the tax season, are free.
What if you have a pro do your taxes? Try to get an appointment in the next week for advice on tax strategies. If that is not available, buy the software and play with it.
For $100, more or less, you can acquire top-of-the-line desktop tax software from either TurboTax or H&R Block. This is for the “business” edition; people without self-employment income can usually get by with cheaper versions.
With either vendor you get the right to create an unlimited number of test files. Use those to experiment.
Start a dummy return using correct ages and marital status. Assuming your circumstances haven’t changed, you can fill in estimates for income and deduction items by copying them from the 2023 tax returns you filed in April, perhaps kicking the numbers up by a few percent if they are likely to rise with inflation. Save this file as Dummy 1.
Precision is not required. You just have to get close enough to land you in the right brackets. Observe the federal and state taxes calculated by the software.
Now save a copy of the test return as Dummy 2 and throw in an incremental transaction. Maybe it’s to sell a loser stock for a capital loss. Or to convert $20,000 of an IRA to a Roth IRA. Or to go big with a charitable contribution.
Now look at the tax totals (state and federal combined). These numbers will be only approximations. But the differential between Dummy 1 and Dummy 2 is likely to be very accurate.
Usually it’s smart to minimize your immediate tax bill. That means accelerating deductions and postponing income. But not always, says Lisa Greene-Lewis, a CPA at TurboTax. A Roth conversion, which entails accelerating the recognition of income, is the most prominent example. But there are others.
Consider this situation: You are sitting on an unrealized $9,000 loss on a bum stock. Another stock position is up $5,000 but the company is in the midst of a merger that will be consummated in January. You have no other gains or losses of consequence.
Take the loss now, and $5,000 of it will be married to the gain next year, in effect only benefitting you at the low 15% rate on long-term gains. The other $4,000 will go against higher-rate ordinary income: $3,000 in 2024 (the annual maximum for this purpose) and $1,000 in 2025. Better strategy: Sell the winner now, paying tax at the 15% rate. Take the loss in January, with the full $9,000 going against high-taxed ordinary income over three years.
Your tax strategizing will inevitably entail some guesswork about your circumstances in future years and about tax law changes. Don’t let the uncertainty stop you from making moves that have a high probability of paying off.
Until recently it seemed rather likely that the Tax Cuts and Jobs Act of 2017 would expire at the end of 2025, making it unwise to postpone income beyond that point. The election changed those odds. Says Bill Smith, a tax lawyer in Washington, D.C. at the business advisory firm CBIZ: “It’s almost a certainty that the vast majority of TCJA provisions are going to be extended.”
Absent some lurch in your income (such as a giant capital gain or a planned retirement), you wouldn’t be far off in assuming that 2025 and later years will look a lot like 2024. Here are some end-of-year moves to contemplate.
#1. Portfolio sales
You may already have gains or losses in your base case, Dummy 1. Dummy 2 incorporates the transaction you’re thinking about adding now. (We are, of course, talking about your taxable brokerage account; changes inside an IRA are irrelevant.) It will probably make sense to harvest any capital losses that remain unrealized.
#2. Conversions
Aftertax (that is, Roth) IRAs are more valuable than pretax IRAs. It often makes sense to convert some of the latter to the former by prepaying income tax on the converted amount. But you should never do this without first getting a price tag on the conversion.
Isn’t the price determined by your tax bracket? No, it’s nothing so simple. You might be in a 24% federal bracket (taxable income between $201,051 and $383,900 on a joint return), but converting $10,000 won’t necessarily cost you just $2,400 in federal taxes. It might run you $2,780. Why? Because it pushes more of your investment income into range of the 3.8% investment income surtax.
There’s no telling what will happen by looking at a bracket table. Find out by comparing Dummy 1, without the conversion, to Dummy 2, with it.
THE MEDICARE SNATCH
The government levies a surtax on prosperous seniors by boosting their Medicare premiums. If you are over 63, keep an eye on the table WHERE. Your 2024 income will determine your premium enhancements in 2026.
