We are at that time of the year again where you should consider meeting with a tax professional to discuss any year end strategies that might reduce your 2023 taxes. The following are some of the tax breaks from which you may benefit, as well as the strategies that could be used to help minimize your taxable income and resulting federal tax liability for 2023. Some strategies might help lower your business’s taxable income for 2023.
Your tax return filing status can impact the amount of taxes you pay. For example, if you qualify for head-of-household (HOH) filing status, you are entitled to a higher standard deduction and more favorable tax rates. To qualify as HOH, you must be unmarried or considered unmarried (i.e., legally separated or living apart from a spouse) and provide a home for certain other people.
If you are married, you will either be filing your return using the married filing jointly or married filing separately filing status. Generally, married filing separately is not beneficial for tax purposes, but in some specific cases, such as when one party earns substantially less or when one party may be subject to IRS penalties for issues relating to their tax reporting, it may be advantageous to file as married filing separately. If one spouse was not a full-year U.S. resident, an election is available to file a joint tax return where such joint filing status would otherwise not apply, and this may help reduce a couple’s tax liability.
Standard Deduction versus Itemized Deductions.
The Tax Cuts and Jobs Act of 2017 (TCJA) substantially increased the standard deduction amounts, thus making itemized deductions less attractive for many individuals. For 2023, the standard deduction amounts are: $13,850 (single); $20,800 (head of household); $27,700 (married filing jointly); and $13,850 (married filing separately). If the total of your itemized deductions in 2023 will be close to your standard deduction amount, we should evaluate whether alternating between bunching itemized deductions into 2023 and taking the standard deduction in 2024 (or vice versa) could provide a net-tax benefit over the two-year period. For example, you might consider doubling up this year on your charitable contributions rather than spreading the contributions over a two-year period. If these contributions, along with your mortgage interest, medical expenses (discussed below), and state income and property taxes (subject to the $10,000 deduction limitation on such taxes that applies to both single individuals and married couples filing jointly; and the $5,000 limitation on such expenses for married filing separately returns), exceed your standard deduction, then itemizing such expenses this year and taking the standard deduction next year may be appropriate.
Medical Expenses, Health Savings Accounts, and Flexible Savings Accounts.
For 2023, your medical expenses are deductible as an itemized deduction to the extent they exceed 7.5 percent of your adjusted gross income. To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. Deductible expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract.
Depending on what your taxable income is expected to be in 2023 and 2024, and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2023 or defer them until 2024.
You may also want to consider health saving accounts (HSAs) if you do not already have one. These are tax-advantaged accounts which help individuals who have high-deductible health plans (HDHPs). If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. These contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2023, the annual contribution limits are $3,850 for an individual with self-only coverage and $7,750 for an individual with family coverage.
In addition, if you are not already doing so and your employer offers a Flexible Spending Account (FSA), consider setting aside some of your earnings tax free in such an account so you can pay medical and dental bills with pre-tax money. Since you do not pay taxes on this money, you will save an amount equal to the taxes you would have paid on the money you set aside. FSA funds can be used to pay deductibles and copayments, but not for insurance premiums. You can also spend FSA funds on prescription medications, as well as over-the-counter medicines, generally with a doctor’s prescription. Reimbursements for insulin are allowed without a prescription. And finally, FSAs may also be used to cover costs of medical equipment like crutches, supplies like bandages, and diagnostic devices like blood sugar test kits.
Sale of a Home.
If you sold your home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of your home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if you rented part of your home or otherwise used it for business, the loss attributable to that portion of the home is deductible.
Discharge of Qualified Principal Residence Indebtedness.
If you had any qualified principal residence indebtedness which was discharged in 2023, it is not includible in gross income.
Deductions for Mortgage Insurance Premiums.
You may be entitled to treat amounts paid during the year for any qualified mortgage insurance as deductible qualified residence interest if the insurance was obtained in connection with acquisition debt for a qualified residence.
Qualified Business Income Passthrough Tax Break.
Under the qualified business income tax break, a 20 percent deduction is allowed for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and nonitemizers, it is taken on your individual tax return as a reduction to taxable income. This tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below a certain threshold ($364,200 for joint filers; $182,100 for other taxpayers) are simpler and more permissive than the rules that apply to individuals with income above those thresholds.
Child Tax Credit.
For 2023, a child tax credit of as much as $2,000 is available for each child under age 17, depending on your modified adjusted income. In addition, a $500 nonrefundable credit is available for qualifying dependents other than qualifying children. Where the credit exceeds the maximum amount of tax due, it may be refundable. The maximum amount refundable for 2023 is $1,600 per qualifying child. The $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed, and (2) qualifying relatives. The amount of the credit is reduced for taxpayers with modified adjusted gross income over $200,000 ($400,000 for married filing jointly) and eliminated in full for taxpayers with modified adjusted gross income over $240,000 ($440,000 for married filing jointly).
Earned Income Credit.
