Back to Basics: Tax Planning

Tax Planning

Back to Basics: Tax Planning

“In this world nothing can be said to be certain, except death and taxes.”
— Benjamin Franklin

With Independence Day upon us, we often think of Franklin and his fellow Declaration of Independence signers. And, while it did just that — declared America independent from Great Britain and free from its “taxation without representation” — taxes definitely didn’t go away. In fact, although our forefathers established the U.S. to avoid high British taxation, federal taxes are still an integral part of running these United States of America today. That said, as a citizen, a little tax planning can go a long way. 

I’ll get to that in a bit but, to quote another great American, Maya Angelou, “If you don’t know where you’ve come from, you don’t know where you’re going.” Let’s travel back in time and look at the history of taxation in our country.

Abridged U.S. tax timeline

  • In 1797, an estate and death tax was the first to exist via the Stamp Act, although it only lasted five years.
  • Abraham Lincoln signed the first individual income taxes in the U.S. into law in 1861 to finance Civil War efforts. Congress repealed it 10 years later.
  • 1862 marked the year Congress implemented excise taxes via the Internal Revenue Act, which began an estate and gift tax system. Like the original income tax law, it only lasted 10 years.
  • In 1894, Congress passed the Wilson Tariff Act and created a flat-rate income tax. Congress repealed it a year later.
  • The War Revenue Act of 1898 created a death tax to fund the Spanish-American War.
  • In 1909, Congress implemented corporate taxes. In the same year, it also passed the Sixteenth Amendment. The states ratified it in 1913 and individual income taxation began.
  • The Internal Revenue Service released the first income tax form in 1914 with a familiar name: Form 1040.
  • The start of tax bracket adjustments came into play with the Revenue Act of 1916 and, along with it, Congress brought the modern estate tax into law.
  • The Revenue Act of 1918 increased income taxes for the Great War effort.
  • Gift tax became part of the taxation landscape in 1924.
  • Social Security taxes came about later, in 1937.
  • In 1942, the Revenue Act increased estate and income taxes.
  • Employer withholding was enforced via the Current Tax Payment Act starting in 1943.
  • In 1944, the Individual Income Tax Act brought standard deductions into the taxation picture.

Since the middle of the last century, taxes have been the major source of funding for the U.S. government. 

Why is tax planning important?

Since the majority of U.S. citizens can’t escape taxes — and haven’t been able to historically — it’s important to plan. But what does tax planning do, exactly? It’s all about reducing or even eliminating taxes.

Basic tax planning begins with the goal of paying as little as legally possible while getting to either side of $1,000 on your tax return. Sure, a refund can be nice. But by overpaying income taxes throughout the year, you’re giving Uncle Sam an interest-free loan that the IRS repays to you via a tax refund. On the flip side, tax planning can help you avoid the shock of a large bill by ensuring you’re paying enough throughout the year. The latter can also help you avoid penalties for underpayment.

Overall, a little tax planning can help you keep more money from each of your paychecks in your hands — and your pockets. It can also give you a better idea of your financial picture and enhance your ability to plan for your financial future. 

How-to

For the upcoming tax year

When it comes to tax planning for the near future, the overarching theme is to analyze what you think will happen by starting with what you already know. There’s no sense in reinventing the wheel, so always use your prior year return to give yourself a head start, and add or subtract what is likely to change. The best place to begin is by considering any changes to your tax situation this year. Why? Those changes can not only shift your tax responsibility but also your filing status. 

  • Have you had a significant change in income this year? Whether it was a big bonus, large raise, or even transition into retirement, you may be looking at a much larger or smaller taxable income.
  • Has your family situation changed? Marriage, divorce, and reaching a certain age can all impact available standard deductions. For the 2019 tax year, individual taxpayers with single filing status can take a $12,200 standard deduction. Those married but filing separately can take the same standard deduction. For heads of households, the standard deduction is $18,350. And those who are married filing jointly can deduct $24,400. The additional standard deduction for those aged 65 and better is $1,300 for 2019.
  • Of course, if you itemize — or you think you will itemize — deductions, make adjustments to and considerations for those amounts accordingly.
  • After considering deductions, look into possible adjustments to your income. Adjustments include those for student loan interest paid or for your traditional IRA contribution.
  • Then take credits into account. Many are available, like the child tax credit for those with dependents age 16 and younger as well as child and dependent care credits for kids. Others include earned income credit for individuals in lower tax brackets and education credits if you’re taking classes or attending university. If you’ve made updates to your home or vehicle in the last year, you may also consider solar and electric vehicle credits. And, due to tax law changes, you may want to review what’s different in credits for 2019.
  • Have you sold or will you be selling assets at a gain — or a loss — this year? Consider and plan how to strategically use these capital gains or losses — or offset them against one another. Expecting more losses than gains? In 2019, you can offset up to $3,000 in ordinary income with capital losses. If your losses add up to more than $3,000, you can carry them forward into future tax years.
  • Take advantage of employer-sponsored benefits paid with pretax dollars (remember my love for HSAs?). When you pay with pretax dollars, you can get more bang for your buck while reducing your tax liability. If you’re wondering about the order in which you may want to fund these accounts, you can refer to my contribution infographic.
  • Take a look at your last paystub and review your income as well as the tax you’ve paid already. Then, adjust withholding as necessary so you can land on either side of the $1,000 mark come tax time.
  • For workers who joined team self-employed this year, making quarterly estimated tax payments may be necessary. The same is true for those who have income other than their salaries. This can include income from passive business ownership, dividends, interest, or gains from selling stocks or bonds. Paying these quarterly estimated taxes on time can help avoid penalties.
  • Last but certainly not least, in general, avoid taking money from your retirement accounts before age 59½. This can help you stay away from the 10% early withdrawal penalty tax as well as the taxable addition to income such a withdrawal can create.

