This is the third year of the end-of-year tax post (feel free to check out the past ones from ​2021​ and ​2022​).

This year, I not only want to help you think about saving on taxes in 2023 but also introduce a number of other ways to save on taxes that you might want to bring into 2024 as well. And if you want to keep going on the topic, you can check out my recent discussion on Taxes with Ankur Nagpal (​🎧 Ep. 147​).

By the end of this post, you’ll learn more about:

• Mental frameworks for approaching taxes

• Standard vs. itemized deductions

• Charitable contributions

• Capital gains, losses, and (tax loss) harvesting

• Energy and solar tax benefits

• Non-qualified deferred compensation plans

• Real estate tax advantages

• Tax savings for startup investing

• Benefits for business owners

Now before we get started, I want you to know that I fully believe in paying taxes; they are important and fund many aspects of society.

However, I also believe in democratizing the information that a small number of people know about taxes and giving you all the knowledge to make informed decisions about lowering your tax liability. That said, this is not tax advice, so please talk with your tax professional for more details. And if you need a recommendation, I am so happy with my personal and business tax firm ​Gelt​ (who, after saving me a ton fixing my prior CPAs mistakes, became a partner of ours).

I hope you all have an incredible holiday season!

Chris

🚰 Support our Clean Water Campaign

 

I recently had an incredible conversation with the founder/CEO of charity: water, Scott Harrison (​🎧 Ep. 148​), and learned so many things, but today I want to share three quick things about water:

1. 1 in 10 people around the world don't have access to clean water

2. Diseases from dirty water kill more people every year than all forms of violence, including war.

3. Every day, women and girls (who are responsible for water collection 8 out of 10 households around the world) spend an estimated 200 million hours collecting water. That's time taken away from education, work, and community development.

For all these reasons and more, Amy and I have created a ​Daffy Campaign​ to build an entire water project with charity: water and bring clean water to a community in need. To help hit our $10,000 goal to fund an entire water project, we're going to be matching the first $5,000 donated (and if we hit that goal, we'll keep going for as much water as we can). If you want to consider supporting the campaign, you can learn more here:

ATH 2023 Clean Water Campaign

Note: you don't need to set up a donor-advised fund with Daffy to contribute to the campaign, but if you want to set one up and use ​this link​, you'll get an extra $25 to donate to this or any other cause once you make your first contribution.

👫 Tax Tips for Everyone

I'll start with the tactics that are most applicable to everyone and end with more tips for business owners.

🪜 Mental Frameworks

Before we dive into specific topics, I want to share a few essential frameworks for approaching your taxes to add context to the tactics covered in this post.

Let’s start with my approach to taxes.

• First, I try to avoid taxes

• Second, I try to defer taxes

• Third, I try to minimize taxes

…all while 100% following the rules of law.

My strategy is to continuously expand my tax knowledge while finding the ​best professionals to partner with​ (to further educate and execute on my behalf).

Here are three other frameworks Ankur shared with me:

• Don’t let the tax tail wag the dog – which means you don’t want tax advantages to dictate how you live. Instead, live the life you want to live and figure out a tax strategy in response to that.

• Understand your return on hassle – which means focus your energy on the few things that make a huge difference versus trying to do everything and burning yourself out.

• Think about your lifetime tax rate – which means it might make sense to front-load taxes to pay substantially less later in life (e.g., Roth IRA)

🧮 Standard vs. Itemized Deduction

The government gives most people an automatic discount, known as the standard deduction, which is about $27,700 for married couples and $13,850 for single filers.

Surprisingly, almost 9 out of 10 people choose the standard option. However, itemized deductions open the door to extra discounts for charitable contributions, student loan interest, investment interest, state and local taxes (up to $10,000), mortgage payments, medical bills (over 7.5% of adjusted gross income), and even losses from gambling.

If the total deductions you can list are more than the standard deduction in a particular year, it's a good idea to go with the itemized deductions, even if you switch back and forth each year. And if it's close, you might want to bring together all your deductions in a single year. This could mean paying your mortgage or property taxes in advance or allocating extra charitable contributions to a year.

