While you may focus on filing your taxes once a year, there are steps every investor can (and should) be taking year-round to reduce their future tax liability. Even a few hundred dollars saved each year from taxes can fund other vital endeavors—saving for retirement, padding your emergency fund, paying down debt, and more.
Here are our top seven tips for lowering your tax bill next year and beyond.
Tip #1: Review Your Income and Expenses Regularly
An easy first step to kicking off your year-round tax planning is to keep a close eye on your income and expenses throughout the year—which you may already be doing if you follow a budget. Moving forward, however, you may want to watch for potential deductions, credits, and opportunities to take advantage of tax-saving investments.
If you incur significant medical expenses, you may be eligible to deduct those from your adjusted gross income when filing your return. In general, hanging on to your receipts can help you figure out later whether there are opportunities to deduct or claim certain expenses, especially if you’re self-employed.
Tip #2: Contribute to Tax-Advantaged Accounts
Tax-advantaged savings accounts are a core component of many investors’ financial plans, as they help you prepare for the future while enjoying some notable tax savings.
If you work for a large company, you likely have access to a 401(k) or 403(b) account. The contributions you make throughout the year to these accounts are tax-deductible, and they will grow tax-deferred. Only when you take withdrawals in retirement will you be required to pay taxes on your contributions and any earnings. The same goes for a traditional IRA.
On the other hand, contributions to a Roth 401(k) or IRA won’t decrease your taxable income now, but they will enable you to enjoy tax-free withdrawals in retirement.
Paradigm can help you develop a more tailored plan regarding your retirement account contributions. There may be periods when your taxable income is lower than usual, in which case you may want to convert funds from a traditional 401(k) or IRA into a Roth account and pay the tax liability now (as opposed to waiting until retirement). A key to long-term tax planning is to consider not just your tax liability this year but over your lifetime as well.
Tip #3: Time Income and Expenses Strategically
If you’re self-employed or a business owner, you may be able to strategically time your income and expenses to optimize your tax liability. For example, if you can defer income until the following year or accelerate certain deductible expenses, you can gain more control over your AGI (Adjusted Gross Income) and tax bracket.
A tax professional can help you understand your options for timing income and expenses.
Tip #4: Know How Your Investments Are Taxed
We mentioned earlier some tax-advantaged accounts, like a 401(k) or IRA. You’ll also want to keep track of the potential tax treatment of other investment types—capital gains, dividends, interest, vested stock options from your employer, etc.
For example, when you sell a stock that has appreciated, you may be required to pay capital gains tax on the profit. If you held onto the asset for less than a year, you may be subject to short-term capital gains tax (typically taxed at your standard tax rate between 0% and 37%). If you hold onto the asset for over a year, the gain may be subject to long-term capital gains tax instead. Long-term capital gains tax is typically less than short-term, ranging from 0% to 20%, depending on your other taxable income.
Understanding the potential tax implications of your investments can help you make more informed decisions about buying, selling, and withholding enough from your paycheck to cover the additional tax liability.
Tip #5: Give Charitably
If you’re interested in incorporating philanthropy into your financial plan, Paradigm can review with you possible tax-effective ways to give charitably to your favorite organizations.
Generally speaking, charitable donations are only tax-deductible if you itemize your deductions. For this reason, some people choose to “lump” their charitable contributions from multiple years together into one year, so their charitable deduction exceeds the standard deduction amount. Establishing a donor-advised fund, for example, can help you effectively execute this strategy.
You can also donate appreciated assets (stocks, bonds, real estate, etc.) instead of giving cash. It’s possible to avoid capital gains tax or other associated tax liabilities by doing so.
Tip #6: Take Advantage of Tax-Loss Harvesting
Tax-loss harvesting is a common tax-saving strategy for investors, especially as the end of the year approaches. The IRS allows you to offset the gains of one investment with the losses from another. Some specific stipulations and conditions usually need to be met to reduce your tax liability, based on your unique situation. The good news is that tax-loss harvesting can be used with any tradable security, making it a suitable option for many investors.
Tip #7: Develop a Team
One of the most critical components of year-round tax planning is working with a professional team to take proactive and practical steps. Our team at Paradigm and your accountant can help you develop and implement personalized tax planning strategies that align with your long-term goals and needs today. Your team is always looking for changing tax laws so we can address their potential impacts on your financial picture as needed.
By implementing these tips, you can incorporate some simple tax-saving strategies into your financial life to help minimize your current and lifelong tax liability. If you’d like to learn more about the tips shared above, don’t hesitate to reach out to our team today.