For 2023, the amount that an eligible married couple can contribute to an IRA for a nonworking spouse is $6,500, which is the same limit that applies for the working spouse.

Benefits of an IRA

As you may know, IRAs offer two advantages for taxpayers who make contributions to them:

• Contributions of up to $6,500 a year to a traditional IRA may be tax deductible, and
• The earnings on funds within the IRA aren’t taxed until withdrawn. (Alternatively, you may make contributions to a Roth IRA. There’s no deduction for Roth IRA contributions, but, if certain requirements are met, future distributions are tax-free.)

As long as a married couple has a combined earned income of at least $13,000, $6,500 can be contributed to an IRA for each spouse, for a total of $13,000. (The contributions for both spouses can be made to either a regular IRA or a Roth IRA, or split between them, as long as the combined contributions don’t exceed the $13,000 limit.)

Higher contribution if 50 or older

In addition, individuals who are age 50 or older can make “catch-up” contributions to an IRA or Roth IRA in the amount of $1,000. Therefore, for 2023, a taxpayer and his or her spouse, who have both reached age 50 by the end of the year can each make a deductible contribution to an IRA of up to $7,500, for a combined deductible limit of $15,000.

However, there are some limitations. If, in 2023, the working spouse is an active participant in one of several types of retirement plans, a deductible contribution of up to $6,500 (or $7,500 for a spouse who will be 50 by the end of the year) can be made to the IRA of the nonparticipant spouse only if the couple’s AGI doesn’t exceed a certain threshold. This limit is phased out for AGI between $218,000 and $228,000.

If you’d like more information about IRAs or want to discuss retirement planning, contact us.

Rules for eligibility

You can make a deductible contribution to a traditional IRA if:

• You (and your spouse) aren’t an active participant in an employer-sponsored retirement plan, or
• You (or your spouse) are an active participant in an employer plan, but your modified adjusted gross income (MAGI) doesn’t exceed certain levels that vary from year-to-year by filing status.

For 2022, if you’re a married joint tax return filer and you are covered by an employer plan, your deductible IRA contribution phases out over $109,000 to $129,000 of MAGI. If you’re single or a head of household, the phaseout range is $68,000 to $78,000 for 2022. For married filing separately, the phaseout range is $0 to $10,000. For 2022, if you’re not an active participant in an employer-sponsored retirement plan, but your spouse is, your deductible IRA contribution phases out with MAGI of between $204,000 and $214,000.

Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty before age 59½, unless one of several exceptions apply).

IRAs often are referred to as “traditional IRAs” to differentiate them from Roth IRAs. You also have until April 18 to make a Roth IRA contribution. But while contributions to a traditional IRA are deductible, contributions to a Roth IRA aren’t. However, withdrawals from a Roth IRA are tax-free as long as the account has been open at least five years and you’re age 59½ or older. (There are also income limits to contribute to a Roth IRA.)

Here’s another IRA strategy that may help married couples save tax. You can make a deductible IRA contribution, even if you don’t work. In general, you can’t make a deductible traditional IRA contribution unless you have wages or other earned income. However, an exception applies if your spouse has earned income and you’re a homemaker or not employed. In this case, you may be able to take advantage of a spousal IRA.

The contribution limit

For 2022 if you’re eligible, you can make a deductible traditional IRA contribution of up to $6,000 ($7,000 if you’re age 50 or older). For 2023, these amounts are increasing to $6,500 ($7,500 if you’re 50 or older).

In addition, small business owners can set up and contribute to Simplified Employee Pension (SEP) plans up until the due date for their returns, including extensions. For 2022, the maximum contribution you can make to a SEP is $61,000 (increasing to $66,000 for 2023).

Contact us if you want more information about IRAs or SEPs, or ask about them when we’re preparing your return. We can help you save the maximum tax-advantaged amount for retirement.

Note: The additional penalty tax is 25% if you take a distribution from a SIMPLE IRA in the first two years you participate in the SIMPLE IRA plan.

