The Importance and Need for Tax Planning

That does not mean you need to pay more in taxes than you must. Year after year, many Americans send more to the Internal Revenue Service than they need to.

Why does this happen? Lots of people do not grasp the need for and importance of tax planning for individuals. They make decisions that cost them more in taxes than they need to pay.

Paying less in taxes is often as simple as considering how you make a large purchase, donate to charity or make a contribution to a retirement savings plan and whether doing it now or doing it later will make a difference to your tax bill. Paying fewer taxes is often as simple as making a tweak here and there to your overall financial plan.

Enter the role of tax paying. In the end, paying the least in taxes for an individual or couple comes down to tax planning and implementing smart strategies for investors.

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What Is Tax Planning?

Tax planning is the practice of using effective strategies to delay or avoid taxes. When you sit down and make a tax plan with your tax planning advisor, you look at ways to defer or avoid taxes by taking advantage of provisions in the tax law that benefit taxpayers. You find ways to accumulate and speed up tax credits and tax deductions. Tax planning means taking advantage of every tax break available to you under the federal tax code.

Tax planning goes hand-in-hand with financial planning, which means making a plan to achieve your short- and long-term financial goals. It is hard to effectively financially plan for your current situation or your future without employing tax planning strategies to meet those goals.

If you enjoy financial success, taxes will be a large expense. Cutting down on those taxes or even eliminating them when possible is an important element of preserving your wealth.

The main purpose of tax planning is to make sure you approach taxes efficiently. Tax planning reduces your tax liability by employing effective strategies that explore ways that not only decrease taxes but secure a more solid future and retirement. It does not matter whether you make $50,000 a year or $500,000 a year. When you take the time to make a tax plan, you will find numerous ways to save money.

This year, especially, taxpayers should make sure to keep in mind the importance of tax management in tax planning. Government support provided during the COVID-19 pandemic may impact your taxable income significantly. From the CARES Act in 2020 to the American Rescue Plan Act of 2021, your taxes may look different during this time. As a result, it’s a good idea to know how these changes happened and what they mean for you.

Tax planning is the fastest way to keep up with these modifications and stay prepared for any further changes as the pandemic continues.

Difference Between Tax Planning and Tax Management

With tax planning, you and your advisor plan and file your tax returns with the main goal focusing on how best to file to reduce the amount of payable taxes. Tax management is when you’re maintaining your records and taxes. During the management phase, you’re focus is around tax rules and deadlines.

What Are the Main Areas of Concern in Tax Planning?

Tax planning means you and your tax planning advisor take an in-depth look at where you are most liable for taxes. Tax planning lets you decide how to approach each situation. You should consider five main areas of concern.

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1. Timing of Income

Most people believe you should make as much money as possible as soon as you can. There may be times, however, when it makes more sense from a tax planning perspective for you to reduce your income rather than increase it.

2. Timing of Purchases

The timing of making a large purchase can affect how much you pay in taxes. This depends on the time of the year you make the purchase and the state where you make the purchase. Tax planning with an advisor would help you decide the best time and way to make the purchase while paying the lowest amount in taxes.

3. Selection of Investments

Whether your investments involve stocks and bonds, precious minerals or real estate, there are specific tax rules that can provide you with ways to reduce your taxes — in particular, your capital gains taxes. When you sell stocks or real estate without thinking about how it will affect you from a tax perspective, you are often throwing away money.

4. Charitable Donations

When and how you donate to a charity also affects what you pay in taxes. Working with a tax planning consultant, you can develop a plan that not only helps charities but also helps you from a tax perspective.

5. Retirement Plans

Selecting the right retirement plan and deciding how much money you wish to contribute toward that plan every year requires thoughtful consideration. Do you want to do a traditional 401(k) where you defer your taxes for the moment but pay them when you take out your money later, or do you want to put your retirement contributions into a Roth IRA and pay taxes on them now so you will not have to pay when you withdraw funds later in your life?

