let's break down the process for reviewing projected income and expenses for tax planning before year-end.
Objective: To estimate an individual's tax liability for the current year based on projected figures and identify actionable strategies to legally minimize this liability before December 31st.
Process Overview:
Gather Information: Collect all relevant financial data for the year to date and projections for the remainder of the year.
Project Year-End Totals: Estimate total income, adjustments, deductions, and credits.
Calculate Projected Tax Liability: Determine the estimated tax due based on the projections.
Identify Tax Planning Opportunities: Analyze the projection for areas where taxes can be reduced.
Analyze & Recommend Options (Scenario Specific): Tailor strategies to the individual's specific situation and goals.
Implement: Take action on chosen strategies before year-end deadlines.
Step-by-Step Breakdown:
1. Gather Information (Year-to-Date & Projections):
Income Sources:
Wages/Salary (Last pay stub, projected remaining pay)
Bonuses (Confirmed or highly likely amounts & timing)
Self-Employment Income (Net income after expenses to date, projected revenue & expenses)
Investment Income (Interest, Dividends - received & projected)
Capital Gains/Losses (Realized gains/losses to date, review portfolio for potential year-end sales)
Retirement Distributions (IRA, 401(k), Pensions - received & planned)
Other Income (Alimony received, rental income, unemployment, gambling winnings, etc.)
Above-the-Line Deductions (Adjustments to Income):
Traditional IRA Contributions (Made & planned)
HSA Contributions (Made & planned - through employer & direct)
Student Loan Interest Paid
Self-Employment Tax Deduction (50% of SE tax)
Self-Employed Health Insurance Premiums
Alimony Paid (if divorce decree pre-2019)
Itemized Deductions (Compare total to Standard Deduction):
Medical Expenses (Paid & projected - subject to 7.5% AGI floor)
State and Local Taxes (SALT) Paid (Income/Sales tax + Property Tax - capped at $10,000 MFJ/Single)
Home Mortgage Interest Paid (Check limits)
Charitable Contributions (Cash & Non-Cash - made & planned - subject to AGI limits)
Investment Interest Expense (Limited to net investment income)
Casualty/Theft Losses (Federally declared disaster areas only)
Tax Credits:
Child Tax Credit / Credit for Other Dependents (Eligibility based on dependents & income)
Child and Dependent Care Credit (Based on care expenses & income)
Education Credits (AOTC / LLC - based on expenses paid & income)
Clean Vehicle Credits (EV/PHEV purchase - eligibility & income limits)
Residential Clean Energy Credits (Solar, etc.)
Other potential credits
Tax Payments Made:
Federal Income Tax Withheld (W-4 status, pay stubs)
Estimated Tax Payments Made (Dates & amounts)
Other Key Info:
Filing Status (Single, Married Filing Jointly, etc.)
Number and Age of Dependents
Prior Year Tax Return (Carryforwards like capital losses, AMT credits)
2. Project Year-End Totals:
Sum up YTD figures and reasonable projections for the rest of the year for each category above.
Be realistic but slightly conservative if unsure.
3. Calculate Projected Tax Liability:
Calculate Gross Income: Sum all income sources.
Calculate Adjusted Gross Income (AGI): Gross Income minus Above-the-Line Deductions. AGI is critical as it impacts eligibility for many deductions and credits.
Determine Standard vs. Itemized Deduction: Calculate total potential Itemized Deductions. Compare this total to the applicable Standard Deduction amount for the filing status. Use the larger of the two.
Calculate Taxable Income: AGI minus Standard/Itemized Deduction. Also subtract Qualified Business Income (QBI) Deduction if applicable (for self-employed/small business owners).
Calculate Preliminary Tax: Apply the appropriate tax brackets to the Taxable Income.
Apply Tax Credits: Subtract applicable tax credits dollar-for-dollar from the preliminary tax.
Consider Other Taxes: Add Self-Employment Tax (if applicable), Net Investment Income Tax (NIIT - 3.8% on investment income if AGI exceeds thresholds), Alternative Minimum Tax (AMT - less common now but still possible).
Calculate Total Projected Tax Liability: The final estimated tax amount.
Estimate Net Amount Due/Refund: Compare Total Projected Tax Liability to Total Tax Payments Made (Withholding + Estimated Payments). This highlights potential underpayment penalties or a large refund (which might mean over-withholding).
4. Identify General Tax Planning Opportunities:
AGI Management: Can AGI be lowered via above-the-line deductions (IRA, HSA)?
Deduction Strategy (Standard vs. Itemized): Are they close to the threshold? Can deductions be "bunched"?
Income Timing: Can taxable income be deferred to next year (if tax rate expected to be lower) or accelerated into this year (if tax rate expected to be higher)?
Expense Timing: Can deductible expenses be accelerated into this year?
Capital Gains/Losses: Is there an opportunity for tax-loss harvesting? Are long-term vs. short-term gains being managed effectively?
