Tax Tips

Taxes.  It’s at the forefront of everyone’s mind. The largest expense for most people every year but many don’t fully understand how it is calculated or ways they could potentially lower their tax bill.

Simply put, your taxes are based on all sources of income and capital gains received throughout the year.  Your income is taxed at a tiered marginal rate then your capital gains are taxed at a fixed rate based on your total income.  

Something clients routinely ask about is how to lower their taxes.  While there is no magic pill that can make taxes disappear, there are many tools at your disposal to defer or reduce some of your taxes that you may not be taking advantage of.  Here is a quick review of some strategies that are often overlooked.

HSA – Health Savings Account

While most people are aware of deducting income through 401k or IRA contributions, a powerful account that is often overlooked is the Health Savings Account.  This is the only ‘triple tax advantaged account’ meaning you get a tax deduction for contributing, tax deferred investment growth, and tax-free withdrawals (if used for medical expenses)

QCD – Qualified Charitable Distributions

For many retirees, charitable giving is a great way to give back and support their communities.  The tax code incentivizes gifting to charity in many ways.  One of the most efficient ways to give is through a Qualified Charitable Distribution. Simply put, this is the act of giving directly to charity from your IRA’s Required Minimum Distributions.  This has a unique benefit in that it is considered an ‘above the line’ deduction.  This means that it directly lowers your income.  During your working years, the tax code incentivizes charitable giving with a tax deduction, but this requires you to itemize deductions.  With a standard deduction of $30,000 it is difficult for most couples to deduct enough to make this worth it.

Bunching

As mentioned above, the standard deduction is a large hurdle for most people to be able to itemize. The itemized deduction list is a short list of qualified expenses incurred by the taxpayer they can deduct.  The most common deductions are State and Local taxes (SALT), mortgage interest, and charitable giving.  State and Local taxes are capped at $10,000 for a married couple, so you would need to have more than $20,000 of mortgage interest and charitable gifts to be able to itemize.   This is where Bunching comes into play.  By using a Donor Advised Fund, the taxpayer can essentially front load multiple years of charitable gifts to be able to take a larger tax deduction.  

Let’s view an example; John and Sally typically donate $5,000 to local charities every year.  They hit the $10,000 SALT cap and pay $5,000 in mortgage interest each year.  In a normal year that is only $20,000 in deductions, so they would take the $30,000 standard deduction anyway.  By utilizing the Bunching strategy, they could donate $25,000 to their Donor Advised Fund in 2025 (5 years of charitable gifts).  This is all considered a charitable gift this year, but they can still give the charities $5,000/year from the Donor Advised Fund.  Now, in 2025 they can itemize $40,000 in deductions PLUS they would be able to use the standard deduction of $30,000 in the following years.

Energy Efficiency

While a small credit, the Energy Efficiency Home Improvement Credit allows up to a $3,200 credit for improvements made after January 1, 2023.  The key word here is ‘credit’ vs ‘deduction’.  This means you dollar for dollar lower your tax bill compared to a deduction which lowers your taxable income.  The credit is split into 2 pieces, $1,200 maximum for exterior components (e.g. windows, doors, skylights) and a $2,000 maximum for system updates (e.g. heat pumps, water heaters, boilers).

The tax credit might not be the largest but for a lot of older homes, these updates have incredible long-term benefits to lower energy bills and increase comfort in your home.  Most states also have programs in place to ease the cost and even provide interest free loans.  Efficiency Vermont and Mass Save are examples of these programs for Vermont and Massachusetts.

Inherited IRA Required Minimum Distribution Final Ruling

Beginning in 2020, the IRS made drastic changes to how Inherited Retirement Accounts are to be handled and distributed.  Prior to December 31, 2019, the inheritor was required to take distributions according to a distribution table based on their age.  For younger inheritors, this meant they could take relatively small taxable distributions and spread the account over decades.  Beginning in 2020, this rule changed to what is known as the ’10 Year Rule’, meaning inheritors had a 10-year window to fully draw the account to 0.  For beneficiaries who are in their highest earning years this can be a very large tax drag and difficult to plan for.

The big question mark for the last 5 years has been the vague language about whether the beneficiary can wait until the end of year 10 and draw it all at once, or if they have to take some kind of minimum distribution over that time.  By waiting as long as possible this would allow the account to grow but also would possibly force the beneficiary into a higher tax bracket during that final year.

On July 19th of last year, the IRS gave their final guidance on this subject.  Required Minimum Distributions are now required each year for the beneficiary, but ONLY if the decedent had reached the age for their Required Minimum Distribution.  This could be age 70.5, 72, or 73 depending on the decedents date of birth.  This also applies to inherited Roth IRAs, which would not have any income tax ramifications but would lower how much the account could grow tax-free during that period.