In focus - US year-end tax planning for individuals

As we approach the end of 2023, our minds naturally turn to the typical things that occupy this time of year: spending time with family and friends, challenging ourselves to eating a record number of mince pies, presents under the Christmas tree, and of course most importantly – year-end US tax planning!

With an election year looming in the UK, it is very easy to get caught up in the debates around the changes a Labour government may implement, should they regain power for the first time since 2010. Will they abolish the non-dom regime? Will they seek to eradicate the current tax benefits that can be associated with carried interest? We also have seen speculation about what the current Tory government may do as part of their election strategy. Tax will undoubtedly form a significant part of this and even though there were tax cuts in the Autumn Statement, rumours of cuts to income tax and changes to the current inheritance tax system, which didn’t happen in that statement, are likely to resurface in advance of the Budget in Spring 2024.

As if the above wasn’t enough to debate and digest, we of course have the US presidential election in 2024 to consider as well. Whilst tax has currently not dominated the US election process to the same extent that it has in the UK, it will certainly be interesting to see if either the Democrats or Republicans decide to make this a key part of their campaign as the election nears.

With all the excitement that comes with the above, it is very easy to look forward and forget about the here and now. With this in mind, what are the key areas of consideration for US taxpayers as we head towards the close of 2023?

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Foreign tax credits

For most US taxpayers residing outside of the US, the most effective route to avoid double taxation is matching their foreign tax credits to their US income. Although the tax may not be payable to the foreign jurisdiction (including the UK) until a later date, those that claim a foreign tax credit on the ‘paid’ basis will want to ensure that the foreign taxes are settled in the same calendar year that the associated income arose.

Key areas to consider:

• Was there a foreign tax credit shortfall in the prior year tax return?
• Did the individual switch from the remittance to the arising basis in the UK?
• Was there a change in income levels or types of income for 2023 compared to 2022?
• Did the individual move overseas during the year?
• Was there a change in employment status during the year, i.e., moving from employed to self-employed?
• Were there any large capital gains or investment income amounts received this year since 5 April?

There are several reasons why an individual on the paid basis may wish to accelerate the payment of foreign taxes; the above are just some of the most common scenarios where we see this as being in point.

Harvesting capital losses and netting gains and losses

2023 has seen another turbulent year for the stock market. Whether it be inflation, rising interest rates, or political and social unrest, there have been various contributing factors to the volatility experienced in the stock market during the year so far.

If taxpayers are currently sitting at a net gain, it may prove beneficial to crystalise capital losses before year-end to reduce their taxable gains and the tax liability associated with this.

Those recognising a net loss can claim up to a $3,000 against their income ($1,500 if married and filing separately). Any losses above this amount can be carried forward to future years, and so are not wasted.

For those residing outside of the US, advice should be taken as to the treatment in the local jurisdiction for any transaction. Some common questions include:

• Will capital gains treatment apply in the local jurisdiction?
• Which country has primary taxing rights, and do I therefore need to accelerate payment of foreign taxes?
• How will exchange rate movements impact the gain and loss position?
• Will I have a different cost basis in the US and local jurisdiction?
• Will additional gains trigger additional net investment income tax?

If you are holding non-UK investments that are classified as reporting funds for UK purposes, it may be worth checking to confirm that the fund continues to meet the conditions throughout your holding period.

It is also key to consider your overall investment strategy, and individuals should speak with their financial advisor before taking any action.

Gifting (including to charity)

For long-term gift and estate planning purposes, you may wish to consider maximising your ability to gift amounts in excess of your lifetime exclusion amount. The lifetime exclusion is currently $12,920,000 (and indexed for inflation) but is scheduled to be significantly reduced with effect from 1 January 2026.

For 2023, individuals can make gifts of up to $17,000 per donee without using the lifetime exclusion. For gifts to a non-US citizen spouse, the amount is $175,000. The exempt amount does not carry over and is therefore useful to consider each year. ‘Gift splitting with a US citizen spouse’ should also be considered, and where applicable, ‘Crummey powers’ can be used to help fund a trust. If looking to gift appreciated assets as part of an estate plan, consideration needs to be given to foreign jurisdiction implications. For example, does the gift trigger a capital gains tax liability? Will the recipient have differing cost basis in the US and the local jurisdiction? Will this be a normal pattern of giving out of income that could qualify for UK exemption if applicable?

When considering charitable giving, it is often advantageous for cash flow purposes (subject to income limitations) to fund a charity on or just before 31 December. Giving appreciated assets (held more than one year) is also often more tax efficient than giving cash. Dual US-UK taxpayers should consider gifting to a dual-qualified charity (and/or donor advised fund). A cash gift by 31 December could also potentially qualify for carry back relief in the UK.

Reducing taxable income

The most obvious way to reduce your tax liability for the year would be to reduce your taxable income. Whilst this may seem counter-productive, there are ways in which you can lower your tax bill and still receive a benefit.

Contributions to your 401(k) plan, traditional individual retirement accounts (IRAs), or Keogh plan will all potentially lower your pre-tax income.

IRA and Keogh plan contributions can still be made for the 2023 tax year until 15 April 2024, but the plans must be in place before the end of the year.?

Individuals living outside the US, who are members of non-US pension schemes, should consider whether it would make sense for them to maximise their contributions in the year. Assuming the contributions were also deductible for local tax purposes, such contributions would also make sense where:

• The ability to make contributions in future may be limited
• There is relief allowed against US tax under the terms of a tax treaty
• The individual has available excess foreign tax credits (in the appropriate basket) which will otherwise be lost, and yet will cover any US tax on the contribution amount

Another way of reducing your taxable income is to increase allowable deductions. Since the restriction on the allowable state tax deduction, we have seen a number of taxpayers switch to the standard deduction or look to increase permitted deductions to continue claiming itemised deductions. Taxpayers who are often close to the threshold between itemising or claiming standard deduction, could consider grouping any charitable deductions (perhaps using a donor advised fund) to ensure that there is a clear benefit from itemising in a given year.

Individuals managing their own unincorporated businesses could consider if there is benefit in looking to realise any business losses prior to end of 2023. Taxpayers will need to consider if they have the income to utilise any losses and take regard to the loss limitation rules. This includes the relatively new excess business income loss rules, which generally limit a claim for excess business losses to $500,000 for a married couple ($250,000 if single).

Pension distributions and conversions?

It is also worth remembering that if you turn 72, you must begin automatic withdrawals from your US retirement plans. If not, you could be subject to a 50% excise tax. Your plan provider will give you the option of applying withholding to the distributions or not. This income will be considered ordinary in nature.

Converting a traditional IRA to a Roth IRA (the so-called backdoor conversions) is still permittable, and whilst this may trigger an immediate tax charge, it can create long-term tax benefits for some taxpayers by avoiding tax on future distributions. Minimum distributions at 72 do not apply to Roth IRAs.

If an individual has foreign tax credits which are about to expire after 2023, they could consider the possibility of triggering a foreign source taxable event before the end of 2023 to utilise such credits. One possible planning technique (if such credits are in the applicable basket) is to transfer UK pension funds into a UK self-invested pension plan, although other considerations such as future reporting also need to be considered.

As always, there is no ‘one size fits all’ approach when it comes to tax planning and strategy implementation. There can be unintentional consequences if your individual circumstances are not reviewed appropriately.

We would always recommend that you contact an advisor to discuss your individual year-end strategy. For taxpayers living overseas, it is imperative that your global tax position is considered, and therefore any action taken must simultaneously factor in the local tax ramifications.

Author:

Thomas Gaughan , Senior Manager, EY Private Client Services

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