Further into the future

Compared to your shorter-term tax planning, the big theme with longer-term planning is understanding how your income changes as you age. Consider the average career arc. Most adults go from income acceleration in their 20s and 30s to a peak earning period in their 40s and 50s. Then, as people retire, they tend to move to a pretty significant drop in their 60s and beyond when income begins to match expenses.

  • You may consider timing your larger purchases and donations for the ability to lump itemized deductions. For example, combining charitable contributions into the same tax year can mean a greater benefit. This is especially important when considering the relatively large standard deductions in effect today.
  • Remember your capital loss carryforwards. Understand when and where you can leverage those amounts for a greater benefit.
  • Deferring taxes until retirement via qualified retirement plans on an ongoing basis can not only reduce your taxable income in the short term but also set you up for success in retirement.
  • Life insurance and/or annuities can also help you defer a portion of your income and reduce what you’ll owe in taxes. The added benefits: Providing for your loved ones when you pass away or cashing your policy out during retirement when you’re in a lower tax bracket. The drawbacks: generally, the relatively high costs.
  • Asset ownership usually comes with its tax perks. For example, buying a home as opposed to renting means you could deduct your mortgage interest and property taxes from your taxable income. Plus, if you meet certain qualifications, you can sell your home with no or little taxable capital gain.
  • For those on the verge of moving into a higher marginal tax bracket over the coming years, especially those entering their peak earning periods, reducing taxable income via deductions and adjustments can also reduce tax liability. Deferring income is another way to manage your marginal tax rate.

Tax planning impact

Ready to put the work in throughout the tax year in preparation for that April 15 deadline? If so, it can mean less of a hit or “windfall” during tax time. By approximating your amount due or your refund, you can also keep your finances in check. In turn, you’ll likely be better able to plan for your other expenses — and your goals. The bottom line? You have more control over your cash — plus you’re able to save money and may even be able to legally hand less over to the government. 

To quote Ben again, “an ounce of prevention is worth a pound of cure.” 

Happy tax planning — and happy Independence Day!

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Jason Speciner
jason@fpfoco.com

Jason Speciner is a CERTIFIED FINANCIAL PLANNER™ professional, an Enrolled Agent, and the founder of Financial Planning Fort Collins, a 100% employee-owned and fee-only firm. He is also a member of the National Association of Personal Financial Advisors (NAPFA) and XY Planning Network (XYPN). Since 2004, he has served clients of all ages and backgrounds with unique experience working with members of generations X and Y. To learn more, check out Jason's blogs and see the media he's been featured in.



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There is a minimum initial investment of $100,000 per Strategy:FOCO client household. This minimum can be met via transfer of existing accounts or with new funds. A client household may generally include accounts for a head of household, a significant other, dependents, and any controlled organizations or entities.

Minimums do not apply to inStream proactive financial planning as a stand-alone service.
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$250,000 - $499,9990.90%
$500,000 - $999,9990.80%
$1,000,000 - $1,999,9990.65%
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Financial planning services are ongoing, and include unlimited phone, email, web and in-person meeting and consultation time. Pricing is based on the unique circumstances of each client situation. Generally, there is a one-time plan development fee ranging from $500 - $2,000 and a monthly fee of $150 - $500; cancel anytime. Clients utilizing investment management services with portfolios of $500,000 or more will typically receive financial planning services for no additional fee.
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$250,000 - $499,9990.90%
$500,000 - $999,9990.80%
$1,000,000 - $1,999,9990.65%
$2,000,000 - $2,999,9990.50%
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