With a little tax planning throughout the year, there is no reason to dread April 15. You can avoid surprises if you regularly pay attention to your income and withholdings and take advantage of tax-saving strategies.
Why should you avoid big refunds? You may momentarily feel elated when it turns out you are getting back a substantial overpayment. But really, all that means is that you’ve been giving an interest-free loan to the government all year long, without as much as a thank-you. You’d improve your financial health if you used that extra cash each month to pay down debt, save it for emergencies or invest it in your portfolio or tax-advantaged retirement account.
How about the flip side: A large tax bill and, possibly, penalties? That’s an unpleasant, costly surprise and you may find yourself short trying to pay it.
If you’re like most people and don’t think about your taxes until the filing deadline, it’s too late to make changes. That’s why it makes sense to do some tax planning throughout the year, but especially in the second half. You will be well prepared to file taxes when the time comes.
What is Tax Planning?
Tax planning is different from tax preparation.
Tax planning takes a comprehensive view of your finances to ensure maximum tax efficiency. It’s all about striking the right balance between minimizing your tax liability while maximizing tax breaks with income and investment opportunities. It is an ongoing, proactive approach.
In contrast, tax preparation refers to readying your finances for filing your federal, state, and local income tax returns. Good organizational skills come in handy for this once-a-year routine of gathering all your documents. Because no changes to the past year’s tax choices can be made at this point, it’s an entirely reactive activity.
How Tax Planning Adds Value
Tax planning typically cuts your tax bill while building your financial assets, a win-win situation.
What tax moves should you consider? Here are several suggestions.
- Enroll in tax-advantaged accounts that allow you to put money aside for retirement, medical expenses, daycare, and education. Contributions to 401(k) or 403(b) retirement plans, Health Savings Accounts (HSAs), Flexible Savings Accounts (FSAs), and Dependent Care Plans are deducted from your gross salary, reducing your taxable income. Depending on the plan, you can benefit from additional tax advantages when you withdraw the savings to pay for eligible expenses. A traditional IRA is an attractive alternative for those self-employed. Also, consider opening a 529 plan to save for PreK-18 expenses. You’ll fund it from your net paycheck, but you may qualify for a tax credit on your state income tax return. A little heads-up: You may enroll in some of these plans only at certain times of the year—all the more reason to manage your money proactively.
- Track your deductions. Even though the 2018 tax reform bill doubled the standard deduction, making it the best choice for most tax filers on their federal return, itemizing still makes financial sense for some. If you own a home, have qualified student loans, or make large charitable contributions, itemizing might net you greater tax savings, especially on your state income tax return.
- Adjust your W-4 withholdings. If you received a large refund or tax bill during the previous year, raise or lower, respectively, your withholdings. Those changes can free up extra cash to put towards investments or make you owe less (or nothing).
- Apply a tax lens to your strategy for buying and selling stocks. If you have the chance to realize a large capital gain, minimize your tax liability by selling underperforming equities in the same tax year.
- Make strategic home improvements. If you’re planning home renovations, check if these qualify for residential energy or historic preservation credits. More often than not, these credits apply to state income taxes, rather than federal.
Tax Planning and Stock Options
Are you receiving incentive stock options (ISOs) or restricted stock units (RSUs) as part of your total employee compensation package? If your company share prices increase, you may own very valuable assets.
However, before you cash in, find out what possible tax considerations there might be.
- You may have to pay the alternative minimum tax, a tax applied in addition to the regular income tax, typically on capital gains.
- Are your distributions classified as qualified or non-qualified? Different tax rates apply.
- Watch your timing. The date when your ISO or RSUs were granted, how long you hold the shares, whether or not you have completed the vesting period when you choose to exercise the options, and when the final sale of the shares occurs could all affect your tax liability.
How Woven Capital Can Help
If all this sounds complicated, take heart. We’re here to help you identify the steps most useful for you and show you how to get started or boost your progress. Tax planning is an ongoing process that shifts and evolves as your wealth grows and changes. We seek to bake tax planning in every aspect of your financial life to account for these changes and capitalize on important opportunities.
As you can see from the examples above, taxes impact nearly every part of your finances. They are present in your spending, saving, investing, and more. Making the most of the tax opportunities available to you can save you thousands of dollars over the years, keeping your money working for you and furthering your goals.
Tax planning is also part of a well-rounded, holistic financial planning approach. Saving money at tax time allows you to put more money toward your financial future. This might be increasing contributions to your investment portfolio and even promoting businesses that act in an ethical and environmentally conscious way through socially responsible investing.
With our team’s guidance and support, you’ll discover that tax planning will become a key driver of your successful investment strategy.
And April 15? No reason to sweat it. It will be just a date on the calendar. Set up a time to talk with our team to help you with your tax planning needs.