Tax preparation and tax planning are separate accounting disciplines that work together to produce the ideal result. Preparation involves the process of calculating and completing a tax return by the due date. It starts sometime after the first of the year and ends when the previous year’s return is filed.
Planning takes place during the tax year itself and, in many cases, several years before that. Tax planning looks into the future. Based on income and goals, it determines the best moves now to decrease your tax base in the future.
For example, a couple saving for their children’s college would not want to neglect tax planning and just put tuition money into a savings account and file whatever taxes are due each year. This would be wasteful. Instead, they would want to plan their contributions to maximize their tax savings over the entire time they are saving, which, if done properly, results in tens of thousands of additional dollars for college expenses.
George Sutherland, Supreme Court Associate Justice (1922 – 1938) said, “The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.”
To do what Justice Sutherland advises is legally correct, advance tax planning is a necessity.
Hundreds of tax strategies exist. Some function independently, while others work together. Here we explore five of the top tax savings strategies.
401(k) & 403(b) Contributions
Employer 401(k) or 403(b) plans allow you to withhold $19,500 per year as of 2020, or $25,500 if you are over 50 years old. Solo 401(k)s for the self-employed allow for at least $19,500 and up to $57,000 for business owners, plus the 50+ catchup contributions.
These contributions reduce your taxable salary. To get the maximum out of these retirement accounts, contributions should be planned over the long term. For example, when considering a budget for a new house, you should also think about the impact on retirement contributions. Financial projections help decide the right balance between mortgage payments and retirement plan contributions.
This strategy fits those with high taxable interest income, such as a retiree living partially on bond interest. By switching to quality municipal issues from their home state, retirees can avoid federal and state taxes on this portion of their income.
Dividend income is great, but whether you reinvest it or spend it, it is important to analyze the tax consequences before making an investment decision.
Some dividends are qualified, which means the government taxes them at the lower capital gains rate. Qualified dividends may be better taxwise, but you also need to consider whether tax savings are offset by higher yields and expected returns in the non-qualified space.
Tax planning and financial analysis determines which dividend investments of both types make the most sense for you.
Harvesting Capital Losses
Anyone with exposure to the capital markets needs to consider harvesting capital losses before the close of the tax year. Should you have capital gains, the taxes can be offset to some degree by selling losing investments. You can then re-purchase the “losers” 31 days after sale, while a similar asset can be purchased immediately.
Rental Real Estate
Rental real estate can be a great investment, but some investors feel discouraged by the tax code, which restricts them from deducting their losses. There is a way to avoid this trap, for those who plan ahead and can swing the requirements. By obtaining the “Real Estate Professional Status” designation, you gain the ability to deduct real estate losses without falling prey to the passive loss rules.
The tax code allows you to deduct the fair market value of appreciated property you donate, which means you pay no tax on the gain (limited to 30% of adjusted gross income). This can be a tax-efficient way to give to charity, and you can even deduct for future year’s contributions through a “Donor Advised Fund”.
As you approach high-income years, it becomes ever more important to employ tax planning. Efficient tax management results in thousands upon thousands of dollars in savings that can be invested into a growing nest egg over time. Most tax reduction strategies must be implemented during the tax year or before, so contact a CPA today to create a long-range tax plan.
Tax Avenger Canton MI is a CPA and Tax Firm dedicated to providing exceptional service to our clients. Our services include business accounting and payroll services, individual and business tax preparation, tax problem resolutions and more! We will help you with your tax plan, maximizing tax breaks and minimizing tax liabilities.
With 20 years’ experience, our firm prides itself on the extensive international and local experience in accounting and taxation. Call and speak to a CPA today for a Free Consultation. Remote services available.