Getting Ahead in 2024: Tax Planning Tips to Start the Year

Many of us are wrapping up the 2023 tax process whether self-preparing or working with a tax preparer.   As we come to the end of this process, it can be helpful to reflect on what changes might make an impact going forward into the new 2024 tax year.  Perhaps when you receive your completed 2023 return you will find some not so nice surprises- your tax bill is higher than you thought, or you received a penalty.   In this article we provide suggestions for how to improve or correct past tax issues as well as proactive tips to put you in a better tax position for the future.  

A good first step when engaging in tax planning is to review what happened last year.  When you complete or receive your 2023 tax return, we recommend focusing your review on certain key points:  

1. Determine your average and marginal rates for Federal and state tax liability.  Your average tax rate represents your total tax paid divided by your total income.  This gives you a sense of how much of your income goes towards taxes.  Your marginal tax rate represents the tax rate that will be applied to the next dollar of income you receive.  This helps you to plan for additional income and what the tax impact will be.  
2. Determine whether you received the standard deduction or if you were able to itemize your deductions. Page 1 of your 1040 form Line 12 will show your total deductions.  If you were able to itemize deductions, you will also have a Schedule A showing the details. The standard deduction reduces your income by a fixed amount- in 2023 this was $13,850 for single filers and $27,700 for those married filing jointly.  Tax law changes passed in 2018 with the Tax Cuts and Jobs Act (TCJA) made itemizing much less common.  Typically, you will need to have higher levels of mortgage interest or charitable giving in order to itemize.  Did you end up with the standard deduction even though you contributed to charity?  Consider some alternative strategies for charitable giving to see if you might be able to itemize and get a greater tax deduction (see our related post Why doesn’t my charitable giving increase my tax deduction?).
3. Look at how your prior tax return (2022) compares to the current return (2023).  Did your average tax rate go up?  Are you in a higher marginal bracket now?  Did you receive the standard deduction when you used to itemize?  If you see any changes, try to determine what was the cause(s).  Perhaps there are actions you can take this year (2024) to mitigate an increased tax rate or be able to itemize deductions.   
4. Check for any under-withholding penalty.  Checking page 2 of your 1040 on Line 38 will reveal if you incurred any under-withholding penalties.  If you see a penalty on this line, it means that you did not pay in sufficient taxes throughout the year via withholding and/or quarterly estimated payments.  This can happen for a variety of reasons:  you changed jobs and did not fill out your new W4 form correctly, you received a large bonus that did not have adequate withholding or perhaps you started a business and now have self-employment income with no withholding.  It is important to determine the cause of the penalty, so that you can adjust going forward by updating your withholding for an employer or starting to make quarterly estimated payments for self-employment income.  

Now that you have a better understanding of what happened last year and any adjustments to consider, you can evaluate if there are any other ways to improve your tax efficiency proactively. 

Be sure you are fully utilizing all tax advantaged account options appropriately.   

• If you have a higher marginal tax bracket- such as the 32% or 35% brackets for Federal tax purposes- you will want to explore all options for tax deferral.  These can include work retirement accounts such as traditional pre-tax 401k or 403b plans.  If you are self-employed, there are also pre-tax retirement plan options available to you such as a SEP IRA or solo 401k.  These types of retirement accounts allow you to avoid paying income tax on the funds you invest now in exchange for paying taxes at a likely much lower rate in the future during retirement.  If you are not fully taking advantage of these plans now, consider doing so in 2024 and benefiting from additional tax savings. 
• If you are at a relatively lower marginal bracket currently- such as 12% for Federal tax purposes- consider utilizing a Roth account option instead such as a Roth IRA or Roth 401k.  While you will pay taxes on any earnings put into savings now, these types of retirement accounts become tax free if you follow the rules for withdrawals and will allow you to take out funds in retirement without paying any tax.  
• You may also have access to a health savings account (HSA) depending on your health insurance plan type.  If you use your HSA for qualified medical expenses then not only will you not pay any taxes on the funds you save now, but they will also be tax free upon distribution.  Any unused value in the account continues to move into the next tax year so there is no use it or lose it problem as in a flexible savings account (FSA).  These accounts can be a great way to save taxes now and in the future.  
• If you have children, check with your employer to see if you have access to a dependent care account (DCA).  These accounts let you contribute up to $5,000/year for a household to be used to help pay dependent care expenses- most folks with young kids in daycare pay well over this amount every year for care.  While you must use these funds in the tax year you contribute, you will not pay any taxes on the income that was contributed.  

Review your brokerage account investment income to see if you can improve tax efficiency.  

• If you have a taxable brokerage account, you know that they produce taxable income depending on what types of investments you hold.  This investment income can be in the form of interest, dividends, or capital gains.  Some types of investment income, qualified dividends, and long-term capital gains are taxed at a more favorable rate than ordinary wage income- often 15 or 20%.  Interest, non-qualified dividends and short-term capital gains are all taxed at the same marginal rate as ordinary wage income and hold no special tax advantages.  Review both Schedule B (Interest and Ordinary Dividends) and Schedule D (Capital Gains and Losses) to determine how much and what type of investment income your account generates.  
• One way to improve the tax efficiency of the funds in your brokerage account is to consider using Exchange Traded Funds (ETFs) rather than mutual funds for your investments.  ETFs are structured to dramatically reduce capital gains distributions that can be larger and variable in mutual funds.  Be aware that it might create unintended tax consequences to sell current mutual funds you are holding at a capital gain to replace them with ETFs.  It is often best to consider the use of ETFs for new additions to the account or positions at lesser gain from a tax perspective.
• Another consideration is to evaluate the level of equity vs. bond fund investment in the taxable brokerage account.  Equity ETFs tend to produce higher proportions of qualified dividends as compared to bond ETFs.  If you have other tax-deferred investment accounts, such as IRAs or 401ks, you might consider having a higher proportion of your equity funds in the taxable brokerage and bond funds in your IRA.  There are also bond funds that invest primarily in municipal bonds as these types of bonds are typically tax-free at the federal level and potentially even the state level (if issued by the state you pay taxes in).   

As you can see, there are quite a few ways to help evaluate and improve your tax profile as we head into a new year.   Perhaps you will find a way to improve a tax issue you encountered in 2023 or you will find a way to proactively better your situation in 2024.  One additional consideration to keep in mind is that the provisions of the TCJA related to taxes for individuals are set to sunset or expire in 2026 unless Congress votes to extend them.  If the sunset goes through, individual Federal tax rates will rise to their pre-TCJA levels.  All changes made to exemptions, standard and itemized deductions and estate tax exemptions will revert to prior rules.  As always, working with a financial planner and tax professional can help you to fully evaluate ways to improve your tax profile as well as prepare for changes ahead.

Liz Alf is the Principal of Clerestory Advisors and fee-only CERTIFIED FINANCIAL PLANNERTM located in Minneapolis, MN.  She is a member of the National Association of Personal Financial Advisors (NAPFA) the Fee Only Network and Wealthtender.  She enjoys serving clients with on-going financial planning and investment management services.