Time to get tax-savvy, once again

Presidents’ Day, Monday, Feb. 19, is a time for kicking back and shopping – for some. For others, it’s a moment to begin gathering tax papers as brokerages send out the second batch of 1099s mid-February. 

According to a survey from online tax preparation company TaxSlayer, 57% of Americans are not confident about their understanding of the tax code and ways their investment portfolio affects their tax burden.  We at Metric Financial in Simsbury, Connecticut, are trying to reduce that number to zero during this tax season by educating consumers about new tax laws that influence investments so that everyone can mitigate his or her personal and professional tax liability while increasing wealth. 

A big mistake that people make is not consulting with a financial adviser about their monetary position and overall investment strategy before they meet with their accountant. Nine times out of 10, there are financial ways to offset your income and select investments that offer the maximum tax savings before an accountant files your tax return with the Internal Revenue Service (IRS). 

Ideally, your financial adviser and accountant should be working in close connection all year round but especially during tax season for the mutual client’s ultimate fiscal benefit. However, that client must also do due diligence and that means some basic tax literacy. Here are some common questions and their perhaps uncommon answers: 

What tax bracket am I in?   

There are seven distinct tax brackets that an individual may fall under based on income. However, a big misconception is that people think they are only taxed in one percentage bracket. In reality, the IRS tax code is tiered, so a person might be taxed at 12% for a portion of the income up to a certain dollar amount, as well as simultaneously taxed at 22 % on a greater amount of income.  A financial adviser and accountant can help determine a consumer’s marginal tax rate, which offers a more accurate depiction of the overall obligation. 

 

Why am I paying capital gains taxes on mutual funds if I didn’t sell anything?  

Every year, investors with mutual funds in non-retirement accounts receive a 1099 with capital gains that they have to pay taxes on, even if they didn’t sell anything. Exchange Traded Funds (ETFs), which also have lower costs and are just as diversified, tend not to distribute the same capital gains, offering people savings. It is always a good time to look at your exposure to capital gains. Likewise, there are ways to offset capital gains in a down market. Your adviser should always take advantage of those environments.  Even if you don’t have gains to offset, you can reduce your income tax burden by taking up to $3,000 in losses against income. That carries forward, so if a person has $6,000 in losses in 2023, he or she can take $3,000 against income this year and $3,000 again in 2024. 

 

Do I need to take a mandatory IRA distribution this year? 

The recent Secure Act 2.0 changed the Required Minimum Distribution (RMD) age to 73 and in 2033, the age will increase to 75. This does not change your RMD for an inherited IRA, which does not require an annual distribution, but the account needs to be empty by year 10 after inheriting. We generally recommend an annual distribution to spread out the taxes. 

 

What is happening with the Tax Cuts and Jobs Act (TCJA)?  

Implemented in 2017, the TCJA provided many sources of tax relief, including lowered tax rates, higher standard deductions, increased child tax credits and doubled the estate tax exemption, among other things. All of these items will sunset after 2025, so it is important to understand how you will be affected. For example, the estate tax exemption will likely get cut in half, so there may be some steps to take (such as gifting), depending on the value of your estate. You should also plan for higher taxes, lower child credits and perhaps start itemizing deductions again since the standard deduction will also be reduced in half. It is a good idea to get with a qualified CPA to determine how your return will be affected. 

 

Should I max out my pretax retirement plan contributions? 

It depends. Remember to think about what it will look like when you take withdrawals in retirement. Anything coming out of retirement accounts will be taxable as income. On the other hand, anything you take out of a traditional brokerage account will only incur capital gains. Long-term capital gains generally are taxed at a lower rate than income, so it’s a good idea to spread your investments around. 

 

 I own my own business, so I don’t have a 401(k). How do I save for retirement?  

Many business owners use a Simplified Employee Pension, or SEP, IRA. This allows you to invest funds for retirement, and contributions are tax-deductible. There is a specific formula for what the IRS will allow you to contribute, so be sure to consult with a tax accountant. If you have employees, a SIMPLE IRA or SIMPLE 401(k) might be better. A financial adviser can help you determine what fits best. 

 

Can I make a contribution to a Roth IRA? 

If you are married and filing jointly, the rule in 2023 is that your eligibility begins to phase out when you and your spouse make more than $218,000. If you are single, it begins to phase out at $153,000. Be careful if you are married and filing separately, because you cannot contribute to a Roth IRA if you earn more than $10,000. The income limits are actually going up for 2024, to $161,000 for single filers and $240,000 for joint filers. The maximum contribution was also increased to $7,000 ($8,000 if you’re over 50). 

 

My company offers both a Roth and a traditional version of a retirement plan. Which should I contribute to?   

Again, it’s important to think about what things will look like in retirement when you withdraw. A Roth is after-tax now and tax-free at withdrawal. A traditional retirement plan is pretax now and taxable at withdrawal.  People need to ask themselves when they will be in a higher tax bracket – now or in retirement – to make the wisest decision. 

 

I need money to repair my home. Can I borrow against the value of my IRA?  

No, a person can only borrow against an employer retirement plan. Once a year, an employee can withdraw money from his or her IRA. However, that needs to be put back into the IRA within 60 days. If it is not returned in 60 days, it will become taxable income and if you are under 59 ½, you will pay a 10% penalty on top of the taxes. 

Americans work hard for their money and the job of any good financial adviser and accountant is to help preserve and grow it. My main mission is to educate people on their tax ramifications, and, more important, the costs of each investment option, so that they can keep more of their returns, reduce payouts and improve their financial picture over time. 

 

Chartered Financial Analyst Timothy Baker is the principal owner of Metric Financial, a Connecticut-based investment management and financial planning firm that offers educational sessions and public seminars on creating and preserving wealth for retirement. For more, visit metricfin.com.