Don’t Miss Out on Your 2023 Tax Breaks

It’s time to shake a leg on year-end tax planning.

As usual, most moves affecting 2023 taxes must be completed before Jan. 1, just weeks away. Here are areas to tackle now—and a few that can slide.

Check withholding and estimated taxes

On Oct. 1, the penalty on tax underpayments rose to a stiff 8% and may hold there. This is worth avoiding, so review your paycheck withholding or quarterly estimated taxes—especially if your income has been uneven or included a windfall like a bonus.

To avoid underpayment penalties, most filers must pay 90% of their taxes long before the April deadline. The due date is Dec. 31, 2023 for employees and Jan. 16, 2024 for those making quarterly payments. The IRS has posted a calculator to help employees figure the right amounts.

Need to pay more? Try to fill the gap by withholding either from your paycheck or your taxable IRA payout. Under little-known tax rules, these moves can wipe out or reduce underpayment penalties, even if the catch-up payment is made late in the year.

Taxpayers can also bypass penalties by paying an amount equal to either 100% or 110% of their 2022 taxes, if they do it on time. (IRS.gov/directpay is a useful option.) In most cases, the 100% threshold applies to filers with adjusted gross income of $150,000 or less, while the 110% threshold applies to those with more.

Standard deduction or itemized?

Filers can reduce their taxable income either by subtracting one overall amount—the standard deduction—or by listing itemized deductions for mortgage interest, state and local taxes, charitable donations, medical expenses and others on Schedule A. Before the 2017 tax overhaul nearly doubled the standard deduction, about 30% of filers itemized.

Now, less than 10% do.

The standard deduction is $27,700 for married joint filers and $13,850 for singles this year, and next year that rises to $29,200 and $14,600 respectively. Filers age 65 and older each get at least $1,500 more.

Some taxpayers will want to switch back and forth from standard to itemized to maximize overall deductions. If so, it can make sense to “bunch” deductions either by accelerating or delaying them into years when you’ll itemize.

Often the best candidates for bunching are charitable donations (see below), but don’t overlook unreimbursed medical expenses. They’re deductible above 7.5% of adjusted gross income, a hard threshold to surmount. For those who do, a wide variety of expenses can count, including Medicare premiums, contact-lens solution and home modifications like an elevator or even a swimming pool.

Optimize charitable donations

Givers should focus on three key tax breaks for donations, as there’s no $300 or $600 deduction for non-itemizers this year.

One is to bunch gifts and itemize deductions in some years but not others. Example: Margaret is a single filer, age 67, who gives $5,000 a year to charity. But that and her other deductions will come to less than her 2023 standard deduction. By making two years of donations either this year or next, Margaret could take the standard deduction one year and itemize for the other to maximize overall tax breaks.

Another is to donate appreciated investments held longer than a year. Donors can often take a deduction for the full fair-market value of an asset without owing tax on its growth—although conditions and limits apply.

Donors who bunch deductions or give appreciated assets may want to use a donor-advised fund, or DAF. These enable the giver to take an upfront deduction and wait till later to direct donations to specific charities. Such funds are often convenient but have fees.

Finally, taxpayers age 70 ½ and older have a highly useful option: qualified charitable distributions, or QCDs, of traditional IRA assets. Each IRA owner can transfer up to $100,000 this year ($105,000 in 2024) directly to one or more charities. The donation can count toward their required minimum payout, if any.

Donors using QCDs don’t get a deduction, but the gifts don’t count as taxable income, either. That can help reduce income-adjusted Medicare premiums and other taxes—and still allow the donor to take the standard deduction.

Watch for large mutual-fund payouts

Investors holding mutual funds in taxable accounts should check whether their funds will make large capital-gains payouts for 2023.

Mark Wilson, a financial adviser who tracks large payouts at CapGainsValet.com, expects large payouts from fewer than 100 funds this year. That compares with about 360 last year, when markets tumbled and some managers sold holdings to meet redemptions.

Still, he says that so far five funds have announced payouts greater than 30% of net asset value, including the BNY Mellon U.S. Equity Fund. Another dozen will be making payouts greater than 20% of assets, including J.P. Morgan’s Tax Aware Equity fund and the DWS Equity 500 Index fund.

Usually investors have time after the announcement to make strategic moves before the payout. These include harvesting losses elsewhere to offset the gains or donating the holding to charity for a deduction.

Plan electric-vehicle purchases

There are lots of factors to consider. One is that buyers who wait until 2024 can receive a tax credit up to $7,500 at purchase, while those who buy this year can’t claim the credit until they file 2023 tax returns.

On the other hand, the list of eligible vehicles could shrink in 2024 after the IRS issues guidance on certain provisions. One of them excludes vehicles with battery components from certain countries, perhaps including China. Income limits of $150,000 for singles and $300,000 for couples filing jointly could also matter, so check the details if you’re close.

Note that many of these constraints don’t apply to leases, which have become more popular as a result. Due to excess inventory, many automakers and dealers are also discounting prices.

Take required IRA distributions

Owners of traditional IRAs born in 1950 or earlier typically must take required withdrawals for 2023 by Dec. 31, 2023. The payouts are based on the account value as of Dec. 31, 2022.

Many heirs of traditional IRAs whose owners died in 2020 or later would normally have to take a required withdrawal this year. However, the IRS is allowing these heirs to skip it for 2023.

Know what can wait

Contributions to traditional IRAs, Roth IRAs, and health-savings accounts for 2023 can typically be made until the tax deadline of April 15, 2024 (April 17 in Maine and Massachusetts). Some self-employed filers can make 2023 contributions to Solo 401(k)s until Oct. 15, 2024.

Write to Laura Saunders at Laura.Saunders@wsj.com