Smart Tax Planning Strategies
Most people put off tax planning until the April deadline or end of year statement shuffling and accounting. By then, it’s often more about the last-minute calculating of tax responsibilities, than a more proactive approach. Efficient tax planning can help you decrease tax liabilities, increase your savings, and achieve your financial goals.
This country has a confusing and often overcomplicated tax code. But if you approach it with a little more forethought – including a little help from a financial planner – you can get ahead of the deadlines and make sure you’re keeping more of that hard-earned income.
Take some time to start understanding your tax bracket, expected taxes, and what you can do to make sure you’re not overpaying. There’s a lot you can tackle on your own – especially if your income and assets are fairly straightforward. However, if you have questions or your situation is a little more involved, a financial planner can help talk through your financial complexities and the ever-changing tax laws. Effective tax planning is not a one-size-fits-all approach – it requires careful consideration of your financial goals, income sources, investments, and unique circumstances.
Before you start planning, you should know your tax bracket. You can find it here. After that, tax planning largely involves three steps: reduce your overall income, increase the number of your tax deductions throughout the year, and take advantage of certain tax credits.
Reduce Your Income
There are a number of things you can do to lower your adjusted gross income (AGI). This is the amount of your income that’s actually taxable. To effectively lower your AGI, you can do the following:
- Tax-Advantaged Accounts: Contribute to tax-advantaged accounts such as 401(k)s, IRAs, or HSAs to help reduce taxable income while saving for retirement or healthcare expenses. Just keep in mind that 401(k) or IRA retirement plan contributions lock in your funds until you reach a certain age—usually around 60. If you aren’t sure whether or not you’ll need the money, build up your savings before you start adding to a 401(k) or IRA account.
- Income Splitting: For couples or families, income splitting involves distributing income among family members in a way that minimizes the overall tax burden.
- Hire your kids: If you have a business and can legally hire them, their first $12,000 in salary becomes a tax deduction for the business, is tax-free to them, and their income will most likely be assessed at a 10% – 12% tax bracket.
- Capital Gains and Loss Management: Time the sale of your investment to take advantage of lower capital gains tax rates and offsetting gains with losses to reduce your tax liability on investment income.
- Estate Planning: Careful estate planning can help you pass assets onto your heirs while minimizing estate taxes. Strategies like setting up trusts or gifting assets during your lifetime can be part of this approach.
Increase Your Deductions
You may want to look at all the taxable deductions you’re entitled to throughout the year. Deductions including charitable donations, personal property taxes, interest on your mortgage, business expenses, student loan interest, medical expenses and more can really add up. Just keep an itemized list of your expenses throughout the year along with any receipts. A simple spreadsheet is enough.
Use Tax Credits
Tax credits work like incentives and they help you lower the amount you owe in taxes. There are a number of expenses that can be offset by tax credits, but the most impactful are when you adopt a child or pay for college expenses. Whether you’re going to your first year of college or earning a professional degree later in your career, you have upwards of $10,000 per household to spend on college credits per year thanks to the Lifetime Learning Credit. You may also qualify for the Earned Income Tax Credit (EITC). For a complete list of all the current tax credits, including these and others related to business expenses, pandemic relief and natural disasters, you can visit the IRS site.
There are different ways to lower your tax liability – but it’s all customizable to your personal context. A financial planner can easily help you navigate the tax implications of various life events, owning businesses or tax laws that’ll be changing in the coming years. Just dig in ahead of that April deadline, and it’ll be a much more thoughtful and comfortable approach to your finances overall.