Wagner & Associates, CPA, LLC

It's important to know tax tips as tax season draws near since they can help consumers save money on their taxes. Taxpayers can increase their refund by reducing taxable income and using credits and deductions. Making the most of contributions and being aware of retirement plan alternatives may also reduce taxes and increase retirement savings. If you want to find the best options for your unique circumstances and goals, taxpayers must speak with a tax expert or financial counselor. Here are must-know tax tips for 2023 to help reduce tax liabilities and increase refunds.

Maximize Deferrals and Contributions to Retirement Plans

Maximizing deferrals and contributions to retirement plans is clients' most common mistake when reducing their income tax burden. By failing to maximize deferrals, clients miss out on free money from their employers through matching programs. To avoid this mistake, clients should maximize deferrals to retirement plans such as 401-K, 457, 403-B, SARSEP, or Simple-IRA.

Many people fail to take advantage of this opportunity or only contribute minimal amounts, missing out on the full potential benefits these plans offer. Clients may not maximize deferrals because they are unaware of how much they can contribute each year. In 2023, maximum deferrals for these plans range from $15,500 to $22,500, with additional catch-up contributions available for those over age 49.

Another easy way to increase or begin deferrals is to allocate half of an annual wage increase to the retirement account, allowing employees to receive an immediate raise while increasing their retirement savings.

Use The Pre-Tax Benefits of Every Applicable Tool on the Cafeteria Plan

A cafeteria plan (also known as a Section 125 plan) allows employees to choose among different pre-tax benefits and then allocate a certain amount of their compensation towards those benefits on a pre-tax basis. This means the employee's taxable income reduces by the amount they contribute to these plans, resulting in lower overall taxes. The most common benefit under a cafeteria plan is healthcare. Still, it can also include dependent care assistance for a child or elderly dependents who cannot stay at home alone due to work obligations.

Taxpayers need to use all available pre-tax benefits under a cafeteria plan to reduce their overall tax burden. Sometimes these plans are referred to as flex spending accounts or 125 plans, but they all refer to the same thing - an employer-sponsored benefit program that allows employees to choose among different benefits on a pre-tax basis.

The cap for individual coverage in 2023 under the Affordable Care Act is $3,050, while the cap for family coverage, which includes coverage for your spouse and dependents, is $6,150. This means that each employee can receive up to $3,050 worth of these additional benefits per year without having them count toward their income for federal tax purposes. If an employer offers a cafeteria plan with multiple options for benefits, each employee may choose which ones they want to use up to the limit of $3,050 per person.

Additionally, if you have a spouse covered under your plan, both individuals can utilize this maximum separately, so together, you could get up to $6,150 in tax-free healthcare benefits ($3,050 x 2). However, it's important to note that not all companies offer plans with these additional benefits beyond basic medical care or may cap them at lower amounts than the federal limits.

This limit prevents companies from offering extra generous health insurance plans that the government subsidizes through taxpayers since they would otherwise be tax deductible as business expenses. However, this maximum does not apply to premiums paid by employers or employees toward health insurance policies.

Use A Bunching Strategy

Under the 2017 Tax Cuts and Jobs Act, the standard deduction amounts for individuals increased from $6,350 to $13,850, while they increased for married couples filing together from $12,700 to $27,700 (as of 2023). Because the standard deduction is larger than their total taxable income, many retirees who do not have considerable income or itemized deductions may no longer profit from taking it.

However, there are ways to work around this limitation by using a "bunching" strategy where you can make large charitable contributions in one year to exceed the standard deduction threshold. If they are high enough, you can combine medical expenses to exceed the 7.5% floor for the deductible amount.

The best approach would be to use both strategies simultaneously so that large medical expenses can be bunched with charitable donations in the same year to maximize deductions and exceed the standard deduction. By using these deductions when available, retirees can still save money on their taxes even if they may have a limited income or itemized deductions owing to their decreased wages.

Use The Qualified Charitable Distribution Rule to Make Charity Contributions

The Qualified Charitable Distribution (QCD) Rule allows people at least 70 years old to make direct IRA contributions to approved organizations without having the funds considered income for federal income tax purposes. The maximum annual QCD limit is $100,000 per person, which counts towards satisfying any mandatory Required Minimum Distributions (RMDs). This means that those who have reached age 70½ may be able to avoid paying both income taxes on RMDs and also reduce their taxable income by making a QCD contribution up to the same amount. Additionally, individuals over 73 can exclude the distribution from their gross income even if they do not itemize deductions or take advantage of other charitable contributions.

Begin Long-Term Planning for Kids

When a child earns income from working part-time jobs, babysitting, mowing lawns, or other sources and open a Roth IRA, they can start the five-year holding period as soon as they make that first contribution. Even if it's only $10, as long as there is no withdrawal before reaching the age of 59 ½ years old, the money will grow tax-free forever afterward. This means that any future contributions made to this account will also be tax-free upon withdrawal in retirement.

Additionally, once the child reaches age 21, even if they close the account, the earnings on those initial contributions are still tax-free since the five-year clock has already started. Therefore, opening a Roth IRA early and leaving a small amount of money in it, such as $10 or so, can benefit them later in life with tax-free growth and savings for their retirement.

Open A 529 Account for a Child (Or Grandchild) As Soon As Possible

A 529 account is an investment vehicle created for saving for higher education that provides tax benefits, including tax-deferred growth and tax-free withdrawals when used for eligible school costs. The gains on those contributions are tax-free and you can withdraw them for any purpose, thanks to a recent change in tax legislation that permits transfers of up to $35,000 from a standard 529 account to a Roth IRA after 15 years.

Parents or grandparents can use the advantages of a Roth account, such as tax-free growth and tax-free withdrawals for non-educational costs like retirement savings, to begin saving early for their child's or grandchild's college tuition.

A 529 plan also offers flexibility in how much money you contribute each year, depending on your financial circumstances, because you don’t need a minimum investment to start one. Additionally, the beneficiary can change every year, providing potential generational advantages.

Use The Kiddie Tax Exemption

The kiddie tax describes the additional tax imposed on minors under 19 or full-time students under 24 who have earned income from wages, salaries, bonuses, tips, commissions, and professional fees. In 2023, if a child has no other income besides these sources, they can earn up to $1,25 in interest and dividends without paying federal tax. This means you can save around $35,000 in the child's name (at an assumed annual rate of return of 4.5%) without tax being due.

However, once their total income exceeds this threshold, the kiddie tax will apply to all their earned and unearned income until they reach age 19 or become full-time students under age 24. The exact amount varies each year based on inflation adjustments made by Congress.