2023 Tax Planning: Tips and Pitfalls 

Posted in: Financial Planning

By Russell Holcombe, MTx, CFP®

Tax planning can get complicated fast—especially when you factor in things like equity awards and deferred compensation. If you like to avoid thinking about taxes until April, you are not alone. But the sooner you start planning ahead, the better chance you’ll have of avoiding common mistakes, and minimizing your tax liability in the process. If you’re a corporate executive, consider adding these 4 strategies to your tax plan.

Avoid Tax Withholding Mistakes

For many employees, how much tax to withhold can be difficult to determine. Often, we see it impact employees of publicly traded companies because of the stock-based compensation. Each type of stock option or equity has a different set of tax rules. Some, like RSUs (Restricted Stock Units) or RSAs (Restricted Stock Awards), are taxable when they vest, while others are taxable when they’re sold. 

The first thing we look at in this situation is making sure enough taxes are withheld to avoid the underpayment penalty and satisfy the safe harbor, which is 90% of your current-year taxes owed or 100-110% of the prior year’s tax due, depending on whether you are above or below $150,000 of Adjusted Gross Income (AGI). Unlike withholdings on a base salary, RSUs are considered “supplemental wage income,” which your employer withholds at a flat 22% federal rate. (The only exception is when income exceeds $1 million, and then the withholding rate increases to 37%.) This does not include state income tax withholding requirements, which vary by state. 

Standard withholding on RSUs could be far less than required to meet the upcoming tax obligation. Imagine you have $300,000 in RSU income and you’re in the 35% marginal bracket. Your employer will only withhold the 22% for federal income tax, or $66,000. Compare this with a marginal tax rate of 35%, where the tax liability is $105,000, that’s an underpayment of $39,000 at the federal level. Neither of these instances include state income tax as, once again, those requirements vary by state. 

It is important to safe harbor so you don’t owe an underpayment penalty when you file the tax return. Your CPA may want you to make an estimated tax payment to avoid this penalty. Since most equity compensation vests in the first or second quarter, these payments would need to be made by the April or June deadlines for the 1st or 2nd quarter. The IRS interest rate for underpayments is now 7%.  

November and December are the best months to approach your CPA to begin planning next year’s taxes. Calculating an estimated tax payment should be fairly straight forward since the vesting dates are known, it is easy to estimate the value that will vest based on the current stock price, and the safe harbor limits can be calculated based on the prior year’s tax return.

When Is a Roth 401(k) a Bad Idea?

The tax system in the United States is progressive so your income is taxed at increasing rates as you make more money.

Most people mistakenly think their future marginal tax rate will be higher than it is today, which makes Roth 401(k) contributions less tax-efficient than traditional 401(k) contributions. 

When is the Roth 401(k) better? The Roth 401(k) contribution is better if you expect your marginal tax rate in retirement to exceed your current marginal tax rate. If your marginal tax rate at retirement is the same as it is now, the traditional and the Roth 401(k) at retirement are essentially equivalent, but many prefer the Roth. The Roth 401(k) is also better if you plan to move to a high-tax state like California or New York.

When is the Roth 401(k) worse? The Roth 401(k) is worse if you expect your federal tax bracket to be lower at retirement. This is most important for people living in high-tax states. Many work there because it’s where there are a lot of high-paying jobs. But what about when they retire? Many people move to lower-cost states with lower cost of living once they retire. Paying a 13% California income tax with a Roth 401(k) and then moving to Texas or Florida where there is no state income tax is expensive. 

Below are the 2023 income tax brackets in California for a married couple filing jointly. Compare that to the 0% income tax in Florida or Texas.

Nobody can predict the future, and it does feel good to have Roth 401(k) growing tax-free forever. There’s nothing wrong with this decision; it just might result in paying more income tax than you would otherwise. 