📈 Charitable Contributions

Charitable donations provide a unique chance to do good while also getting a reward in return.

When you donate a dollar to charity, the government is quite generous; your taxable income goes down by a dollar. But if you want to get even more benefit, you can donate appreciated assets (like stocks), where you get a double tax break, because you also avoid any capital gains tax you'd pay if you sold the asset and contributed the cash, while still getting the deduction on the full amount.

For example, if you give a charity $1000 cash they get $1000, and you get a $1000 deduction on your taxes. However, if you give $1000 of a stock that you bought for $100, that stock might only be worth $700 to you after you factor in the taxes you'd owe on capital gains, but the charity gets the full $1000, and you get to deduct $1000 too.

There is also no wash sale rule on charitable donations. If you hold any stock worth more than you paid, you donate it to save on capital gains. Then, immediately buy the same stock you donated, and then you can step-up your cost basis for free.

Donating Items

Charitable giving isn't just about money; you can donate things at home, like electronics or clothes. This way, you can support causes you care about while getting a tax benefit. Donating items becomes an attractive option, especially if you have many things you no longer need at the end of the year.

Donor Advised Funds

Donor Advised Funds (DAFs) offer a simple way to manage charitable contributions without unnecessary complications. These funds provide a centralized platform where you can organize and streamline your charitable giving efforts. It lets you front-load your entire donation and give from that fund whenever you want. Moreover, the money you put into a DAF can be invested, so it grows over time, which means you get a tax break, and the charity benefits more in the future. This avoids the hassle of coordinating stock transfers and dealing with minimums that some charities might have. I use ​Daffy​, and you can ​get a free $25​ to give to a charity of your choice. You can also check out my episode with Daffy co-founder Adam Nash ​(🎧 Ep. 50)​ for more on DAFs.

💸 Capital Gains, Losses and Tax Loss Harvesting

Not all income is taxed equally, and capital gains (profits from the sale of investments or assets) often enjoy more favorable treatment.

In the United States

• Long-term capital gains held for over a year are subject to lower tax rates (mostly 15%), with the highest tier capped at 20%.

• Short-term gains held for less than a year are typically taxed at ​ordinary income rates​.

The tax code has a provision allowing you to utilize capital losses to counterbalance capital gains. However, if you lack capital gains, there's a silver lining – you can deduct up to $3,000 of losses annually against your income, carrying forward any remaining losses.

This opens up an opportunity for harvesting losses but requires you to understand the wash-sale rule first. According to this rule, you cannot repurchase the same security (or one that is "substantially identical") for 30 days to claim a loss. The good news is that various ETFs and index funds have similar yet not "substantially identical" pairings. This allows you to sell one for a loss and purchase the other without violating the wash-sale rule.

While you can manage this process independently (and probably should before the end of the year), using robo-advisors (I use ​Wealthfront​) is much easier. I wrote more about tax loss harvesting in ​All About Investing Part 2​.

🏦 Tax-Advantaged Accounts

I really wanted to get to the topic of tax-advantaged accounts in this post, which would include 401ks, IRAs, Solo 401ks, HSAs/FSAs, DAFs, and more. But there was already so much to cover that it's going to have to come in the future. However, last month I published an awesome episode on this topic with Katie Gatti Tassin ​(🎧 Ep. 144)​. So if you want to go deeper on that topic, check it out.

🎧 Ep. 144 on Tax-Advantaged Accounts

🪫 Energy Efficiencies

The ​Inflation Reduction Act​ made energy improvements even more appealing.

The lifetime cap on tax benefits for improvements like installing heat pumps and upgrading windows, insulation, and furnaces now stands at $1,200, allowing homeowners to make eco-friendly changes and receive tax benefits. However, it's crucial to note that specific stipulations and conditions may apply to different items, so homeowners should investigate the details before making these upgrades.

Additionally, if you're considering a clean vehicle (electric, hybrid, fuel cell), the tax credit offers a $7,500 benefit. It's important to remember that this credit has an income cap, meaning your income may impact the amount you're eligible to receive.