Fortunately, there are several ways that the penalty tax (but not the regular income tax) can be avoided. However, the rules are complex. As the taxpayer in one new court case found, if you don’t meet the requirements, you’ll be forced to pay the penalty.

Basic rules

Some exceptions to the 10% early withdrawal penalty tax are only available to taxpayers who take early distributions from traditional IRAs, while others can only be used with qualified retirement plans such as 401(k)s.

Some examples of exceptions include:

• Paying for medical costs that exceed 7.5% of your adjusted gross income,
• Taking annuity-like annual withdrawals under IRS guidelines,
• Withdrawing money from an IRA, SEP or SIMPLE plan up to the amount of qualified higher education expenses for you, your spouse, children or grandchildren, and
• Taking withdrawals of up to $10,000 from an IRA, SEP or SIMPLE plan for qualified first-time homebuyers.

Facts of the new case

Another exception is available for the total and permanent disability of the retirement plan participant or IRA owner. In one case, a taxpayer took a retirement plan distribution of $19,365 before he reached age 59½, after losing his job as a software developer. According to the U.S. Tax Court, he had been diagnosed with diabetes, which he treated with insulin shots and other medications.

The taxpayer filed a tax return for the year of the distribution but didn’t report it as income because of his medical condition. The retirement plan administrator reported the amount as an early distribution with no known exception on Form 1099-R, which was sent to the IRS and the taxpayer.

The court ruled that the taxpayer didn’t qualify for an exception due to disability. The court noted that an individual is considered disabled if, at the time of a withdrawal, he or she is “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.”

In this case, the taxpayer was previously diagnosed with diabetes, but he had been able work up until the year at issue. Therefore, the federal income tax deficiency of $4,899 was upheld. (TC Memo 2023–9)

Lessons learned

As the taxpayer in this case discovered, taking early distributions is one area where guidance is important. We can help you determine if you’re eligible for any exception to the 10% early withdrawal penalty tax.

The rules for taking required minimum distributions (RMDs) are complicated, so here are some answers to frequently asked questions.

What if I want to take out money before retirement?

If you want to take money out of a traditional IRA before age 59½, distributions are taxable and you may be subject to a 10% penalty tax. However, there are several ways that the 10% penalty tax (but not the regular income tax) can be avoided, including to pay: qualified higher education expenses, up to $10,000 of expenses if you’re a first-time homebuyer and health insurance premiums while unemployed.

When do I take my first RMD?

For an IRA, you must take your first RMD by April 1 of the year following the year in which you turn 72, regardless of whether you’re still employed.

How do I calculate my RMD?

The RMD for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s “Uniform Lifetime Table.” A separate table is used if the sole beneficiary is the owner’s spouse who is 10 or more years younger than the owner.

How should I take my RMDs if I have multiple accounts?

If you have more than one IRA, you must calculate the RMD for each IRA separately each year. However, you may aggregate your RMD amounts for all of your IRAs and withdraw the total from one IRA or a portion from each of your IRAs. You don’t have to take a separate RMD from each IRA.

Can I withdraw more than the RMD?

Yes, you can always withdraw more than the RMD. But you can’t apply excess withdrawals toward future years’ RMDs.

In planning for RMDs, you should weigh your income needs against the ability to keep the tax shelter of the IRA going for as long as possible.

Can I take more than one withdrawal in a year to meet my RMD?

You may withdraw your annual RMD in any number of distributions throughout the year, as long as you withdraw the total annual minimum amount by December 31 (or April 1 if it is for your first RMD).

What happens if I don’t take an RMD?

If the distributions to you in any year are less than the RMD for that year, you’ll be subject to an additional tax equal to 50% of the amount that should have been paid out, but wasn’t.

Plan ahead wisely

Contact us to review your traditional IRAs and to analyze other aspects of your retirement planning. We can also discuss who you should name as beneficiaries and whether you could benefit from a Roth IRA. Roth IRAs are retirement savings vehicles that operate under a different set of rules than traditional IRAs. Contributions aren’t deductible but qualified distributions are generally tax-free.

