Tax planning is crucial for both individuals and businesses. By understanding and implementing effective strategies, you can reduce your tax liability and keep more of your hard-earned money. Here’s a comprehensive guide to help you navigate the world of tax planning.

Understanding Tax Planning

Tax planning involves analyzing your financial situation to ensure that all elements work together to allow you to pay the lowest possible taxes. It’s an essential part of financial planning, aiming to reduce tax liability and maximize contributions to retirement plans.

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Key Components of Tax Planning

Effective tax planning involves several key components, each designed to minimize your tax liability and maximize your financial benefits. Here’s a closer look at the five pillars of tax planning: Deducting, Deferring, Dividing, Disguising, and Dodging.

1. Deducting

Maximizing your deductions is one of the most straightforward ways to reduce your taxable income. Here’s how:

• Standard Deduction vs. Itemized Deductions: You can either take the standard deduction or itemize your deductions. The standard deduction is a fixed amount set by the IRS. For 2023, it’s $13,850 for single filers and $27,700 for married couples filing jointly. Itemized deductions include specific expenses such as state and local taxes, mortgage interest, charitable contributions, and medical expenses exceeding 7.5% of your AGI. If your itemized deductions exceed the standard deduction, you should itemize.

• Tax Credits: Unlike deductions, tax credits directly reduce your tax bill. Common tax credits include the Earned Income Tax Credit (EITC), child tax credits, and education credits like the American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit (LLC).

• Lifestyle and Spending Habits: Certain tax credits and deductions are available based on your lifestyle and spending habits. For example, you may qualify for credits related to education expenses, energy-efficient home improvements, or adoption costs.

2. Deferring

Deferring involves delaying income recognition and the payment of taxes to future years. This strategy leverages the time value of money:

• Timing Income and Expenses: By strategically timing when you receive income and when you pay expenses, you can defer taxes to a future date when your tax rate may be lower. For example, if you expect to be in a lower tax bracket next year, you might delay receiving a bonus until January.

• Tax-Deferred Accounts: Retirement accounts like 401(k)s and traditional IRAs allow you to defer taxes on contributions and earnings until you withdraw the funds in retirement. This not only reduces your current taxable income but also allows your investments to grow tax-deferred.

3. Dividing

Dividing, also known as income splitting, involves shifting income to family members in lower tax brackets to reduce the overall family tax burden:

• Income Splitting: By transferring income-producing assets to family members in lower tax brackets, you can reduce the overall taxes paid by your family. For example, transferring shares to a child or spouse who has a lower income can result in the income being taxed at a lower rate.

• Gifts and Trusts: Using gifts or setting up trusts can facilitate income splitting. However, be mindful of gift tax rules and the potential complexities of trust arrangements.

4. Disguising

Disguising involves converting income from one form to another to take advantage of lower tax rates:

• Capital Gains vs. Ordinary Income: Ordinary income is taxed at higher rates than long-term capital gains. By converting ordinary income to capital gains, you can reduce your tax rate. For example, holding investments for more than a year before selling can qualify you for the lower long-term capital gains tax rate.

• Dividends and Interest: Certain types of income, such as qualified dividends, are taxed at a lower rate than ordinary income. Structuring your investments to receive more income in the form of qualified dividends can reduce your tax liability.

5. Dodging

Dodging, in the context of tax planning, refers to legally arranging your finances to minimize taxes without engaging in tax evasion:

• Tax Avoidance vs. Tax Evasion: Tax avoidance involves using legal methods to reduce your tax bill, such as claiming deductions and credits, timing income and expenses, and structuring investments tax-efficiently. Tax evasion, on the other hand, is illegal and involves hiding income or falsifying information to avoid paying taxes.

• Tax-Advantaged Investments: Utilizing investments that offer tax benefits, such as municipal bonds (which are often exempt from federal taxes) or real estate investments that allow for depreciation deductions, can help you legally minimize your tax liability.

Tax Planning Strategies for Individuals

Maximize Deductions: Utilize all available deductions and credits. Standard deductions are set amounts, while itemized deductions are specific expenses that may exceed the standard deduction.

• Standard Deduction: For 2023, it’s $13,850 for single filers and $27,700 for married couples filing jointly.

• Itemized Deductions: Include expenses like state and local taxes, mortgage interest, charitable contributions, and medical expenses that exceed 7.5% of your AGI.

• Utilize Tax Credits: Unlike deductions, tax credits reduce the amount you owe directly. Key tax credits include those for children, education, and energy efficiency.

• Child-Related Credits: Adoption credit, child tax credit, and dependent care credit.

• Education Credits: American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit (LLC).

• Other Credits: Earned Income Tax Credit (EITC) and credits for energy-efficient home improvements.

• Invest in Tax-Advantaged Accounts: Retirement accounts like 401(k)s, traditional IRAs, and Roth IRAs offer significant tax benefits. Contributions to 401(k)s and traditional IRAs are tax-deferred, while Roth IRAs provide tax-free withdrawals in retirement.