Retirement savings plans are one of the best ways to pare down your tax burden every year, and working with your financial consultant will help you determine which plan is best for you now.

Why Should I Tax Plan?

The main reason to tax plan is to ultimately have more money that you can either invest in new projects, save or even spend. Or do all three. The choice is yours.

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There are more good reasons why tax planning is necessary, as well.

1. Strategic Tax Planning and Tax Management Can Lower Your Taxes

In the end, tax planning is all about reducing your tax bill. Keep in mind that tax planning:

• Is especially important if you own a business or if you are self-employed.
• Makes sense if your investments have hefty unrealized losses or gains.
• Is useful when you experience a major event in your life, such as getting married or divorced, having a baby, buying a home or retiring.
• Is helpful if you move to a new job or sustain a significant change in your income, either up or down.
• Can help you save money if you are sending one of your children to college for the first time.

2. Tax Planning Gives You Time to Strategize and Get the Most Out of Your Benefits

Too often, people wait until the very last second to try to use a tax benefit. While this works on occasion, effective tax planning requires that you allow for time to study the situation and make the appropriate decisions. Smart tax planning happens all year long, not on the last day of the year or the day before your taxes are due.

3. Tax Planning Lets You Take Advantage of Changes the IRS Makes

Tax laws are always a little different every year. Often, there are only minor changes, but after 2017, tax laws looked significantly different. Tax planning allows you to ready for these changes, whether minor or major, and make decisions about how you wish to deal with them and how they will affect your taxes.

The COVID-19 pandemic brought with it government financial support in the form of stimulus checks and tax breaks to those most affected, so the need for tax planning is greater than ever. The Consolidated Appropriations Act that went into effect at the end of 2020 will ensure that the economic protections provided during 2020 will be honored again for the 2021 tax season. This Act offers extensions and expansions on tax relief provisions added to aid taxpayers through the duration of the pandemic.

Ensuring you understand year-to-year tax law changes can help you save money while also making informed decisions that can benefit you in the long run.

4. Tax Planning Helps You Avoid Deadline Dread

Regardless of changes the government makes to tax laws, decisions about how you want to deal with these changes and with your taxes every year have a firm deadline of midnight on April 15. Tax planning at the appropriate time means you are well prepared to deal with any contingency and in no danger of suffering deadline dread. A tax planning consultant ensures you are ready.

What Are Strategic Income Tax Planning Strategies for Individuals?

When you work with a tax or wealth advisor, you can develop strategies to reduce your tax bill, save money and plan for your future. These customized strategies are one of the many advantages of tax planning with a professional. Here are several tax strategies you might want to consider that reflect the importance of taxes for personal finance planning.

1. Make the Most of Tax-Efficient Accounts

In most cases, this means taking advantage of retirement savings plans. Depending on which type of plan you choose, you can reduce your current tax bill or your future tax bill.

Whether you choose a traditional IRA, 401(k), a Roth IRA, or a Roth 401(k) they are all subject to limits on how much you can contribute. The amount is quite different between all four, and so it is smart to talk to a tax consultant about what might be the best plan for you.

Traditional 401(k)s and IRAs are the best idea when you want to defer taxes until later. Roth 401(k)s and IRAs are the best choices when you want an investment that offers you tax-free potential growth.

It’s also good to know that, through the 2020 and 2021 tax years, the government has made accommodations that relate to contributing to and withdrawing from these types of accounts. If the pandemic has necessitated that you change how you contribute to your retirement funds, make sure you understand the rules on withdrawing and how you’ll need to make up for it in the following years.

2. Mix And Match Your Accounts

When you split your contributions among various types of accounts, whether they are retirement savings plans or brokerage accounts, you give yourself space to determine what your future taxes will be and how to deal with them. This is only possible if you take the time now to create different accounts that allow you to diversify your taxes.