Donating to charity

In 2022, in order to receive a charitable donation write-off, you must itemize deductions on your tax return. What if you want to give gifts of investments to your favorite charities? There are a couple of points to keep in mind.

First, don’t give away investments in taxable brokerage accounts that are currently worth less than what you paid for them. Instead, sell the shares and claim the resulting capital loss on your tax return. Then, give the cash proceeds from the sale to charity. In addition, if you itemize, you can claim a full tax-saving charitable deduction.

The second point applies to securities that have appreciated in value. These should be donated directly to charity. The reason: If you itemize, donations of publicly traded shares that you’ve owned for over a year result in charitable deductions equal to the full current market value of the shares at the time the gift is made. In addition, if you donate appreciated stock, you escape any capital gains tax on those shares. Meanwhile, the tax-exempt charity can sell the donated shares without owing any federal income tax.

Charitable donations from your IRA

IRA owners and beneficiaries who’ve reached age 70½ are permitted to make cash donations totaling up to $100,000 annually to IRS-approved public charities directly out of their IRAs. You don’t owe income tax on these qualified charitable distributions (QCDs), but you also don’t receive an itemized charitable contribution deduction.

The upside is that the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to worry about restrictions that can potentially delay itemized charitable write-offs. Contact your tax advisor if you want to hear about the full benefits of QCDs. If you’re interested in taking advantage of this strategy for 2022, you’ll need to arrange with your IRA trustee or custodian for money to be paid out to one or more qualifying charities before year end.

Giving to loved ones

The principles for tax-smart gifts to charities also apply to gifts to family members and loved ones. That is, you should sell investments that are currently worth less than what you paid for them and claim the resulting tax-saving capital losses. Then, give the cash proceeds from the sale to your children, grandchildren or other loved ones.

Likewise, you should give appreciated stock directly to those to whom you want to give gifts. When they sell the shares, they’ll pay a lower tax rate than you would if they’re in a lower tax bracket.

In 2022, the amount you can give to one person without gift tax implications is $16,000 per recipient (increasing to $17,000 in 2023). The annual gift exclusion is available to each taxpayer. So if you’re married and make a joint gift with your spouse, the exclusion amount is doubled to $32,000 per recipient for 2022.

Tax-smart gifts

Whether you’re giving to charity or loved ones (or both) this holiday season, it’s important to understand the tax consequences of gifts. Contact us if you have questions about taxes and any gifts you want to make.

It has been quite a year — high inflation, rising interest rates and a bear stock market. While there’s not a lot you can do about any of these financial factors, you may have some control over how your federal tax bill for the year turns out. Here are some strategies to consider executing before year end that may reduce your 2022 or future tax liability.

1. Convert your traditional IRA to a Roth IRA

The down stock market could make this an especially lucrative time to convert all or some of the funds in a traditional pre-tax IRA to an after-tax Roth IRA. Although you must pay income tax on the amount converted in 2022, Roth accounts hold some significant advantages over their traditional counterparts.

Unlike traditional IRAs, for example, Roths aren’t subject to required minimum distributions (RMDs). The funds in a Roth will appreciate tax-free. Qualified future distributions also will be tax-free, which will pay off if you’re subject to higher tax rates at that time, whether due to RMDs or other income.

How does the poorly performing stock market incentivize a Roth conversion? If your traditional IRA contains stocks or mutual funds that have lost significant value, you can convert more shares than you could if they were worth more, for the same amount of tax liability.

Roth conversions are also advisable if you have lower income and therefore are in a lower tax bracket this year. Perhaps you lost your job at the end of 2021 and didn’t resume working until this past summer, or you’re retired but not yet receiving Social Security payments. You may be able to save by converting before the end of the year.

Currently, you can use a Roth conversion as a workaround for the income limits on your ability to contribute to Roth IRAs — what’s known as a backdoor Roth IRA — because converted funds aren’t treated as contributions. But be aware that, if you’re under age 59½, you can’t access the transferred funds without penalty.