While December 31st might seem like a deadline for some energy efficiency improvements, some benefits extend beyond a single year. The Act extends tax benefits for specific improvements until 2033. This gives homeowners flexibility, making it clear that tax planning for energy efficiency is not a one-time opportunity.

To learn more about saving money with energy efficiency and solar, check out my conversation with Matt Ferrell ​(​🎧​Ep. 135)​

☀️ Solar Investing

If you’re a high W2 earner or a business owner with a lot of income, I have not seen a better strategy for reducing your taxes than solar investing.

Unlike traditional real estate, commercial solar ventures can offer tax credits up to 40% of the initial investment. These tax credits, different from deductions, directly reduce the taxes you owe. When you combine the credits with depreciation and the potential income (typically with commercial solar), you can immediately see 70% to 80% of the investment.

But to maximize the taxes and offset some active income, you must be classified as a “solar professional,” which requires you to dedicate 100 hours per year to solar-related activities (though 100 hours across an entire year is a lot less than it seems).

Discovering and participating in solar projects can be facilitated through partnerships and platforms with reputable entities, such as ​Valur​ and similar platforms. These platforms simplify the investment process and allow investors to diversify their portfolios by exploring various solar opportunities.

💰 NQDC for High W2 Earners

One option for high W2 earners is to participate in a Non-Qualified Deferred Compensation Plan (NQDC). These plans enable individuals to divide their income into immediate and deferred portions. The deferred income is then paid out a specified number of years later (and invested pre-tax until that time).

Your employer does need to offer a NQDC, but if they don't already they might consider doing it as an employee perk. However, one downside is in the non-qualified aspect, meaning the plan may lack the same level of protection as a 401k in case of bankruptcy or creditor issues. Definitely consider the employer's stability before participating.

I did this at Google. After leaving the company and starting my startup (at a much lower salary), I finally got paid my deferred compensation when I had a much lower tax bracket.

Many Fortune 500 companies, especially in the tech sector, frequently employ these strategies as a recruiting incentive and strategic tax optimization tool despite potential administrative efforts.

🏘️ Real Estate Tax Advantages

The government offers lots of tax benefits for real estate. One of the most common is that homeowners can deduct mortgage interest payments up to $750,000, providing a significant tax advantage (though I wrote about some tax tactics to deduct the interest on $1m+ homes in ​this post​). Additionally, when selling a primary residence, individuals can enjoy tax-free gains of up to half a million dollars, fostering a favorable environment for homeownership.

Decoding the Opportunity Zones Advantage

​Opportunity Zones​ provide a distinctive opportunity to defer capital gains taxes while potentially realizing tax-free profits in the long run.

These zones were created to encourage investments in underdeveloped areas, offering investors a chance to contribute to community growth. Investors can defer taxes until 2026 and receive an automatic step-up basis if the investment is held for ten years.

This strategic alignment can lead to short-term and long-term tax advantages, making it a worthwhile consideration for individuals seeking tax-efficient wealth-building strategies.

Commercial Real Estate Tax Benefits

There are countless tax benefits for real estate investors, like being able to generate massive "expenses" through depreciation or using 1031 exchanges to reinvest the proceeds after selling a property and deferring taxes owed.

I'm not going to go deep into real estate in this post, but I did in last week's episode with Ankur (​🎧Ep. 147​) and with real estate investor Brandon Turner (​🎧Ep. 80​).

However, one note for high W2 earners is that if you or your spouse are able to achieve the status of “real estate professional” (which requires 750 hours per year) you can use all the real estate losses you generate from depreciation to offset all your other income.

🧑‍💻 Qualified Small Business Stock (QSBS)

Qualified Small Business Stock (QSBS) offers the potential for huge tax benefits if you start, invest in or work at small businesses or startups.

After holding shares for at least five years, the IRS (and many states) give you the greater of 10x your basis or $10 million in tax-free gains.

The company needs to be a C corporation with assets under $50 million when you become a shareholder. Also, the tax-free exemption is “per company per taxpayer,” so if you invest in multiple businesses or give shares to family members, those all have separate exemptions. Finally, if you realize the gains before the five-year window is finished, you can roll your gains into another company for the remaining time.

