What is Tax Planning?

Tax planning is considering your whole situation and making any necessary changes or decisions before the tax year is complete. Think of it as forward looking. When you prepare your tax return, you are looking backwards at things that have already happened and figuring out any credits or deductions that you can take based on things you cannot change.

Here are some examples of Tax Planning:

  • Self-Employment Income
    • If you can contribute more money to an Individual K retirement plan, this plan must be set up by December 31st of the tax year. If you figure this out while you are preparing your taxes (previous year) it is too late to have this plan for that year.
  • Charitable Deductions
    • Since the Tax Cuts & Jobs Act, the standard deduction is much higher which means your itemized deductions must add up to an even higher number to be useful. Charitable Deductions are on the Itemized schedule and may not be high enough to get a tax break. A strategy here would be to combine some of your charitable deductions into the same year. You could put a few years’ worth of your normal donations into a Donor Advised Fund and take the deduction in one year but can send money throughout the years. Another strategy at age 70 is taking advantage of a Qualified Charitable Distribution (QCD). You can gift directly from your IRA to the charity and never have to have to pay tax on that money.
  • Retirement Plan Withdrawal Strategies
    • An example I have seen here is when a retiree’s medical expenses increase significantly during the year. Medical expenses might offset some income. Knowing this ahead of time could allow for you to change amounts you are taking out of taxable and non-taxable accounts. These must happen in the same tax year to work, not after the fact when you are preparing your tax return.
  • Capital Gains & Losses
    • First, you should not let the tax tail wag the dog. That being said, there some things that are nice to know when selling some assets—capital loss carryovers, income for the year, deductions that may lower the income tax bracket for a particular year.
  • Diversification of Future Income
    • This is looking at your current savings and deciding how to allocate your savings based on your current income tax brackets as well as the future which is unknown. I personally like to have different buckets to pull from on the future. If you are in a low-income tax bracket now, then try to take advantage of the lower rates now. Again, this is dependent on many different factors of your situation.
  • Education Savings
    • Starting a 529 Plan for your child at an early age may give you state tax deduction, and all the earnings are tax free when used for qualified education expenses. The earlier you start, the more compounding there is and thus more tax-free growth for the future.

This is not an exhaustive list of how tax planning works, but hopefully it gives you the gist of how working with a Financial Advisor can facilitate some of these strategies versus looking backwards when preparing your tax return.

Financial Journey LLC is a registered investment advisor offering advisory services in the state of Virginia and in other jurisdictions where exempted. Information provided is for educational purposes only and not, in any way, to be considered investment or tax advice.

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