Further, be aware that a Roth conversion will likely increase your adjusted gross income (AGI). As such, it could affect your eligibility for tax breaks that phase out based on AGI or modified adjusted gross income (MAGI).

2. Defer or accelerate income and deductions

A common tax reduction technique is to defer income into the next year and accelerate deductions into the current year. Doing so can allow you to make the most of tax breaks that phase out based on income (such as the IRA contribution deduction, child tax credits and education tax credits). If you’re self-employed, for example, you might delay issuing invoices until late December (increasing the odds they won’t be paid until 2023) and make equipment purchases in December, rather than January (assuming you use cash-basis accounting).

On the other hand, you might want to defer deductions and accelerate income if you expect to land in a higher tax bracket in the future. You can accelerate income by, for example, realizing deferred compensation, exercising stock options, recognizing capital gains or engaging in a Roth conversion.

High-income individuals should think about income deferral from the perspective of the 3.8% net investment income tax (NIIT), too. The NIIT kicks in when MAGI is more than $200,000 for single and head of household filers, $250,000 for married filing jointly and $125,000 for married filing separately. Deferring investment income could mean escaping that potentially hefty tax bite.

3. Manage your itemized deductions wisely

Accelerating deductions generally is helpful only if you itemize your deductions, of course. If you don’t think you’ll qualify to itemize, think about “bunching” itemized deductions so that they exceed the standard deduction (in 2022, $12,950 for single filers, $25,900 for married filing jointly and $19,400 for heads of household). If you claim itemized deductions this year and the standard deduction next year, you could end up with a larger two-year total deduction than if you took the standard deduction both years.

Potential expenses ripe for bunching include medical and dental expenses (if you qualify to deduct eligible expenses that exceed 7.5% of your AGI), charitable contributions, and state and local tax (SALT). For example, you could get dental services before year end, make your 2022 and 2023 charitable donations in December of this year, and pre-pay property taxes due next year, if possible.

The deduction for SALT-like property tax generally is subject to a $10,000 cap. Check, though, to determine if you might be able to take advantage of a pass-through entity (PTE) tax. More than two dozen states and New York City have enacted these laws, which permit a PTE to pay state tax at the entity level, rather than the individual taxpayer level. PTEs aren’t subject to a federal limit on SALT deductions.

4. Give to charity

The AGI limit for deductible cash donations has returned to 60% of AGI for 2022. But the possibility for substantial savings from making a charitable donation remains. For example, if you donate appreciated assets that you’ve held at least one year, you can deduct their fair market value and avoid income tax on the amount of appreciation if you itemize.

A qualified charitable distribution (QCD) from your IRA may confer tax benefits. Taxpayers who are age 70½ years or older can make a direct transfer of up to $100,000 per year from their IRAs to a qualified charity — and exclude the transferred amount from their gross income. (Note that transfers to a donor-advised fund or supporting organization don’t qualify). If you’re age 72 or older, a QCD can count toward your RMDs, as well.

You also may want to explore establishing a donor-advised fund. You can set it up and contribute assets in 2022 to claim a deduction for this year, while delaying your selection of the recipient charity and the actual contribution until 2023.

5. Harvest your capital losses

This is another way to leverage the poor market performance in 2022 — selling off your investments that have lost value to offset any capital gains. If your capital losses exceed your capital gains, you can deduct up to $3,000 ($1,500 for married filing separately) a year from your ordinary income and carry forward any remaining excess indefinitely.

You could further juice the benefit of loss harvesting by donating the proceeds from the sale to charity. You’ll offset realized gains while boosting your charitable contribution deduction (subject to AGI limitations on the charitable contribution deduction).

Take heed of the wash-rule, though. It says you can’t write-off losses if you acquire “substantially identical” securities within 30 days before or after the sale.

Act now

It’s been a rocky financial year for many people, and uncertainty about the economy will continue into next year. One thing is certain, though — everyone wants to cut their tax bills. Contact us to help you with your year-end tax planning.