The 2024 income boundaries used for 2026 premiums, and the enhancement amounts, won’t be announced until late next year. In the table are Forbes forecasts for the numbers. The add-ons shown are annualized, assume two people on Medicare filing a joint return, combine Part B (doctor) and part D (drug) premium surcharges, and don’t include the basic premium.
Income, as Medicare defines it, is the sum of adjusted gross income and tax-exempt interest.
Unlike the ones used in the Internal Revenue Code, these income brackets are of the sudden-death kind. Wandering $100 over a break point could cost you $3,370, for a 3,370% marginal tax rate. Amusing.
The Medicare Stealth Tax
#3. Bunching
The standard deduction for a young couple is $29,200, which means that itemized deductions totaling less than that amount do no good. Consider putting several years of giving into one year by contributing to a donor-advised fund, then disbursing the money over time. This might make sense if the total donation, with other itemized deductions, puts you well above the standard deduction. It especially makes sense if you use long-held appreciated securities for the donation, since the deduction is figured on their current value, with the appreciation never taxed.
Wealth advisors often recommend combining a charity bunch-up with a Roth conversion. Test different amounts. Keep a close eye on the results. You might not know, but the software will know, that the deduction from appreciated securities is capped at 30% of adjusted gross income.
#4. QCDs
Anyone over the age of 70-1/2 can send “qualified charitable distributions” totaling up to $105,000 a year directly from an IRA to a charity (other than a donor advised fund). This is a powerful way to be generous, because it keeps taxable IRA assets out of not just taxable income but also adjusted gross income. AGI has tentacles reaching into many parts of your tax return and even into Medicare premiums (see box).
What’s the better deal, doing QCDs a little at a time or using Nvidia shares to set up a donor fund? Depends on your income, the original cost of the shares and those tentacles. Don’t try to make sense of it all. Just experiment.
#5. Salary deferral
You can put $23,000 a year ($30,500 if you’re 50 or older) into 401(k)s as employee contributions. Haven’t hit the limit for 2024? Go for a buzzer-beater. As an employee, you’d need a tolerant payroll department to arrange a giant one-time contribution from your next paycheck. If you’re self-employed you have until December 31 to get the money safely into your solo 401(k).
Which is better, a deductible 401(k) contribution or the post-tax (Roth) kind? Roth is best for gig workers eligible for the 20% pass-through deduction that Trump concocted in 2017. Eligibility depends on AGI. Let the software do the thinking for you by creating two dummy returns.
#6. Withholding fix.
Are your estimated tax payments too small? On the dummy return, fill in four estimated payments (including the one you’re doing in January) and the withholding amounts you expect on your W-2s. Now look to see if there’s going to be a penalty for underpayment.
It’s too late to revise the insufficient April, June and September payments. But there’s another way to get out of the penalty box. Get your payroll department (if it’s willing to cooperate) to adjust your withholding in the last paycheck. Strangely, the IRS treats all W-2 withholding as if it came in as 52 equal amounts, even though in this case there’s a lump sum at the end. If you’re past 73 and haven’t taken all your required IRA distributions for the year, you can play the same game with the last IRA payout.
Software tips:
If you are a regular user of tax software you can speed up the dummy return process by opening your 2023 program, saving a copy of your 2023 return and messing with that copy. For Dummy 1, raise a few key entries (such as one of the W-2s, one of the dividend 1099s and one of the Social Security amounts) so that the income total reflects inflation. Save a copy as Dummy 2 and put your Roth conversion or whatever on that. The bracket boundaries will be a bit obsolete, but the Dummy 2 versus Dummy 1 differential will probably be close to the truth.
Another shortcut involves the What-if feature in TurboTax. Find that by going to “Forms” and searching for “What.” The program won’t allow you to insert estimates directly into the “Current Tax Return” column, so ignore that column. Instead, put base-case estimates into Column 2 and increments in Column 3, then have the program add Column 2 to Column 3 and show the result in Column 4. Note: Because of a bug in the software, you have to erase Column 4 and recreate it every time you alter the other columns.