The earned income tax credit (EITC) is determined by multiplying your earned income for the year (but only up to a maximum amount of earned income) by a credit percentage that varies depending on whether you have any qualifying children and, if so, the number of qualifying children. The EITC is also subject to a limitation based on your adjusted gross income. For 2023, the maximum amount of the EITC is (1) $600 for a taxpayer with no qualifying children, (2) $3,995 for a taxpayer with one qualifying child, (3) $6,604 for a taxpayer with two qualifying children, and (4) $7,430 for a taxpayer with three or more qualifying children. In addition, the EITC cannot be claimed if your investment income (including interest, dividends, capital gain net income, and net rental income) exceeds $11,000 for 2023.
Dependent Care Credit.
If you incurred expenses to care for a child or another dependent so that you can work, you may be eligible for the child and dependent care credit. This credit is available to individuals who, to work or to look for work, have to pay for childcare services for dependents under age 13. The credit is also available for amounts paid for the care of a spouse or a dependent of any age who is physically or mentally incapable of self-care. The credit is not available for amounts paid to a dependent or a taxpayer under age 19. The amount of the credit is a specified percentage of your total employment-related expenses – generally, 35 percent reduced (but not below 20 percent) by one percentage point for each $2,000 by which your adjusted gross income for the tax year exceeds $15,000. Employment-related expenses incurred during any tax year which may be considered cannot exceed $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals.
Premium Tax Credit.
A health insurance subsidy is available in the form of a premium assistance tax credit for eligible individuals and families who purchase health insurance through the Health Insurance Marketplace, also known as the “Exchange.” The provision is the result of the Patient Protection and Affordable Care Act (PPACA). This credit is refundable and payable in advance directly to the insurer on the Exchange. In the past, individuals with incomes exceeding 400 percent of the poverty level were not eligible for these subsidies. However, the cap has been eliminated through 2025 and therefore, anyone can qualify for the subsidy. In addition, the percentage of your income paid for health insurance under a PPACA plan is limited to 8.5 percent of income. Thus, if you buy your own health insurance directly through an Exchange, you can receive increased tax credits to reduce your premiums.
Education-Related Deductions and Credits.
Certain education-related tax deductions, credits, and exclusions from income may be available for 2023. For example, tax-free distributions from a qualified tuition program, also referred to as a Section 529 plan of up to $10,000 are allowed for qualified higher education expenses. Qualified higher education expenses for this purpose include tuition expenses in connection with a designated beneficiary’s enrollment or attendance at an elementary or secondary public, private, or religious school, i.e., kindergarten through grade 12. It also includes expenses for fees, books, supplies, and equipment required for the participation in certain apprenticeship programs and qualified education loan repayments in limited amounts. A special rule allows tax-free distributions to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister). As a result, a 529 account holder can make a student loan distribution to a sibling of the designated beneficiary without changing the designated beneficiary of the account.
Depending on your modified adjusted gross income for the year, you may also qualify for: (1) an American Opportunity Tax Credit of up to $2,500 per year for each eligible student; (2) a Lifetime Learning credit up to $2,000 for tuition and fees paid for the enrollment or attendance of yourself, your spouse, or your dependents for courses of instruction at an eligible educational institution; (3) an exclusion from income for education savings bond interest received; and (4) a deduction for student loan interest.
If you qualified for any student loan forgiveness in 2023, the forgiven amount will generally be excludible from your income for federal tax purposes. However, you may be liable for state or local income taxes because of the discharge.
Clean Energy Credits.
For 2023, the clean energy tax credits available include (1) residential energy property credits (the energy efficient home improvement credit and the residential clean energy credit) and (2) vehicle-related credits (the new clean vehicle credit, the previously owned clean vehicle credit, and the alternative fuel refueling property credit). These credits were significantly expanded by the Inflation Reduction Act, generally beginning in 2023.
The energy efficient home improvement credit is credit for 30 percent of the costs of all qualified energy efficiency improvements and residential energy property expenditures you make during the year. This credit is subject to an annual limit of $1,200, and there are also limits for specific types of qualifying improvements. These limits are: (1) $250 for any exterior door ($500 total for all exterior doors), (2) $600 for exterior windows and skylights, (3) $600 for other qualified energy property (including central air conditioners; electric panels and certain related equipment; natural gas, propane, or oil water heaters; oil furnaces; water boilers), and (4) a higher $2,000 annual limit for heat pumps and heat pump water heaters, biomass stoves, and boilers. The Inflation Reduction Act also added a credit of up to $150 per year for home energy audits. Roofs do not qualify for the credit beginning in 2023.
The residential clean energy credit equals 30 percent of the cost of certain qualified property installed on or used in connection with your home. Qualifying properties are: (1) solar electric property, (2) solar water heating property, (3) fuel cell property, (4) small wind energy property, (5) geothermal heat pump property, and (6) battery storage technology. There is no annual or lifetime limit on the residential clean energy credit except with respect to fuel cell property, which is limited to $500 for each half kilowatt of capacity. In addition, if more than one person lives in your home, the combined credit for all residents cannot exceed $1,667 for each half kilowatt of fuel cell capacity.
