Sorry to bring bad holiday news, but the year-end tax calculations are not in your favor.
There are many lists full of year-end tax changes, but the fact is, you can’t save much money at this point in the calendar. If you start tax planning at such a late time and flip a few switches, you simply won’t accomplish much. Your income is pretty much a known quantity after about fifty weeks, and there’s no way to go back and erase it so that your April tax bill will be lighter.
The immutability of year-end income has always been a truism, but there used to be a lot more leeway in deductions, and maximizing them was big business. Then in 2018, the Tax Cuts & Jobs Act eliminated many line items, such as unreimbursed employee benefits, and increased the standard deduction. Inflation has pushed the 2023 standard deduction to $13,850 for single filers, $27,700 for joint filers and $20,800 for heads of household. Seniors get even more: an additional $1,950 for single filers and $1,550 for joint filers. So now about 90% of taxpayers are taking that lump sum out of their income and no longer itemizing it on Schedule A. For the 2024 tax year, the standard deduction figures will be even higher.
For most people, this means that tax-saving measures they may have taken in the past, such as making donations to charities, are off the table. Technically, you can still do things like maximize pre-tax 401(k) contributions before December 31, but it may be too late to get them processed through your payroll provider by Thanksgiving. You can make contributions to your health savings account up until the tax deadline if you qualify. So you still have time to do that, but you have to make sure that they are done outside of payroll deductions in order for them to count for 2023.
A math example
One tip that continues to make its way onto year-end tax move lists is to prepay your January mortgage payment in December to maximize the amount of interest you can deduct. This is a good example to illustrate that the numbers usually don’t work out despite all the extra effort you have to put in.
“The benefit of that mortgage deduction is not as great as it used to be,” says Larry Pon, a CPA based in Redwood City, California.
The theory behind this move is that by making an extra mortgage payment in December, you can increase your mortgage interest deduction for that year, which could reduce your taxable income and therefore lower your overall tax bill. When you have a new mortgage, you usually pay interest because the payment is a ratio of interest to principal that changes over time. If that’s your case, you’ll likely pay interest of 6% to 7% or more, which will add up.
How much can you actually save by making one payment early and therefore having 13 payments for 2023? “It depends on the client’s circumstances, including the marginal tax rate, mortgage interest rate and the amount of the additional payment,” says Ekaterina St. Ores, a certified financial planner and registered tax preparer from McMinnville, Oregon.
As St. Ores calculates, if you have a new mortgage with a $500,000 balance and a 7% interest rate, you could potentially save about $500 if you advance one payment. This is based on a monthly payment of €3,145, of which €2,083 is interest and €1,062 principal, and a marginal tax rate of 24%.
The numbers will vary depending on the age of your mortgage and the rest of your financial situation. If you took out a $300,000 mortgage for 10 years at 3% interest and you’re in the 12% bracket, you’re not going to save that much. If this is your situation, your monthly payment will be €1,264, which amounts to €570 interest and €695 principal. So your savings would be about $70.
One big caveat is that you’ll need to figure out how to get your servicer to credit the payment on your 2023 tax return. “Sometimes going to a branch is better than paying online,” says St. Ores. “When you make the payment, you must ensure that the bank treats it as a regular payment as a repayment of the payment due on January 1, and not as a one-off additional principal repayment. This is important.”
Another warning: this is usually a one-time strategy. If you accelerate to 13 payments for 2023, you’ll end up with 11 payments in 2024. For this to continue, you’ll need to make two advances, then three, and so on.
Pon points out that the situation will be different after 2025, when the current tax provisions expire. Unless legislative action is taken, taxpayers will return to the old way of doing things, which means all the deduction strategies of the past will come back into play.
“I’m teaching tax preparers right now and I tell the students, 2026 is coming and you’re going to have to relearn how to do a Schedule A,” Pon says. But another important lesson he passes on is that tax preparers have learned in recent years that taxpayers need to pay more attention to the long game rather than focusing on last-minute decisions.
To do that, you can start over in January and evaluate your expected income for the year. Then you can maximize the tax-deferred options available to you, such as your 401(k), and spread them out over the year. You can also look for opportunities to manage your investment gains and losses as market conditions change, without having to rush.
“We used to focus our tax planning on depreciation and deductions,” says Pon. “Now it’s more of a long-term planning strategy.”