Reflections

Year-Round Tax Reduction Strategies

By Sean Condon, CFP®

Taxes are on investors’ minds earlier than usual this year, as the American Families Plan proposal makes many important changes to the current law.  If this bill becomes law, we will provide a more detailed analysis.  For the moment, key changes include an increase in the top tax bracket and an increase in capital gains rates on families making more than $450,000.

While current changes remain cloudy, there is always an opportunity to plan for taxes year long.  Waiting until next April can lead to tax mitigation triage, with investors looking for a way to throw a couple of thousand dollars somewhere at the last minute.  Examples below will discuss why year-round tax preparation is important, and what you can do to start right now even while we wait for any tax changes to become law.

The Real Tax Day

Bill got a new job in February in his chosen career.  During onboarding, he calculated what his income was going to be for the year, following the IRS guide carefully.

Bill performed his job excellently until September, and he was promoted to manager.  He also received a significant raise. Little did he realize that he had entered a new tax bracket.  Because he did not make any changes to his tax plan, Bill will have a hefty tax bill for the year.

Here is another example:  Sally earned the same as she did last year with no other notable changes to her income. Her investment portfolio, however, had a very strong year of dividends and capital gains.  This portfolio activity would drastically impact her tax strategy, unless she was wise and implemented a tax-loss harvesting strategy with any investments that did not perform well.

It is unwise to only evaluate your taxes at tax time because your tax situation is constantly open to change.  Too often taxpayers fall into the mindset that they pay taxes once a year.  The truth is that you pay taxes every single day; April is just when everyone checks for mistakes, either overpayments or underpayments throughout the year.

You need to evolve your strategy and increase or decrease your tax reduction tactics depending on the changes in your day-to-day life.  If your income goes up, so might your retirement savings.  If you lose your primary job and start a part-time side hustle, you may need to stop any withholdings until you get back on your feet.

Most comprehensive tax mitigation plans simply will not work unless you implement them throughout the whole year.  Here are a few that you can begin to implement now to keep the taxman at bay.

Winning at Taxes

One incredible tax reduction strategy for your current income year is a pre-tax retirement savings account.  401(k)s, 403(b)s, and simple IRAs are different examples of pre-tax plans. Designed to encourage retirement saving, they send your tax liability down the road into retirement.  This allows you to avoid paying taxes on the money you put into savings during this tax year and pay the taxes on your withdrawals during retirement instead.

Health Savings Accounts (HSA) are another good option to help lower the current year’s tax bills.  HSAs are savings plans designed to aid people with high-deductible health insurance.  If the contributions that you make are only spent on medical expenses, they will never be taxed. Just remember, to fully take advantage of the tax benefits of an HSA, you must make deposits from your paycheck, just like with a 401(k).

Charitable contributions are another great way to reduce your tax liability this year.  Donating to a qualified recipient reduces your income tax liability in the form of a deduction.  If you are going to have to pay an arm and a leg to the IRS, why not give to a cause you support instead?

It should be noted that winning at taxes does not always mean using pre-tax savings plans to defer your taxes down the road.  The idea of wealth management is to grow wealth, which is probably what you are planning to do.  If you only focus on saving tax money today, you might end up paying more in the future when you start to use the assets you have accumulated.

For example, suppose that you expect to make $150,000 per year as income during your working years.  However, if you expect an annual withdrawal of $300,000 from retirement, waiting to pay your taxes until later, might not make sense. In situations like these, it probably makes more sense to pay the taxes now but invest in post-tax savings like a Roth IRA.

Roth IRAs and Roth 401(k)s offer retirement savings where you pay your taxes now on your income but all the growth from your savings will be tax-free on withdrawal.  If you have multiple millions of dollars in growth at the time you begin taking money out for retirement, you will likely pay a lot less in taxes by going with a Roth.

Don’t Guess

Back in 2014, there were reportedly 2,652 pages of tax law and nearly 70,000 pages of supporting documents.  It is much longer now, though no one can seem to agree how long.  But even if you have managed to memorize every word of it, it would not advise you on which tax strategy is best for your unique, personal situation.

As the year draws to a close, now is a great time to review your current tax situation with your CPA and your advisor.  With some planning, it can be easy to recommend changes to your retirement or charitable contributions, tax-loss harvesting, stock options strategies, or even simple cash flow if you have a better idea of what taxes might be due in April.

You do not want to miss out on taking full advantage of all the tax reduction strategies available to you, so let’s start now.  You can reach us by calling (844) 377-4963 or emailing windgate@windgatewealth.com.  You can also book an appointment online here.

Perritt Capital Management, Inc. is the Registered Investment Advisor for Windgate Wealth Management accounts and does not provide tax advice. Consult your professional tax advisor for questions concerning your personal tax or financial situation and your insurance agent for insurance advice.

Data here is obtained from what are considered reliable sources; however, its accuracy, completeness, or reliability cannot be guaranteed.

First published October 2021.

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