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Tax Planning Strategies for Businesses

Qualified Business Income (QBI) Deduction: Owners of pass-through businesses can deduct up to 20% of their business income. This can significantly lower your tax bill.

• Timing of Income and Expenses: Use the cash method of accounting to manage when you recognize income and expenses. This flexibility can help you stay in a lower tax bracket.

• Capital Gains and Losses: Defer capital gains taxes by reinvesting in Qualified Opportunity Funds or through like-kind exchanges of real property.

• Retirement Contributions: Set up or contribute to retirement plans like SEP, SIMPLE IRA, or 401(k). Small businesses may qualify for tax credits for setting up these plans.

Tax Planning Strategies for Investors

• Diversify Your Portfolio: Spread your investments across various types to reduce risk and take advantage of different tax treatments.

• Harvest Investment Losses: Sell underperforming investments at a loss to offset capital gains. This strategy can reduce your taxable income.

Tax Planning vs. Tax Gain-Loss Harvesting

Tax gain-loss harvesting is a valuable tax management strategy related to investments. It helps by using a portfolio's losses to offset overall capital gains. According to the IRS, short and long-term capital losses must first offset capital gains of the same type.

• Offsetting Gains: Long-term losses offset long-term gains before short-term gains. Short-term capital gains, from assets held less than one year, are taxed at ordinary income rates.

2023 Long-Term Capital Gain Limits:

• 0% for single filers with income up to $44,625 ($89,250 for joint returns, $59,750 for heads of household, $44,625 for married filing separately)

• 15% for single filers with income between $44,626 and $492,300 ($553,850 for joint returns, $523,050 for heads of household, $276,900 for married filing separately)

• 20% for incomes higher than the 15% threshold

2024 Long-Term Capital Gain Limits:

• 0% for single filers with income up to $47,025 ($94,050 for joint returns, $63,000 for heads of household, $47,025 for married filing separately)

• 15% for single filers with income between $47,026 and $518,900 ($583,750 for joint returns, $551,350 for heads of household, $291,850 for married filing separately)

• 20% for incomes higher than the 15% threshold

Using Losses to Offset Gains: If you have capital gains, selling underperforming investments at a loss can help offset those gains. For instance, if you have $10,000 in capital gains and $10,000 in capital losses, the losses offset the gains, potentially reducing your tax liability to zero. However, be aware of wash sale rules, which require you to wait at least 30 days before repurchasing the same investment to avoid the loss being disallowed.

Excess Losses: The IRS allows you to use up to $3,000 of capital losses ($1,500 if married filing separately) to offset other income. Any remaining losses can be carried over to future years to offset future gains.

How a CERTIFIED FINANCIAL PLANNER™ Can Help with Tax Planning

A CERTIFIED FINANCIAL PLANNER™ (CFP®) can be an invaluable asset in your tax planning efforts. Here’s how they can help:

Expertise and Knowledge

CFPs® have extensive training and knowledge in financial planning, including tax laws and strategies. They stay updated on the latest tax regulations and can provide expert advice tailored to your specific financial situation.

Comprehensive Financial Analysis

A CFP® will conduct a thorough analysis of your financial situation, considering your income, expenses, investments, and long-term goals. This holistic view allows them to identify the best tax planning strategies for you.

Customized Tax Strategies

CFPs® develop personalized tax strategies to maximize your deductions and credits, defer income, and optimize your tax-advantaged accounts. They consider your unique circumstances, such as your career stage, family situation, and retirement plans.

Investment Management

CFPs® can help you manage your investments in a tax-efficient manner. They can advise on tax-loss harvesting, selecting tax-efficient investments, and timing your transactions to minimize taxes.

Retirement Planning

A CFP® can guide you in setting up and contributing to retirement accounts like 401(k)s, traditional IRAs, and Roth IRAs. They ensure you take full advantage of the tax benefits these accounts offer.

Estate Planning

CFPs® assist with estate planning to minimize estate taxes and ensure your assets are distributed according to your wishes. They can help set up trusts and other tools to manage your estate tax efficiently.

Ongoing Support

Tax planning is not a one-time task. A CFP® provides ongoing support, regularly reviewing and adjusting your tax strategies to adapt to changes in tax laws and your financial situation.

By working with a CERTIFIED FINANCIAL PLANNER™, you can effectively reduce your tax liability and preserve more of your income, helping you achieve your financial goals.

Bottom Line

Effective tax planning is vital for reducing your tax liability and maximizing your savings. By understanding and applying these strategies, you can take control of your financial future. Always consult a tax professional to tailor these strategies to your specific situation.

Ready to maximize your tax savings? Consult with a tax professional today to develop a personalized tax plan that aligns with your financial goals. Visit ONE Advisory Partners and start your journey to smarter tax planning and financial success.

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Reference

Time. Tax Planning: What It Is, How It Works, and Best Strategies

Internal Revenue Service. 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000

Internal Revenue Service. Administrative, Procedural, and Miscellaneous

Investopedia. Tax Planning: What It Is, How It Works, Examples