3. Reduce Your Taxable Income

Reducing your income does not mean you want to make less money every year. It does mean you take a look at strategies that could decrease your Adjusted Gross Income (AGI) by using effective tax strategies. This includes:

• Putting contributions into retirement savings plans.
• Making donations to charity.
• Using investment losses to reduce your income.

4. Implement Personal Income Tax Planning Strategies for Investors

Everyone wants to invest wisely, of course, but there are specific investments that provide generous tax benefits. For instance, you do not pay federal taxes on municipal bonds, and that is often true of state and local taxes as well. Managers of taxed-manage mutual funds work hard to ensure they are tax-efficient. There are many other types of similar investments you can make, so it is important to talk to your tax advisor to understand what the tax benefits may be connected to different kinds of investments.

5. Connect Your Investments With the Right Type of Account

It does not make much sense to have tax-efficient investments if you are not putting them in the right place. You want to make sure your investments work with accounts that offer the best tax treatment. For instance, if you have investments like taxable bonds or stock funds that generate income, it is smarter to hold them in a tax-deferred account like a traditional IRA. This will give you the greatest potential benefits.

6. Hold Onto Your Investments to Avoid Higher Capital Gains Taxes

Normally, it does not make sense to keep a stock that you want to sell only because you want to avoid taxes. Sometimes, however, you do want to hold off on selling an investment. For instance, if you sell stocks that you held for less than a year, they will be taxed at your ordinary income rate.

If you wait longer than a year to sell stocks, they are taxed with a long-term capital gains rate. In many cases, a long-term capital gain rate will be significantly less than your regular income tax rate. Before you decide to sell a stock, check with your tax advisor about tax implications.

7. Employ Your Losses to Offset Your Gains

If you have any investment losses, use them to offset your gains on investments. Tax gain-loss harvesting can minimize your tax liability. If you lose more on your investments than you gain, you can then use those losses to offset as much as $3,000 of earned income in a single year. So if you make $50,000 a year, but you lost $3,000 in investments, your taxable income would only be $47,000. You can also carry additional losses forward.

Should I Hire a Tax Planning Consultant?

Hiring a tax planning consultant is almost always a good idea. If you have trouble understanding your taxes or why tax planning is necessary, finding a consultant should be one of your top priorities. Carefully analyzing your taxes in advance enables you to save money. Using a tax planner is usually the best way to get the most out of your tax plan.

Working with a tax planner and using tax planning services protects your investments and gains. The right consultant will know the need and importance of tax planning and help you understand it, too. The benefits of tax planning mean that you achieve tax efficiency by better understanding investment decisions. A tax planning advisor/financial consultant can help you understand how each investment contributes toward financial goals such as:

• Liquidity
• Diversification
• Future funds

And you figure out your comfort level with each option.

A tax planning consultant can tell you how each of these investment decisions will affect your overall tax situation. Their goal is to lower your tax liability, so you not only pay fewer taxes but also have more money on a yearly basis to save, spend or invest.

HSC Wealth Advisors Can Develop an Effective Tax Plan

HSC Wealth Advisors is a fee-only wealth management firm. We do not accept commissions or compensation from any other sources. Our only compensation comes from our clients. We are affiliated with the National Association of Personal Financial Advisors (NAPFA) and Registered Investment Advisor (RIA).

Because of this, our clients are our number one priority, and we are always on your side, whether it is developing estate and tax planning strategies or advising you on investment decisions. We never sell products that pay commissions to our financial advisors. We use no-load, no-transaction-fee mutual funds and ETFs.

Many people find it easier to take their taxes and tax planning methods to others rather than do it themselves. As times evolve and taxes become even less straightforward, the need and importance of tax planning with the help of an outside source grows.

We understand the need for good tax planning, which is why our CERTIFIED FINANCIAL PLANNERS™ work hard to ensure you develop the most tax-efficient plan possible. You can call us today at 434-316-9356 or visit our contact us page, where you can leave us information about how to get in touch with you as well as tell us how we can help you, including what role you’d like us to play in your tax planning. A member of our team will get back to you as soon as possible.

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