How to reduce your taxes in 2024
On December 29, 2023, The Wall Street Journal published the article, To Lower Your Taxes in 2024, Make These Moves Now.
I should say the article’s recommendations aren’t specific to 2024; they can apply at any time in any year. As such, consider these tips evergreen things that you can apply to any year going forward (unless tax legislation eventually changes and renders any of these things obsolete).
The article’s tax-lowering tips are:
I WILL keep an eye on my AGI
AGI is “Adjusted Gross Income,” which is one of the most important numbers on your tax return.
It’s kind of the starting point of your income, before you start to take deductions. It’s also a number that is used in determining many other things and/or potential extra taxes on your return.
For example, it’s the starting point to determine if you’re eligible for making deductible contributions to an IRA, if you’re going to have to pay extra for Medicare, if you’re going to be subject to the Net Investment Income Tax, etc.
All else equal, the higher your AGI, the higher your income taxes and other potential knock-on taxes or surcharges. As such, being cognizant of your AGI is the first step in doing tax planning. To the extent you can lower your AGI – such as by making contributions to a Health Savings Account or an IRA – you can potentially help manage and minimize your taxes.
I talked in detail about AGI in Episode 27 of the Retirement Planning Education podcast.
I WON’T let a low-income year go to waste
While it may feel good to be in a really low tax situation - such as being in the 10% or 12% federal tax bracket) - it could be in your long-term interest to NOT let yourself have such low income.
For example, maybe you just recently retired and your wages have since stopped. And you haven’t yet started Social Security. Perhaps your only source of taxable income is some interest from bank accounts and dividends from a brokerage account. You probably have the lowest taxable income you may have for the rest of your life (i.e. once Social Security starts, your income will be higher forever).
You could potentially take advantage of the abnormally low income year of income to “fill up” the lowest tax brackets and not let them go unused. Perhaps doing Roth conversions or selling appreciated securities in a brokerage account to “tax gain harvest” could be good ways to make tax-efficient use of otherwise really low income years.
I WILL be aware of state-tax traps in money-market funds
This one is a bit clickbaity in using the term “traps.” But the underlying gist is accurate.
Interest paid on securities issued by the US Department of Treasury is free from state income tax. And many “money market” funds - which increased in popularity recently as interest rates have risen – pay some or all of their interest from interest on US Treasury securities. As such, many people think interest from money market funds is not taxable at the state level.
However, even if a money market fund gets some or all of its interest from US Treasuries, that doesn’t necessarily mean that interest will indeed be free from state income tax. That’s because some funds actually pay interest via a form of borrowing against US Treasuries known as repurchase agreements, or “repo.” The interest in this case is directly from US Treasuries.
On the surface, it may appear like the interest is from US Treasuries and hence state income tax-free. But in actuality it’s not.
I WILL act quickly on tax planning if my spouse – or the spouse of someone close to me – dies
This one is a bit morbid and can come off as callous. But it’s actually a very important point to consider.
People who are married and file a joint tax return generally have more favorable tax treatment of their income compared to single people; a dollar of income is taxed less for married people that it is for single people.
When one spouse dies, the surviving spouse can still file a joint tax return for that year, regardless when in the year the other spouse died. After the year of death, the surviving spouse will need to file as a single person.
In the year of the spouse’s death, the surviving spouse could take advantage of that final year of larger married tax brackets and standard deductions by pulling forward income they’d otherwise have to recognize at some point in the future. An example could be to do a Roth conversion or take a larger IRA distribution than they otherwise would have.
I WILL keep records of my home improvements
When you sell your primary residence, you can typically exclude from taxation $250k if single, or $500k if married, of gain on your house. This assumes you owned and lived in the property at least two out of the five years leading up to the date of the sale.
Generally speaking, the gain is the difference between the amount at which you sell your house, and the price you originally paid for it. For example, if you sell your house for $700k and you paid $400k, that would be a $300k gain.
However, there is more to it than that. The amount of gain is reduced by certain closing costs such as the realtor expenses paid when you sell the property.
Also, the original cost, or “basis,” of the property is increased by the amount of improvements you made to the property. All else equal, the higher the cost of the improvements, the smaller the potentially taxable gain. Therefore, it’s important to keep records and receipts of all improvements you make to your primary residence.
I did a full discussion of the topic of the gain exclusion on selling your primary residence in Episode 71 of the Retirement Planning Education podcast.
I WON’T miss out on my tax break for Qualified Charitable Distributions
Qualified Charitable Distributions, or QCDs, are when you make a donation to a qualified charity directly out of your IRA, specifically if/when you’re at least 70 ½ years old.
If you are charitably inclined and over 70 ½, QCDs are almost certainly the most tax-efficient way to donate money (more so than writing checks or giving cash out of your bank accounts).
However, there is a potential snag that trips people up with QCDs; not properly reporting them on their tax returns.
When you make a QCD, you will get a 1099-R at the end of the year from the custodian of your IRA. But the QCD will not in any way be marked or denoted as QCD; it will look like a normal (and taxable) IRA distribution on the 1099-R. It’s up to you to ensure you (or your tax return preparer, if you use one) manually account for the QCD as a QCD, and not a normal distribution, on your return.
I talked about QCDs in depth in Episode 75 of the Retirement Planning Education podcast.
I WON’T get caught by higher interest rates on tax underpayments
The US income tax system is a “pay as you go” structure, where you’re intended to pay tax as you earn or recognize income. If you don’t pay enough tax throughout the course of the year, the IRS may charge you interest on the amount of tax you should have paid but didn’t during each quarter.
Over most of recent history, the interest rate charged was relatively low to the point it wasn’t necessarily a major concern to try to avoid such underpayment penalties.
However, since interest rates shot up during 2022 and 2023, so has the amount of penalties people have to pay when they don’t pay enough tax throughout the year.
Now, it’s more important to be more aware of paying the proper amount of tax during the year to avoid or minimize interest penalties.
This is a complicated topic, but I helped break it down and explain it in a YouTube video, Estimated Taxes, Tax Withholdings and Underpayment Penalties. The video is a couple of years old, but still very relevant and applicable today.
I hope you found the above information helpful. And thank you Laura Saunders at The Wall Street Journal for writing the article!