Employees can benefit from this tax incentive through the startup's stock options as long as they are exercised while the company's assets (not valuation) is under $50 million. However, keep in mind that exercising options may be expensive and have tax consequences.

🧑‍💼 Tax Benefits for Business Owners

If there's a group the IRS seems to want to give the most tax breaks to its business owners. Here are a few of the tax advantages you get as a business owner:

• Solo 401k's

• Qualified Business Income (QBI) benefit

• Elective state taxes (to bypass the $10,000 limits on state and local tax deductions)

• S-Corporation election

• Hiring your children

Solo 401k's

This was one of my biggest optimizations for 2023. The Solo 401k is a retirement account for small business owners who don't have any non-spouse W2 employees and it's amazing. When set up properly, you (and your spouse if they're an employee) can contribute up to $66,000 into your Solo 401k, through employee and employer contributions. And if your plan allows for it, you can make after-tax contributions and roll them over to a Roth IRA (commonly known as the mega backdoor Roth IRA).

The options for Solo 401k's weren't great when I looked at them last year and I almost ended up going with mysolo401k.net, but fortunately I came across ​Carry​ (formerly Ocho) and decided to open my account there and it's been amazing. We've since consolidated all of our past 401k's from previous employers into our Carry Solo 401k, which has made managing our retirement accounts so much easier. I'm a huge fan of Carry and they're offering our subscribers 50% off the Pro Plan at: ​chrishutchins.com/carry​

QBI Deduction

The Qualified Business Income (QBI) deduction grants business owners an automatic deduction of up to 20%.

The QBI benefits are subject to limitations tied to the wages paid, so finding the right equilibrium is crucial to minimizing overall tax liability. While online resources may offer general guidance, the complexity of QBI calculations underscores the importance of seeking professional advice.

Elective State Taxes

Business owners in high-income states (e.g., California) can benefit significantly from their company electing to pay their state taxes, which has the effect of going around the $10,000 limit on state and local tax deductions. There are a lot of rules here, so I'd recommend seeking out professional guidance to make sure you're eligible and doing it right.

S Corporation Election

When you opt for S Corp status, you can split your net income into salary and owner distribution.

This division is beneficial because only the salary portion is subject to self-employment taxes (e.g., Social Security and Medicare). Typically, the S Corp becomes more advantageous when your net income reaches around $100,000 (but for some states like New York, this number could be higher).

The downside is that reducing your salary through an S Corp can affect your social security benefits (since they're based on your top 35 earning years), but I ran the numbers and for me, the benefits far outweighed the cost.

Also, the amount you pay yourself in W2 salary as an S Corp directly influences the contributions you can make to your Solo 401k account, so if you want to maximize your Solo 401k contributions, you'll want to make sure to pay yourself at least the contribution maximum ($66k) or more (if you want to make all your contributions pre-tax).

Hiring Your Children

Business owners have a legitimate way to involve their children in the family business (while fostering financial responsibility).

Hiring children for genuine tasks (e.g., social media assistance or office work) is legal. It allows children to earn income (no taxes below the standard deduction) and makes them eligible to start a Roth IRA. This move initiates the compounding process earlier and sets the stage for long-term financial growth.

Consider having your children invest every dollar in the Roth and give them spending money to maximize contributions.

The compounding effect of starting a Roth IRA at a young age can significantly impact their financial future.

💭 Parting Thoughts

I hope this post gives you valuable insights to optimize your taxes. Exploring these strategies further (and talking with your tax professional) can lead to significant financial benefits and smarter decision-making in managing your tax liabilities.

Thanks to Ankur for sharing insights and information to help you lower your tax liability. You can learn more about ​Carry​ and check out their ​free resources​.

Your input matters! We invite you to contribute to our community's knowledge base if you have tips for maximizing tax savings. Together, let's build a resourceful space for effective tax-saving strategies.

Feel free to send your thoughts to [email protected]. Thanks!

Chris

Feel free to send your thoughts to ​​[email protected]​​.​