A new clean vehicle credit of up to $7,500 may be available if you acquired a qualified electric vehicle and placed it in service (i.e., taken delivery of the vehicle) this year. To qualify, the vehicle must have been assembled in North America. The calculation of the credit amount will depend on when you take delivery of the vehicle. If you took delivery before April 18, 2023, the total new clean vehicle credit equals a base amount of $2,500 and is increased by the amount of propulsion energy produced by the battery. For vehicles delivered on or after April 18, 2023, the credit amount equals $3,750 for vehicles meeting a critical minerals requirement plus $3,750 for vehicles meeting a battery component requirement. Price limits (i.e., MSRP limitations) apply depending on the vehicle type ($80,000 for vans, SUVs, and pickup trucks; $55,000 for other vehicles).
The Department of Energy provides a list at FuelEconomy.gov of eligible clean vehicles that meet the requirements to claim this credit, including the applicable MSRP limitation. The credit is not available if your adjusted gross income for the year is over $300,000 (married filing jointly), $225,000 (head of household), and $150,000 (single). Beginning in 2024, the new clean vehicle credit can be transferred to the dealer and used as a down payment at the time of sale.
Beginning this year, a credit is also available for the purchase of a previously-owned clean vehicle. The credit amount is the lesser of (1) $4,000, or (2) 30 percent of the cost of the vehicle. To qualify for the previously owned clean vehicle credit, the vehicle must be sold by a dealer for a sale price not in excess of $25,000, and the sale must be the first transfer of the vehicle since August 16, 2022. In addition, the buyer must be an individual taxpayer who cannot be claimed as a dependent by another taxpayer, who purchases the vehicle for use and not for resale, and who has not been allowed the previously owned clean vehicle credit in any of the 3 years preceding the sale of the vehicle. The credit is not available to taxpayers with adjusted gross income over $150,000 (married filing jointly), $112,500 (head of household), and $75,000 (single). Like the new clean vehicle credit, this credit will be transferable to the dealer beginning in 2024.
The alternative fuel vehicle refueling property credit is allowed with respect to any single item of qualified alternative fuel vehicle refueling property placed in service during the tax year not in excess of (1) $100,000 in the case of depreciable property, and (2) $1,000 in any other case. Qualifying property includes bidirectional charging equipment, and the credit can also be claimed for electric charging stations for two- and three-wheeled vehicles that are intended for use on public roads.
Section 179 Expensing and Depreciation Deductions
The two business tax deductions that present the best opportunities for reducing your business’s taxable income are the Section 179 deduction, where your business can elect to deduct the entire cost of certain property acquired and placed in service during the year, and the bonus depreciation deduction, where 80 percent of the cost of business property may be expensed. Under the Section 179 expensing option, your business can immediately expense the cost of up to $1,160,000 of “Section 179” property placed in service in 2023. This amount is reduced dollar for dollar (but not below zero) by the amount by which the cost of the Section 179 property placed in service during 2023 exceeds $2,890,000.
The bonus depreciation rules apply to all businesses unless the business specifically elects out of these rules. An election out might be preferable where a business expects a tax loss for the year and the bonus depreciation would just increase that loss or where it might be advantageous to push depreciation deductions into future years. For example, if the owner of a pass-thru entity to whom these deductions would flow expects to be in a higher tax bracket in future years, such deductions might be of more use in those future years. When applying both the Section 179 deduction and the bonus depreciation deduction to an asset, the Section 179 deduction applies first.
If you need a vehicle for your business, purchasing a sport utility vehicle weighing more than 6,000 pounds can trigger a bigger deduction than if a smaller vehicle is purchased. This is because vehicles that weigh 6,000 pounds or less are considered listed property and the related first-year deduction is limited to $20,200 for cars, trucks and vans acquired and placed in service in 2023. For vehicles weighing more than 6,000 pounds, however, up to $28,900 of the cost of the vehicle can be immediately expensed.
It is worth noting that if you leased a passenger automobile in 2023 with a value of more than $60,000, the deduction available for that lease expense is reduced. In such cases, you must include in gross income an amount determined by a formula the IRS issues each year.
Qualified Business Income Deduction
If you are conducting your business as a sole proprietorship, a partner in a partnership, a member in an LLC taxed as a partnership, or as a shareholder in an S corporation, the qualified business income (QBI) deduction can significantly help reduce taxable income. The QBI deduction allows eligible taxpayers to deduct up to 20 percent of their QBI, plus 20 percent of qualified real estate investment trust dividends and qualified publicly traded partnership income. A W-2 wage limitation amount may apply to limit the amount of the deduction. The W-2 wage limitation amount must be calculated for taxpayers with a taxable income that exceeds a statutorily defined amount (i.e., the threshold amount). For any tax year beginning in 2023, the threshold amount is $364,200 for married filing joint returns and $182,100 for all other returns.
Since the QBI deduction reduces taxable income, and is not used in computing adjusted gross income, it does not affect limitations based on adjusted gross income such as the medical expense deduction or the calculation of social security income that is includible in income. However, the QBI deduction does not apply to a “specified service trade or business,” which is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.
As you can see, there is much to consider before you prepare your 2023 personal and business tax return and calculate any estimated tax payments that might be due in 2024. You could call me at your convenience or professional tax preparer to meet and review potential strategies for reducing your 2023 taxable income and tax liability.
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