(Bloomberg) — Americans who enjoyed capital gains from a stock market rally or interest from high-yield savings accounts in 2023 may have some surprises waiting for them on their tax bill.
This is showing as one of the main topic of this year's tax filing season. But there are even more considerations that taxpayers should be aware of before the April 15 deadline. This includes a new, free way to file federal taxes, if you qualify, and higher interest rates that the Internal Revenue Service will charge for underpayments.
“I always refer to this time of year as the time when all the skeletons come out of the closet — all the things that went wrong that you learn about now during tax season,” said Tim Steffen, director of advanced planning for Baird. Asset management.
Below are some of the top issues to be aware of — and some wrinkles to consider for the coming year, according to a Bloomberg survey of tax experts, financial advisors and CPAs.
A new (and free) way to files
The IRS is piloting a new one Live file tool this tax season. The free online portal guides taxpayers with relatively simple federal returns on how to file a Form 1040 and then submit it directly to the IRS. Filers with more than $1,500 in interest income cannot use the service, and the only deductions that can be claimed — on top of the standard deduction — are education expenses and student loan interest.
A small test pilot, which was introduced in February to government employees, led to a full scale launch of service on March 12 for eligible taxpayers in 12 states. The program will be evaluated after the registration season to determine its future.
Higher interest income for many people
Interest rates on high-yield savings accounts, certificates of deposit and the like have made savers good money in 2023. The write-off? Unlike long-term gains on stocks, which can be taxed at 0%, 15% or 20%, interest income is taxed at ordinary income rates, which go up to 37%.
Interest rates have been so low for so long that this year's profit bill could come as a shock to depositors, especially if they don't have an adviser monitoring their income on a regular basis.
If you have capital losses from losing investments, you can use them to offset up to $3,000 of ordinary income per year. But “in a bull market like we've had, most people are using their losses to offset their capital gains,” said Alvina Lo, chief wealth strategist at Wilmington Trust.
If you held the CD in a tax-deferred account like an IRA, however, you don't have to pay income taxes on that interest this year. You will pay income tax on the money in that account when you withdraw it later in life.
Read more: High-yield savings accounts hit Americans with bigger tax bills
Need to Re-do Roths
Larger earnings may also mean you may need to “undo” some or all of your Roth IRA contributions.
How much you are able to contribute to a Roth IRA after taxes depends on your adjusted gross income. So if your income is higher than expected – for example, because of large amounts of interest income – you may need to withdraw the contributions you've made.
“We hear a lot about this — people who at the beginning of last year made a Roth IRA contribution without realizing their income would be too high,” said Steffen of Baird Wealth Management. “With gig workers, you really don't know what your income is going to be for the year. And large capital gains can prevent you from contributing to a Roth.”
However, avoiding a penalty is very simple. Simply take the money out of the Roth, along with any earnings on it, before you file your return. Savers can also do what's called a “recharacterization” and move the entire amount into a traditional IRA.
Read more: How to make the most of your retirement savings in 2024
Higher fees charged by the IRS
Higher interest rates may also mean higher interest to be paid on certain amounts owed to the IRS. The rate the IRS applies to things like significant underpayments on estimated quarterly payments is now 8%, up from 3% a few years ago. The rate is set every quarter at three percentage points above the short-term treasury rate.
There are so-called “safe harbor” provisions that protect taxpayers from penalties. For example, joint filers with adjusted gross income of more than $150,000 can be exempt from the fees if they paid at least 110% of the equivalent amount of tax owed on the previous year's return.
Conversely, if a taxpayer pays their tax bill, the IRS says it will pay the same rate in interest.
Future strikes in 2024
Balances in many retiree accounts are likely to increase in 2023 — which is great, but it means the minimum amount the IRS says retirees must withdraw from tax-deferred accounts in 2024 to avoid penalties could increase . These withdrawals are taxed at ordinary income rates.
Here's how it works. The IRS requires retirees with money in 401(k)s and IRAs to take “minimum distributions required,” or RMD, in the early 70s. The amount is determined by taking the account balance at the end of the previous year and dividing it by a number found in the IRS tables of life expectancy by age.
After a nearly 28% gain for the S&P 500 in 2021, the nearly 20% decline the following year meant that minimum RMDs for retirees with stocks were relatively low in 2023. But the opposite is likely to be true. true for 2023 and retirees may have to withdraw more money this year.
Additionally, anyone who was a non-spouse beneficiary of an inherited IRA in recent years may need to plan for more taxable income. It used to be that multiple beneficiaries could stretch out the taxable withdrawals they were supposed to take from the accounts over their lifetimes.
This would reduce the risk of bumping into a higher tax bracket on withdrawals. But the rules now require, in most cases, that the accounts must be emptied within 10 years.
The IRS's proposed rules also require a minimum amount to be withdrawn from the accounts each year to avoid a penalty. The IRS has waived penalties for missed distributions in recent years because of confusion over how the regulation is applied, Steffen said. “But we expect them to (go into effect) eventually.”
Baird is advising affected clients to expect to have to take a required distribution in 2024, but feel free to wait until the end of the year to see if the IRS lifts the penalty again, he said.
To contact the author of this story:
Suzanne Woolley in New York at (email protected)