Cut Your 2024 Taxes Before It's Too Late

Taxes | Tax Cut | Tax Deduction | Withholding | Estimates | December 4, 2024

This Week's Quote:  "There is no substitute for hard work." 
     - Thomas Edison

It’s still too early to make tax moves based on November’s down-to-the-wire elections and their effect on tax cuts expiring at the end of 2025. But other year-end tax planning for 2024 is possible—and important. 

In particular, higher interest rates have significantly raised penalties for underpaying taxes to Uncle Sam for 2024. Many heirs of traditional IRAs also need to plan multiyear withdrawal strategies now that the Internal Revenue Service has issued definitive guidance for these accounts. 

As usual, most moves to reduce 2024 taxes need to be completed by Dec. 31, and the clock is ticking. Here are several to know about. 

Check your withholding and estimated taxes

The penalty on income-tax underpayments for the first three quarters of 2024 is a steep 8%, and the fourth-quarter rate will likely be 7%. That’s well above the 3% rate of a few years ago, and the increase has already cost taxpayers billions in higher interest costs. 

To avoid underpayment penalties, filers must pay at least 90% of the tax they owe well before the April due date. The deadline is Dec. 31 for employees and others who have taxes withheld, and it’s Jan. 15, 2025, for filers paying quarterly estimated taxes.

So it’s important to evaluate paycheck withholding or quarterly payments for this year, especially if you’ve had uneven income or received a windfall like a bonus or a large capital gain. The Internal Revenue Service has posted a calculator to help employees determine withholding. 

If you need to pay more, try to raise withholding rather than make a direct payment to the IRS. Withholding can reduce underpayment penalties on income earned earlier in the year, while a quarterly payment usually won’t. Employees can raise withholding through their paychecks, while retirees often opt to raise it on taxable IRA payouts.   
   
Taxpayers can also bypass these penalties by paying an amount equal to either 100% or 110% of their 2023 taxes. The 100% threshold applies mostly to filers with adjusted gross income of $150,000 or less, while the 110% threshold applies to those with more. This can be done either through withholding or a direct payment to the IRS. 

But remember: For filers paying estimated taxes, the safe harbors apply per quarter. So it’s too late to avoid underpayment penalties for 2024’s first three quarters, except through higher withholding. However, making a payment to the IRS now will stop the interest clock. (IRS.gov/directpay is a useful option.) For more on this complex topic, see this WSJ story and IRS Publication 505.

A final note to taxpayers living in 34 states with federally declared disaster areas this year: The IRS has extended tax deadlines for these areas that could lower underpayment penalties.

Plan withdrawals from inherited traditional IRAs 

This year the IRS clarified when many heirs of traditional IRAs must take payouts from them. Heirs should plan carefully and consider taking more than the minimum.

In late 2019, Congress decided that most nonspouse heirs of traditional and Roth IRAs should drain the accounts within 10 years if the original owner died in 2020 or later. But the new law didn’t specify whether heirs of traditional IRAs must take required minimum distributions, or RMDs, for years one through nine.

So the IRS suspended RMDs for 2021-2024 while it worked on guidance. But that grace period for distributions is coming to an end. 

The new rules clarify that nonspouse heirs must take RMDs for 2025 and after, if the account owner had to take these payouts. Owners hit this required beginning date at age 70 ½ in 2020, and it has since risen to 73.

For heirs, RMDs in years one through nine are based on their own life expectancy. 

However, if the IRA owner died before having to take RMDs, the heir doesn’t have to take them in years one through nine. 

Beware: Taking just the minimum withdrawal may not be smart if it leads to a balloon payout in year 10 that pushes the heir into higher tax brackets.

The new guidance doesn’t extend the 10-year window for those who inherited in 2020-2024, so several years have passed for some heirs. Also note that while the law sets minimum payouts, it doesn’t set maximum ones.

For more information, see IRS Publication 590-B. 

Standard deduction or itemized?

Filers can reduce taxable income either by a fixed amount—the standard deduction—or by listing individual deductions for mortgage interest, state and local taxes, charitable donations, medical expenses and other eligible costs on Schedule A.

Before the 2017 tax overhaul nearly doubled the standard deduction, about 30% of filers itemized. Now less than 10% do, although that’s still about 15 million filers.

For 2024, the standard deduction is $29,200 for married joint filers and $14,600 for singles. For 2025, it will be $30,000 and $15,000, respectively. Filers age 65 and older each get at least $1,500 more for 2024 and at least $1,600 more for 2025.

When the 2017 overhaul’s changes expire at the end of 2025, the increased standard deduction will lapse too. Unless, that is, Congress takes action.

Some taxpayers switch from standard to itemized in different years to maximize overall deductions. If so, it can make sense to “bunch” deductions either by accelerating or delaying them into years when you’ll itemize. 

Often the best candidates for bunching are charitable donations. For example, a married couple might donate $15,000 to favorite causes twice in one year and then skip giving the next year.

In addition, bunchers shouldn’t overlook medical-expense deductions. They’re only deductible above 7.5% of adjusted gross income, a high hurdle. But above that, a wide variety of expenses can count, including Medicare premiums, travel fees, contact-lens solution and home modifications like an elevator or even a swimming pool.

Reconsider home energy credits  

In 2022, Congress expanded and extended tax credits for individuals who make a broad range of energy-efficient improvements to their homes.  

They are proving popular. About 3.4 million filers claimed more than $8 billion in credits for 2023, according to Treasury Department data. Unlike tax deductions that lower income, a tax credit is typically dollar-for-dollar reduction of tax. 

Ari Matusiak, who heads Rewiring America, a nonprofit, says the credits are far more generous than in the past. “They are there for the taking, available every year, and they often can be combined with state or utility incentives,” he said. 

The credits fall into two categories. Residential Clean Energy Credits are typically for bigger-ticket items like solar, wind and geothermal power generation; solar water heaters; and battery storage. For 2023, 1.2 million filers claimed more than $6.3 billion in these credits, or about $5,000 per tax return. Rooftop solar was especially popular. 

This credit covers up to 30% of the cost of allowed improvements, with no annual or lifetime maximum. 

Then there’s the Energy Efficient Home Improvement Credit. Among other things, it applies to home insulation, windows and skylights, central air conditioning and heat pumps. For 2023, more than 2.3 million filers took these credits. The total cost was $2.1 billion, or about $880 per return. Annual maximums often apply, but there aren’t lifetime limits. 

Beginning in 2025, manufacturers of equipment eligible for this credit will have to register with the IRS and obtain a number for each item. Filers claiming it will have to include the numbers on their tax returns.

The expanded credits are slated to continue through 2032. For more information, see the home energy tax credits page at IRS.gov.

Credit goes to Laura Saunders, published October 25, 2024 in the Wall Street Journal.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.
 
This Week’s Author, Mark Bradstreet