The U.S. Senate and House of Representatives have passed the Inflation Reduction Act (IRA). President Biden is expected to sign the bill into law shortly. The IRA includes significant provisions related to climate change, health care, and, of course, taxes. The IRA also addresses the federal budget deficit. According to the Congressional Budget Office (CBO), the IRA is projected to reduce the deficit by around $90 billion over the next 10 years.

Although the IRA falls far short of Biden’s originally proposed $2 trillion Build Back Better Act, the $430 billion package nonetheless is a sprawling piece of legislation bound to affect most Americans over time. Here’s an overview of some of what the bill includes.

Significant tax provisions

For starters, how is the federal government going to pay for all of it? Not surprisingly, new taxes are part of the equation (along with savings from, for example, lower drug prices). But the bill is designed to not raise taxes on small businesses or taxpayers earning less than $400,000 per year. Rather, wealthier targets are in the crosshairs.

The first target is U.S. corporations (other than S corporations) that have more than $1 billion in annual earnings over the previous three years. While the current corporate tax rate is 21%, it’s been well documented that many such companies pay little to no federal income tax, due in part to deductions and credits. The IRA imposes a corporate alternative minimum tax of 15% of financial statement income (also known as book income, as opposed to tax income) reduced by, among other things, depreciation and net operating losses. The new minimum tax is effective for tax years beginning after December 31, 2022.

As a result of last-minute negotiations, private equity firms and hedge funds are exempt from the minimum tax. They could have been covered by a provision that generally includes subsidiaries when determining annual earnings. The tradeoff is that the IRA now will extend the excess business loss limitation for certain businesses for two years.

Although the initial bill language also closed the so-called “carried interest” loophole that permits these interests to be taxed as long-term capital gains rather than ordinary income, the loophole ultimately survived. Democrats agreed to remove the provision closing it to secure the vote of Sen. Kyrsten Sinema (D-AZ) — but they added another tax to make up for the lost revenue. The IRA will now impose a 1% excise tax on the fair market value when corporations buy back their stock.

In a statement, Sinema said she would work with Sen. Mark Warner (D-VA) on separate legislation to enact carried interest tax reform. To do so outside of the budget reconciliation process, however, would require 60 votes in the Senate in addition to a majority of the House. With midterm elections in the fall, and control of both houses of Congress hanging in the balance, imminent action on that front seems unlikely.

The IRA also provides about $80 billion over 10 years to fund the IRS and improve its “tax enforcement activities” and technology. Notably, the IRS budget has been dramatically slashed in recent years, dropping by 20% in 2020, compared to 2010. The CBO estimates that the infusion of funds will allow the IRS to collect $203 billion over the next decade from corporations and wealthy individuals.

Climate and energy provisions

The IRA dedicates about $370 billion to combating climate change and boosting domestic energy production. It aims to reduce the country’s carbon emissions by 40% by 2030.

The legislation includes new, extended and increased tax credits intended to incentivize both businesses and individuals to boost their use of renewable energy. For example, the bill provides tax credits to private companies and public utilities to produce renewable energy or manufacture parts used in renewable projects, such as wind turbines and solar panels. Clean energy producers that pay a prevailing wage also may qualify for tax credits.

Clean vehicle credit

The current tax credit for qualified plug-in electric vehicles has been significantly revised in the IRA. Currently, a taxpayer can claim a credit for each new qualified plug-in electric drive motor vehicle placed in service during the tax year. The maximum credit amount is $7,500. Certain vehicle requirements must be met.

The credit phases out beginning in the second calendar quarter after a manufacturer sells more than 200,000 plug-in electric drive motor vehicles for use in the U.S. after 2009. Under the IRA, the plug-in vehicle credit has been renamed the clean vehicle credit and the manufacturer limitation on the number of vehicles eligible for the credit has been eliminated after December 31, 2022.

The bill changes how the clean vehicle credit is calculated. Specifically, a vehicle must meet critical mineral and battery component requirements. There are also price and income limitations. The clean vehicle credit isn’t allowed for a vehicle with a manufacturer’s suggested retail price above $80,000 for vans, sport utility vehicles and pickups, and above $55,000 for other vehicles.

