John J. Diak, CFP®
The Benefits of Early Tax Planning
When it comes to taxes, the more carefully you plan, the better position you will be in when tax day comes. The IRS doesn’t make it easy to minimize your taxes, so protecting your own interests requires diligence throughout the year. When you don’t prioritize tax planning, you can cost yourself a considerable amount of money in missed opportunities and mistakes.
In turn, the lost money can affect your savings, retirement funds, and household cash resources. Paying a few thousand dollars in extra taxes or penalties now can mean losing thousands of dollars throughout your accumulation years. That money would never be invested to compound interest over time and paying too much during retirement can have an even greater immediate impact on your cash flow.
Here’s how to start tax planning now.
Cover the Basics
You can’t start your tax planning without knowing the basics: deadlines, tax bracket and rate, deductions, and credits.
Tax season is cyclical, and the IRS establishes a set of deadlines each year. While the dates vary slightly, they typically fall at around the same time every season. Familiarize yourself with the timeline and mark your calendar for next season at the same time each year. When can you expect your W2 or 1099s? When are quarterly taxes due if you’re self-employed? What are the deadlines for contributions and deductions? When does your tax preparer require you to have your paperwork submitted? If you anticipate needing to file an extension, give yourself plenty of time to do so. The failure to file a penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late.
Some of the important numbers you need to know change every so often, too, so you’ll need to check the standard deductions, tax bracket, the tax rate that applies to you, and retirement plan, FSA, and HSA contribution limits.
Knowing your marginal income tax rates and where you fall in the bracket is the baseline for how you will determine what you owe. If it changed from last year, you’ll need to update your planning. Knowing your standard deduction will help you determine whether you should itemize or not. Knowing your contribution limits will help determine if maxing out is an option.
Check to see if any new or existing tax credits apply to you. This could depend on legislation passed during the previous year. For example, changes to the Child Tax Credit or education credits could significantly lower your tax bill or lead to a refund.
The tax rulings and deadlines are not set in stone. Make an effort to stay abreast of changes so you can effectively plan. Gather the appropriate documents with plenty of time to spare, keep impeccable records throughout the year, and set yourself up for as much ease as possible.
Audit Your Finances
Your finances are always in flux and require regular review. The most beneficial tax strategies last year might not apply this year, or you may be able to begin using a new strategy now that wouldn’t have been helpful in the past.
Did you get a pay increase or bonus at work or add a stream of income? Are you in a different tax bracket now? Did you purchase a home or pay off your mortgage? Do you have upcoming medical expenses to consider? Did you return to school, or do you have a child in college now? Did you turn 50?
Any of these factors and more could have a consequential impact on your taxes. It could be time to incorporate a different approach. Whereas taking a standard deduction may have worked well for you up to this point, it might be time to begin itemizing. Maybe this is the year to begin maxing out your retirement plan contributions, make catch-up contributions, or fully fund your flexible spending account (FSA). Or maybe you adjust your withholding on your paycheck so that you won’t receive a refund at the end of the year and save more cash upfront.
Effective tax planning requires reassessing your needs each year and throughout the year while also thinking longer-term for the future. This might mean recognizing the value of taking some last-minute deductions, putting off deductions for the following year, or using more sophisticated strategies such as spreading gift deductions over a period of five years.
Work with a Professional
Part of your job as a responsible taxpayer and financially savvy investor is ensuring you’re familiar with the basics of tax planning. You should be acquainted with tax brackets, rates, how deductions and credits work, and keep an eye on major changes. Regardless of your situation, we encourage you to work with a tax professional to be sure you take advantage of all available methods to cut your tax bill.
Your tax professional can help you determine your standard deduction amount so you can decide whether or not to itemize and plan accordingly. If you are going to itemize, it makes sense to factor this into your spending activity throughout the year.
Your financial advisor and accounting professionals can work together to help you determine how to best use tax-advantaged investing in reducing your tax liability. Planning your contributions to deferred-tax retirement accounts, such as a 401(k) or IRA isn’t always straightforward, so your advisor can offer guidance to optimize your tax savings each year and over time.
It might be to your advantage to set up a trust, increase your charitable giving, or incorporate advanced tax-saving strategies into your plan. A significant bump in income or an inheritance, for example, can change the way you need to approach your taxes abruptly.
It’s especially critical that you consult financial professionals if you have more complex circumstances than a typical taxpayer. For example, if you are a small business owner, real estate investor, or looking to protect generational wealth, you should look for professionals with specific expertise in these areas.
Avoid Tax Scams
Unfortunately, tax-related scams are rampant, so it’s important to be on the lookout for them as you are planning. The criminals involved in tax scams are targeting a large pool of potential victims — all taxpayers — but they are particularly adept at reaching people who are anxious about doing the right thing, such as recent widows or divorcees or the elderly, and those who have more money or assets at play.
Tax scammers are growing increasingly sophisticated in their methods, often using highly-convincing online ads or email solicitations. Common ruses include the misapplication of laws or rules that may appear legitimate but leave the taxpayer holding the bag after the fact while the scammer made off with a fee. Other examples include solicitations for foreign investments painted as tax shelters that turn out to be extremely high-risk or outright fraud. And another common ploy is for scammers to convince property owners to sell and avoid capital gains by receiving proceeds through installment plans that go unpaid.
A good rule of thumb is that if it seems too good to be true, it probably is. Always make sure you have a trusted financial professional review the purported tax savings or investment opportunity. While the IRS is aware of some of these scams and you may find recourse, taxpayers should always be wary.
Starting early with your tax planning rather than scrambling at the last minute can help you worry less and increase your ability to optimize your tax savings. If your taxes are generally straightforward, make sure you have your basics covered and reassess your needs regularly. If you have more complex taxes, seek professional guidance as soon as possible and avoid so-called “creative” tax strategies that could backfire on you.
John J. Diak, CFP® is the Principal & Client Wealth Manager at Oatley & Diak, LLC in Parker, Colorado. He assists clients through many difficult lifestyle changes such as business downturns, retirement planning, divorce, the death of a spouse, and family estate issues among others. Oatley & Diak, LLC is a family-run registered investment advisory (RIA) firm that provides clients with investment management and financial planning services in a hands-on, intimate environment. Learn more about them at oatleydiak.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This material was prepared by Crystal Marketing Solutions, LLC, and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate and is intended merely for educational purposes, not as advice.