Retirement Savings: Are tax-advantaged accounts (401k, IRA, HSA) being maximized?
Charitable Giving: Are donations being made in the most tax-efficient way (e.g., appreciated stock)?
Credits: Are they maximizing eligibility for all available credits?
5. Analyze & Recommend Options (Scenario Specific)
Now, let's apply this to a hypothetical scenario:
Scenario: "Alex," Single filer, age 40.
Projected W-2 Income: $120,000
Projected Bonus (Dec): $10,000
Projected Interest/Dividends: $2,000
Projected Long-Term Capital Gains (Realized): $5,000
Portfolio: Has unrealized short-term capital loss of $4,000 in one stock.
401(k) Contribution: $15,000 (Max for 2023 is $22,500, plus catch-up if applicable)
HSA: Eligible via High Deductible Health Plan, contributed $0 so far (Max for 2023 Single is $3,850).
Projected Itemized Deductions:
SALT: $10,000 (State income tax + property tax)
Mortgage Interest: $6,000
Charitable Contributions (Cash): $1,500
Total Itemized: $17,500
Standard Deduction (Single, 2023): $13,850
Federal Tax Withheld YTD + Projected: $18,000
Analysis based on Scenario:
Projected Gross Income: $120k + $10k + $2k + $5k = $137,000
Projected AGI (Initial): $137,000 (Assuming no above-the-line deductions yet)
Deduction Choice: Itemized (
17,500)isgreaterthanStandard(
13,850). Alex will itemize.Projected Taxable Income (Initial): $137,000 (AGI) - $17,500 (Itemized) = $119,500
Projected Tax Liability (Estimate - using 2023 brackets): Tax on $119,500 falls into the 24% marginal bracket. The calculated tax would be approx. $19,100 (this requires applying bracket tiers). Add NIIT if applicable (AGI threshold for Single is $200k, so Alex is below this).
Projected Net Due/(Refund): $19,100 (Est. Tax) -
18,000(Withheld)=
1,100 Due.
Tax Minimization Options for Alex:
Maximize HSA Contribution:
Action: Contribute the maximum $3,850 to the HSA before year-end (or tax filing deadline if contributing for the prior year).
Impact: Reduces AGI by $3,850 (to $133,150). Reduces Taxable Income by $3,850 (to $115,650). Saves approx.
924infederalincometax(
3,850 * 24% marginal rate). Also provides triple tax benefits (tax-free growth, tax-free withdrawals for medical).
Increase 401(k) Contribution:
Action: Increase 401(k) contributions in the remaining paychecks to reach closer to the $22,500 maximum. Can contribute an additional $7,500. This might require adjusting W-4 temporarily or making a large % contribution if payroll allows.
Impact: Every $1,000 contributed reduces AGI and Taxable Income by $1,000. Contributing the full $7,500 would save approx.
1,800infederaltax(
7,500 * 24%).
Tax-Loss Harvesting:
Action: Sell the stock with the $4,000 unrealized short-term loss.
Impact: This loss first offsets the $5,000 long-term capital gain. The net gain becomes $1,000 (taxed at lower long-term rates). Correction: Short-term losses offset short-term gains first, then long-term gains. Since Alex only has LT gains, the $4k ST loss offsets $4k of the LT gain. Net LT Capital Gain = $1,000. This reduces income subject to capital gains tax. If losses exceeded gains, up to $3,000 could offset ordinary income.
Bunch Charitable Contributions:
Action: Alex is already itemizing. If he plans to donate ~$1,500 next year as well, consider making next year's donation this year (accelerating). Donate an extra $1,500 before Dec 31st.
Impact: Increases itemized deductions by $1,500 (to $19,000). Reduces taxable income by $1,500. Saves approx.
360infederaltax(
1,500 * 24%). Consider donating appreciated stock instead of cash if held >1 year for potentially greater benefit (avoids capital gains tax on appreciation + gets deduction for fair market value).
Review Withholding:
Action: Since Alex projects owing ~$1,100 (before implementing other strategies), he might consider adjusting his W-4 slightly for the last few pay periods or ensure he has cash set aside to pay by the April deadline to avoid penalties (though the amount is likely below penalty thresholds). Implementing options 1-4 would likely result in a refund instead.
Recommendations for Alex:
Priority 1: Max out the HSA contribution ($3,850). This offers immediate tax savings and long-term tax-free growth/withdrawals for healthcare.
Priority 2: Perform the tax-loss harvesting ($4,000 loss). It directly reduces the tax impact of the realized capital gains.
Priority 3: Increase 401(k) contributions as much as cash flow allows towards the $22,500 limit. Significant tax savings potential.
Consider: Accelerating planned charitable donations if feasible, especially using appreciated stock.
6. Implement:
Alex needs to contact his HSA provider to make the contribution, log into his brokerage account to sell the losing stock, potentially adjust his 401(k) contribution percentage via his employer's portal, and make any additional charitable donations before December 31st.