Failing to create a plan is the most expensive mistake taxpayers can make
Many people scramble to find ways to reduce their taxes as April 15 approaches – and then dive back into busy lives and don’t give them another thought until the following year.
But not making time for advance tax planning is one of the biggest and most expensive mistakes taxpayers can make. As you become successful, taxes will most likely serve as your single biggest expense over the long-term. That makes taking advantage of every applicable tax break a critical part of your financial and/or business plan.
Year-round tax planning is an essential way for people and businesses to guarantee that nasty tax bills don’t pop up unexpectedly. It’s the process of estimating your tax burden ahead of time, and analyzing your situation so you can strategize ways to lower your current or future liability.
Tax planning helps you make smarter business decisions and establish a clear direction for your company. It must be done every year; the government is constantly making changes to the tax code that might inspire action, whether you hope to reap the benefits of a law before it expires or delay a purchase until the following year to benefit from a new provision that’s taking effect.
Read this carefully: these options for avoiding or deferring taxes won’t be available if you don’t know about them until the last-minute: when it’s time to file your tax returns. Legally shifting income between individuals and companies can take months or longer, for instance, and the most tax-advantageous company retirement plans take time to implement and must be in place before Dec. 31.
The Tax Cuts and Jobs Act (TCJA) made federal tax rules more complicated than ever, and that makes the benefits of solid tax planning more important than ever as well. By proactively planning ahead, you can uncover a world of options that enable you to keep more of your hard-earned cash in your pocket instead of Uncle Sam’s – and even turn tax season into a financial boost, not a burden.
What’s the goal?
There are two powerful benefits that make successful tax planning stand out from other financial strategies. It’s key to a financial defense, which essentially means spending less so you have more money to save and invest. It also guarantees results in a way that can’t be relied upon from riskier, market-driven investments.
The most effective tax planning addresses these goals:
- Lowering the amount of taxable income
- Reducing the tax rate
- Controlling when taxes are paid
- Receiving every applicable tax credit and deduction
- Taking charge of the Alternative Minimum Tax (AMT). The AMT was created to ensure that high-income households can’t use deductions to avoid paying their fair share of taxes. The TCJA made major changes to the AMT, significantly increasing exemption amounts and dramatically raising the phaseout thresholds for these exemptions.
Incidentally, while everyone benefits from tax planning, it’s particularly vital if any of these situations apply throughout the year:
- You are self-employed or own a business
- You have investments with unrealized gains or losses
- You experienced a life-changing event – for instance, selling a home, marriage or divorce, retirement, or the birth of a child
- Your income has gone significantly up or down, or you changed jobs
- You moved, especially between states
- You are sending a child to college for the first time
- You purchase health insurance from the government health exchange, linking premiums to your income
9 smart and easy ways to reap the benefits of tax planning
- Save for retirement. Deferring taxation from a current high bracket to a time you are likely to be in a lower bracket is a common tax strategy. Retirement plans are a popular way to achieve this goal. Contributing money to a traditional IRA reduces gross income up to $6,500, and the money saved grows tax-deferred until you retire. Employer-sponsored plans like 401(k)s are another way to defer income until retirement. Contribution limits for these plans are usually much higher than that of an IRA. In 2018, the employee contribution limit for a 401(k) was $18,500.
- Harvest investment losses. Tax gain/loss harvesting uses your portfolio’s losses to offset overall capital gains that are subject to taxation. You can offset unlimited investment gains – and up to $3,000 of ordinary income each year – by selling investments that have suffered losses. If your losses exceed your gains and the $3,000 of ordinary income, you can carry them over with no expiration to be used in future tax years.
- Consider 1099 contracting. Thanks to the new tax code and its pass-through deduction, self-employment – or 1099 contracting – is a better tax choice than collecting a salary in most cases. For the first time, individual taxpayers are allowed a deduction of 20 percent of qualified business income earned in a qualified trade or business. That means a 1099 contractor will pay considerably lower taxes on equal pay, as long as you qualify and stay under certain income limits.
- Structure your company wisely. An important decision many small business owners face in the wake of the new tax law is whether incorporating as an S-corporation or a C-corporation offers better tax benefits. There are advantages to both: tax rates for C-corps were slashed from 35 to 21 percent, although dividends are subject to double taxation because they are taxed again at the individual level. Many S-corp owners can benefit from the new 20 percent deduction of pass-through income, the biggest tax break for small business owners in decades. And in some cases, a multi-tiered structure that enables the entire business to enjoy the tax benefits of multiple entities is the right solution.
- Provide for college education. The new tax code modified and eliminated some benefits for people who are saving for college or paying off student loans. But if you are paying exorbitant amounts for your children’s college education, there are several tax benefits you still can use.
The American Opportunity Credit, for instance, allows taxpayers to reduce their taxes by as much as $2,500 a year per student for qualified education expenses. If the credit brings the amount of tax they owe to zero, they can have 40 percent of any remaining amount of the credit refunded to them, up to $1,000.
A Section 529 plan investment account allows savings to grow tax-free, and distributions to a beneficiary are also tax-free if they are used to pay for qualified college costs. The new tax law also allows 529 plans to cover qualifying expenses for private, public, and religious schools from grades K-12 for the first time.
- Make charitable gifts. If you itemize your tax deductions, charitable gifts can be a savvy way to lower your taxes. Donating appreciated assets is especially tax-efficient because it allows you to avoid paying capital gains on the appreciation.
- Gift assets to your family. A simple way to slowly remove money from your estate is by giving it away. If your estate is larger than the normal exclusion amount, you can lower its value by giving away $15,000 per year to each of your heirs or anyone else you choose without triggering the gift tax. Your spouse can give away money as well, leading to a total gifting capability of $30,000 per year per recipient.
- Invest in municipal bonds. Many people with high incomes now face a 3.8 percent Medicare surtax on investment income. Investing in municipal bonds can avoid this additional tax – and usually all federal and state income taxes.
Put simply, the tax equivalent yield (the yield an investor would require from a taxable bond to equal the yield of a comparable tax-free municipal bond) has increased for taxpayers in higher brackets, making tax-free municipal bonds more attractive. As a side note, the income threshold for trusts subject to the 3.8 percent surtax is only $12,500, making municipal bonds an attractive investment option for avoiding it there as well.
- Don’t trigger the AMT. Schedule A of your tax return lists the deductions you took in 2017. If you become subject to the AMT, you will likely lose the benefit of some of these deductions. If that happens, it may be wise to accelerate or delay some income or deductions to avoid triggering the AMT.
Tax laws are constantly changing, and being proactive about tax planning ensures that you don’t miss out on opportunities to reap the benefits of favorable tax law provisions – or utilize all the deductions and credits that you deserve.
Tax planning is not a process that can be done effectively at the last minute. An experienced certified public accountant will spend time with you throughout the year to identify the right strategies that maximize your savings and accomplish your long-term financial goals.
Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact in their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.