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Most Effective Tips To Proactively Plan and Manage Taxes

manage taxes

Taxes are commonly thought of as a once-a-year sprint, but they play a much larger role in your life. Taxes affect every part of your financial plan, including how you save, invest, and spend money.  All financial decisions you take will have tax implications and hence it is critical to work with a team of financial experts who can help you develop a better strategy to achieve your financial objectives.

In this article, we will discuss the importance of effective tax planning and also suggest a few tips to save on taxes.

What is Tax Planning and How Does It Differ from Tax Preparation?

Let’s start by distinguishing tax planning from tax preparation. Tax preparation is the act of gathering financial records (1099s, W-2s, and so on) each year and filing your taxes with the help of a CPA. Your tax advisor will be able to advise you on basic tax filing techniques and deductions, but usually they won’t spend more time examining your finances in depth. Professional tax filers receive your data after the events of the tax year have occurred, leaving little room for proactive decisions. When it comes to tax preparation, accuracy and efficiency come first.  Essentially, tax preparation is a backward looking exercise.

Tax planning, on the other hand, is a forward-looking strategy for lowering your long-term tax liability so that your total tax burden is as low as possible during your lifetime. 

Your financial advisor has the advantage of knowing your full financial situation and can provide you with advice throughout the year. Financial advisors will analyze your planned actions for a particular year, such as charitable donations, real estate purchases or sales, rebalancing your portfolio, and retirement savings, and walk you through the short- and long-term tax consequences of your decisions through proactive tax planning.

You will have more confidence in your tax return if you have a solid tax planning strategy in place since you will know what to expect. 

Your financial advisor’s job is to conduct strategic evaluations of your overall financial picture and provide you with creative, realistic, and well-informed options to assist you make the greatest financial decisions for you and your family.

What Taxable Events Impact Your Finances?

As previously said, taxes have an impact on nearly every aspect of your financial situation. When you look at your finances through the lens of taxes, you can make better decisions that will affect not only your tax bill but also your overall financial plan.

  • Healthcare/Medicare premiums
  • Capital gains and losses in investments
  • Asset allocation
  • Roth Conversions
  • Tax-loss harvesting
  • RMD strategies in retirement
  • Social Security planning
  • Charitable donations

This is only a glimpse of the many ways taxes might affect your financial position.

Tax Planning Strategies and How They Help?

In addition to saving money, Tax planning strategies assist taxpayers to avoid tax penalties, maximize their tax deductions, organize their financial documents, and plan for the future.

Adjust Your Withholding

Did you have an unexpected tax liability last year? You’re not the only one who feels this way. This may be caused by the new tax law changes. So,  it’s a good idea to update your W-4 form after any tax law change.

The new W-4 differs from the old form and it is intended to help taxpayers better align the amount withheld by their employer with their projected tax liability for the year. If you have any major life events (marriage, divorce, children, etc. ), it’s a good idea to update your W-4 with your employer. You can do it at any time.

Contribute to a 401(k)

Contributing to a pre-tax retirement account, such as a 401(k) or 403(b) plan, is a great method to minimize your taxable income. Contributions are done through payroll deductions and are only available through your present job. Your taxable income is lowered by the amount you contribute before taxes, lowering your overall tax burden for the year. A Roth, or after-tax, contribution option is now available from most businesses who provide retirement plans.

When determining whether to donate pre-tax or Roth, consult your tax or financial advisor because, while the Roth contribution will not reduce your current year taxes, it may benefit you in the future by lowering your possible tax burden.

Donate to Nonprofit Organizations

Donations to nonprofit organizations can also assist in reducing your taxable income and minimize your tax bill if you itemize your deductions rather than taking the standard deduction. Make sure you’re giving to a recognized tax-exempt organization, which is commonly identified by its 501(c)(3) status or by its religious affiliation. If you’re unsure, you can contact the nonprofit, chat with a tax professional, or use the IRS’s online search engine.

Keep a record of your donation; many organizations will send you an acknowledgment letter with the date and amount of your gift. If you’re donating in-kind property, you’ll need a receipt as well as either a written appraisal or a photograph of the item in case the IRS has any issues.

Double Up Itemized Deductions

This method entails doubling your deductions and applying them all in one year, allowing you to reap the tax benefits of a bigger itemized deduction where you would otherwise claim a standard deduction. For example, you may pay your current-year property taxes in January and then pre-pay your property taxes for the next year in December. If you’re donating to charity, you may contribute twice as much in a single year.

Tax-Loss Harvesting

You might consider tax-loss harvesting throughout the year if you have a non-retirement investment account. This is when you sell investment assets at a loss and use the proceeds to offset any capital gains you make throughout the year.

A loss equals a dollar-for-dollar offset of any realized profits, lowering your potential capital gains tax for the year. It’s possible that this is already being done for you behind the scenes if you deal with a financial advisor. You can still deduct up to $3,000 in taxable income if you don’t have any realized profits. Keep in mind that these asset sales only apply to taxable assets, such as those held in a personal or trust investment account.

As IRAs and 401(k)s grow tax-deferred, they are not subject to capital gains taxes and hence are not eligible for tax-loss harvesting. Since there are a lot of rules that must be followed in order to count your tax loss, talk to your financial adviser and CPA ahead of time about any asset sales or reinvestments. You can use a variety of tactics to manage your tax liability throughout the year.

When making financial decisions, it’s always a good idea to consult with your financial advisor and a tax specialist.

These are just a few ways of managing your long-term tax liabilities.  There are many others that may or may not apply to your particular situation.  Visit with an experienced financial advisor to make sure you are using all the tax planning tools available to you.

About Me

Don Larson, CFP® is the owner and founder of Larson Wealth Management. Don started in the investment advisory industry in 1999 after he graduated from Arizona State University with a Bachelor of Science degree in Business Finance.

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