All planning involves looking ahead to reach a specific goal. People are inclined to make careful plans when they consider making a home purchase, accepting a new job, taking a dream vacation, or investing for retirement. But when it comes to taxes, they often leave matters to chance, perhaps not realizing the tax savings that can result. THE GOAL OF TAX PLANNING IS TO SAVE YOU MONEY!
Every taxpayer has the right AND the responsibility to lower his/her tax bill using a number of different legal methods. Tax planning is the tool that helps you evaluate your financial situation in light of current laws to make sure that you get the benefit of all deductions you’re entitled to.
Your Tax Planning Barometer
Consider tax planning BEFORE making a decision about any of the following:
- Borrowing money for any purpose
- Paying off a loan
- Contributing to or taking funds from any type of retirement plan
- Buying or selling any kind of property (vacation home, rental property, other real estate, stocks and bonds, partnership interest, vehicles, personal residence, a business or business assets, tax shelter, etc.)
- Getting married
- Negotiating a divorce agreement
- Making investments where your participation will be minimal
- Making a large gift to your child or other relative
- Changing the form of your business to a partnership or corporation
- Incurring business expenses as an employee
- Holding an uncollectible note
When is the Best Time to Start?
To gain the most benefit from your tax planning, you need to make it a consideration all year long. However, many taxpayers find that fall is the best planning season. By then, law changes and new tax rates are usually known, and there’s still enough time to make adjustments before year’s end. You should strongly consider tax planning if your income, deductions, income tax withholding, or estimated tax payments are significantly more or less than last year.
Planning Strategy – A Matter of Timing
Planning strategy is often built on two basic timing precepts:
- Rule 1 – Generally, payment of tax owed on income transactions should be postponed as long as possible provided no penalty is incurred or there is not a pending law change that would adversely affect you.
When you postpone the payment of tax on a transaction (e.g., an installment sale), it’s almost like getting an interest-free loan from the government. You have the use of the money until the postponed tax must be paid.
However, sale transactions can also produce hidden dangers from tax underpayment penalties. You will want to plan ahead carefully when you have a sale to be sure that you are covered as far as any penalty is concerned. Your tax advisor will be able to make the best suggestion.
- Rule 2 – Year-to-year tax bracket changes should be considered when making decisions to pay deductible expenses or receive taxable income. Law change or fluctuations in your income and expenses may shift you to different tax brackets from year to year. As a general rule, it’s best to receive income in years your tax rates are low, and pay expenses when they are high.
What are the Benefits of Tax Planning?
- By planning ahead, you can adjust withholding and estimated tax payments to help eliminate or reduce tax penalties. Making adjustments may also help you postpone payment of tax (you’ll be taking advantage of Rule 1) or let you shift some income or deductions to different tax years to at least lower your taxes (in other words, you’ll be making use of Rule 2).
- If you have a casualty loss (e.g., a loss due to fire, theft, or natural disaster), shifting income from one year to another may allow you a greater loss deduction. In some cases, you can even choose in which year to claim the loss.
- Tax planning helps you evaluate whether a deduction will really benefit you. Many taxpayers like to make their last state estimated tax payment in December so they can get a federal deduction for it in the current year. This strategy is often a good one, but under certain circumstances, you gain nothing tax-wise. Planning can help you tell for sure!
- Buying and selling property create all kinds of tax planning opportunities. For example, if you expect to sell real property at a gain in the near future, your planning should question the timing of the sale closing AND whether it’s best to report your gain all at once or over several tax years (i.e., an installment sale). Another tax break available for property dispositions is the so-called tax-deferred exchange. If you intend to buy another property similar to the one you sold, your plans should consider how an exchange could work for you.
- Retirement decisions can cost a lot in extra tax dollars if you don’t take the time to develop a sound tax plan. BEGIN THE PLANNING WELL BEFORE YOU’RE SCHEDULED TO RETIRE TO MAKE SURE YOU COVER ALL THE OPTIONS. For example, say you’re an employee and your employer offers you a choice between getting your pension as an annuity or as a lump-sum payout.
Your planning needs to include crunching numbers to determine the best way to go. You might be eligible for certain special averaging calculations that apply to pensions and can save a lot on taxes! Or perhaps a rollover to an IRA needs to come into the picture. Planning will help you find the best answer!
- The tax law provides special breaks for home sale gains, and planning can help make sure you qualify for them. Homeowners may exclude all (or a part) of a gain on a home if they meet certain occupancy and holding period requirements. Be sure to check before finalizing a sale to make sure you meet the necessary qualifications.
- Borrowing funds creates interesting tax planning opportunities. The interest on many loans is deductible. Right? NOT ALWAYS! Ensure you are able to deduct the interest, and do your planning homework before you sign on the dotted line!
- Tax planning is a must when there are property settlements due to divorce situations. Because of the manner in which the tax law handles transfers of property between spouses, what appears to be a fair split on the surface can turn into just the opposite in the long run.
- When it’s time to purchase business equipment, plan first. The tax law contains complicated rules about computing depreciation on business property purchased in the last quarter of the year. Timing of your purchases could be vital to ensure that you get the most from your expenditures.
If you need assistance with your tax planning needs, please give this office a call.