The clean vehicle credit isn’t allowed if a taxpayer’s modified adjusted gross income (MAGI) for the current or preceding tax year exceeds $150,000 for single filers, $300,000 for married couples filing jointly and $225,000 for heads of household.

The IRA also contains a tax credit for a used plug-in electric drive vehicle purchased after 2022. The tax credit is $4,000 or 30% of the vehicle’s sale price, whichever is less. There are also price and income limitations.

Home energy improvements

Individual taxpayers can also receive tax breaks for home energy efficiency improvements, such as installing solar panels, energy-efficient water heaters, heat pumps and HVAC systems. And a “Clean Energy and Sustainability Accelerator” will use public and private funds to invest in clean energy technologies and infrastructure.

Health care provisions

The IRA allows Medicare to negotiate the price of prescription drugs and prohibits future administrations from refusing to negotiate. It also caps Medicare enrollees’ annual out-of-pocket drug costs at $2,000 and monthly insulin costs at $35 and provides them free vaccines. Additional provisions to rein in drug costs include a requirement that pharmaceutical companies that raise the prices on drugs purchased by Medicare faster than the rate of inflation rebate the difference back to the program.

The IRA also should reduce health care costs for Americans of all ages who obtain health insurance coverage from the federal Health Insurance Marketplace. It extends the expansion of subsidies — in the form of refundable premium tax credits — under the America Rescue Plan Act through 2025. These subsidies had been scheduled to expire at the end of 2022.

Much more to come

The IRA is a sweeping piece of legislation that affects many sectors of U.S. business, as well as most citizens. Additional information, guidance and regulations related to its numerous, far-reaching provisions are inevitable. We’ll keep you up to date on the developments that could affect your finances and federal tax liability.

Traditional vs. Roth

Here’s what makes a traditional IRA different from a Roth IRA:

Traditional IRA. Contributions to a traditional IRA may be deductible, depending on your modified adjusted gross income (MAGI) and whether you (or your spouse) participate in a qualified retirement plan, such as a 401(k). Funds in the account can grow tax deferred.

On the downside, you generally must pay income tax on withdrawals. In addition, you’ll face a penalty if you withdraw funds before age 59½ — unless you qualify for a handful of exceptions — and you’ll face an even larger penalty if you don’t take your required minimum distributions (RMDs) after age 72.

Roth IRA. Roth IRA contributions are never deductible. But withdrawals — including earnings — are tax free as long as you’re age 59½ or older and the account has been open at least five years. In addition, you’re allowed to withdraw contributions at any time tax- and penalty-free. You also don’t have to begin taking RMDs after you reach age 72.

However, the ability to contribute to a Roth IRA is subject to limits based on your MAGI. Fortunately, no matter how high your income, you’re eligible to convert a traditional IRA to a Roth. The catch? You’ll have to pay income tax on the amount converted.

Your tax hit may be reduced

This is where the “benefit” of a stock market downturn comes in. If your traditional IRA has lost value, converting to a Roth now rather than later will minimize your tax hit. Plus, you’ll avoid tax on future appreciation when the market goes back up.

It’s important to think through the details before you convert. Here are some of the issues to consider when deciding whether to make a conversion:

Having enough money to pay the tax bill. If you don’t have the cash on hand to cover the taxes owed on the conversion, you may have to dip into your retirement funds. This will erode your nest egg. The more money you convert and the higher your tax bracket, the bigger the tax hit.

Your retirement plans. Your stage of life may also affect your decision. Typically, you wouldn’t convert a traditional IRA to a Roth IRA if you expect to retire soon and start drawing down on the account right away. Usually, the goal is to allow the funds to grow and compound over time without any tax erosion.

Keep in mind that converting a traditional IRA to a Roth isn’t an all-or-nothing deal. You can convert as much or as little of the money from your traditional IRA account as you like. So, you might decide to gradually convert your account to spread out the tax hit over several years.

There are also other issues that need to be considered before executing a Roth IRA conversion. If this sounds like something you’re interested in, contact us to discuss whether a conversion is right for you.