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Why Tax Planning Is Essential To Wealth Management

"It’s Not What You Make, It’s What You Keep"

Nobody likes paying taxes. The polling company Gallup has been asking people whether their taxes are too high, too low, or about right since 1956. Not surprisingly, a record number of people feel their taxes are too high. If you’re one of those people, we have good news: part of a comprehensive financial plan includes a multiyear tax plan. This can help you avoid any sudden increase in your tax bill as well as plan your income so that you can keep more of what you’ve earned to enjoy the fruits of your labor.

Tax Brackets and Income Deductions

We begin with marginal tax rates. The first step of tax planning is looking at your financial goals, how much income it will take to meet those goals, and then structuring it so as to fully soak up one tax bracket without stumbling into the higher one. There are also income thresholds to be mindful of to avoid paying the Net Investment Income Tax of 3.8% and any additional Medicare IRMAA taxes. As part of a thought-out tax plan, this can be done by delaying or accelerating payments or obligations. You can use tax-advantaged savings instruments such as IRAs or HSAs to reduce taxable income while saving for retirement and healthcare expenses, respectively.

Beyond the tax rate, we next decide whether to use the standard deduction or to itemize. With the increased standard deduction from the Tax Cuts and Jobs Act, itemized deductions are less appealing. To get the best of both worlds, we often help clients bunch as many taxdeductible expenses as possible into a single year, itemize those deductions, and then take the standard deduction the year after. This approach not only avoids tax obligations (such as the $10,000 SALT deduction) but can also allow you to fund charitable projects you support. If you have a larger than normal tax burden, perhaps because of selling a large asset, a Donor Advised Fund (DAF) allows you to make several years’ worth of charitable donations and claim the deductions this year while the organization receiving the funds will disperse them for years into the future. If you donate securities instead of cash to a DAF, you can avoid paying capital gains taxes on your donation, thus getting the DAF more funds to affect positive change and getting you a lower tax burden.

If you’ve reached the age of Required Minimum Distributions (RMDs) and you’d like to make a charitable contribution that also counts toward your RMD requirement, you may donate a Qualified Charitable Distribution (QCD) up to $100,000 to an approved charity. This allows you to support an organization you care about while deducting the donation from your gross income (keeping you in a lower tax bracket) and without itemizing deductions, meaning you can take the standard deduction while also enjoying the benefits of a QCD.

Investment Strategies

A useful tax planning strategy for people deriving income from investments is to take advantage of the tax benefits provided on long-term capital gains. If you’ve held on to an asset for more than a year, the appreciation on the asset is taxed between 0% - 20% after you sell it, rather than taxed at ordinary income rates, which are almost always higher. If you sell an asset for a loss, that loss can be “harvested” to subtract from the taxes on capital gains, with any losses that exceeded gains able to be carried forward to future tax years.

A larger move you can take if you have a Traditional IRA is to convert it to a Roth IRA. This can offer long-term tax rewards by avoiding RMDs, but you do have to pay income taxes on the converted amount, so choosing the timing of when, if ever, to convert is crucial. Our Wealth Advisors are well-equipped to advise you on this. A multiyear tax plan allows you to coordinate your finances to avoid any sudden tax increases and aim for the lowest tax burden possible. It is an essential aspect of any comprehensive financial plan.

Return to October 2023 Newsletter

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