HSA Plan Maximization

Unlike 401(k) contributions, HSA contributions are not subject to FICA tax. The family limit in 2023 is $7,750 (+ $1,000 if over the age of 55) and can be tax-free if used for qualifying medical expenses. We have seen families build up several hundred thousand dollars in their HSA. Even though they are on Medicare and their medical expenses have gone down, this money can be used for expenses not covered by Medicare, including dental, vision, hearing aids, home modifications like tubs and ramps, Medicare premiums (A, B, C, D) and long-term care premiums up to certain amounts. 

When we have clients that are maximizing their 401(k) up to the limit of $22,500 in 2023 (or $30,000 if over 50), we ask if they have considered maxing out the HSA. 

Both are tax-deferred, but the HSA is better than a Roth because you get a deduction today, avoid the FICA tax, and can possibly avoid the income tax if you can spend the money on qualified expenses. 

Our general recommendation is to max out the 401(k) traditional or Roth (that decision is based on the article above) to receive the full company match and then maximize the HSA if cash flow permits. Once you max out the HSA, the decision to defer more dollars into the 401(k) should be based on your personal financial story. If you can afford to max both, please do. But if you have a limit, the HSA should be on your radar. 

Can You Make the Disability Benefit Tax-Free?

Most employers provide their employees with a long-term disability benefit that is equal to a percentage of the base salary. It is usually 50% or 60% of eligible compensation with a dollar cap of $10,000 or $15,000 per month. Some employers allow you to opt-in for more coverage, which is important to consider since it usually does not require evidence of insurability during open enrollment. 

If the employer pays the premiums, meaning you don’t see a payroll deduction for disability insurance, the benefits if you become disabled are taxable. However, if the employee pays the premiums, benefits are not taxable. If you and your employer split the premium costs, you will also split the tax liability based on the pro rata distribution. Some employers allow for employees to elect to make the disability benefit tax-free. If your employer provides that option, we highly recommend taking advantage of this feature.

Disability is the biggest risk to a family, and it rarely provides enough coverage for the family without altering lifestyle. If you can avoid the income tax on the disability income, it might be just enough to bridge the gap during a very difficult emotional and financial time.  

Important Changes in 2023

• Social Security wage base increases to $160,200. Maximum wage base for retirement plan contributions increases to $330,000 and the 401(k) deferral limit increases to $22,500 ($30,000 for those age 50 and older).
• IRA limit increases to $6,500 ($7,500 for those age 50 or older).
• HSA limit increases to $3,750 for individuals and $7,750 for family coverage (+ $1,000 for those age 55 and older).
• Gift tax limit increases to $17,000 per person and the annual estate tax exclusion increases to $12.92 million per spouse.
• The business mileage reimbursement rate increases to 62.5 cents per mile.

Are You Being Strategic with Your Tax Plan?

Are you a corporate executive looking to make the most out of your tax planning but you’re unsure where to start? At Holcombe Financial, we can help you explore these strategies and more. Schedule a no-obligation introductory meeting to see how we can help by calling us at (404) 257-3317 or emailing hello@holcombefinancial.com. 

About Russell

Russell (Rusty) Holcombe is the CEO and strategist at Holcombe Financial, a financial advisory firm serving entrepreneurs and corporate executives and managers. With over 25 years of experience, Rusty spends his days leading Holcombe Financial (a firm his father founded) and providing financial services that help his clients grow and protect their wealth so they can experience financial independence. Rusty is the author of You Should Only Have to Get Rich Once, which has won multiple awards, and created Holcombe Financial’s proprietary financial planning software, which helps clients make smarter financial decisions.

Rusty earned a bachelor’s degree in business administration with a focus in finance and real estate from Southern Methodist University and a master’s degree in taxation from Georgia State University. He is also a CERTIFIED FINANCIAL PLANNER™ professional. In his free time, Rusty and his wife, Regina, tend to their personal farm and grow their own food. You can often find him pursuing his hobby of long-distance running. To learn more about Rusty, connect with him on LinkedIn. You can also watch his latest webinar on investing.